(Dan here…posted a day later)
The Financial Crisis Tenth Anniversary
Yesterday, August 9, is being widely proclaimed as the tenth anniversary of the beginning of the financial crisis that fully crashed in September, 2008, with the recession that began at the end of 2007 plunging more profoundly and widely after that. The specific event on August 9, 2007 was the limiting of withdrawals from US mortgage backed hedge funds by the BNP Paribas bank in Paris. In a post yesterday, one of the leading analysts and prophets of the crisis, Dean Baker, noted that BBC erroneously claimed that housing prices in the US began falling after that date, when in deed Dean accurately notes that it was the decline in housing prices starting somewhat earlier that led to this action by BNP Paribas ten years ago.
As one of those who analyzed what was going on better than most and with better timing, I link to my post of July 11, 2008, which analyzed what had been happening and forecast a full-out crash coming soon, which indeed occurred a bit over two months later. The title of that post is “Falling from the Period of Financial Distress into the Panic and Crash.” I note that the unpublished paper I cited in that post by me with Mauro Gallegati and Antonio Palestrini, “The Period of Financial Distress in Speculative Markets: Interacting Heterogeneous Agents and Financial Constraints,” was finally published in Macroeconomic Dynamics in Feb. 2011, vol. 15, pp. 60-79. A few comments now.
1) Regarding the matter of the housing market bubble, everybody, including Dean Baker, always cites the numbers provided by the Case-Shiller index of housing prices in the 10 and 20 largest municipalities. This is indeed an excellent source, but it is not the only one, and it is arguably biased because of its focus on large metropolitan areas. A much broader index is that estimated by the Federal Housing Finance Agency. Whereas the Case-Shiller index peaked around June, 2006, the FHA one peaked in January, 2007, over a half year later. The FHA index is arguably more representative of the broader market, although it is probably true that the worst of the speculative markets and crashes were in larger metro areas, with declines in some of those already at down 10 to 12 percent by August, 2007, as Dean accurately notes in his post. But even now I rarely see anybody citing the FHA index, with the occasional exception of Calculated Risk.
2) Regarding the behavior of the Fed in the crash, Dean is right to pound on them not getting that the housing bubble was a problem and that the decline from its peak was a problem threatening a recession, indeed a major one, although they were clearly getting worried after the beginning of the period of financial distress ten years ago, especially as mortgage financiers began going belly up one after another. As it is, the one person at the Fed who seems to have seen the danger earlier than any other, although she was overruled and later went along with some of the Pollyanna policies, was Janet Yellen. Needless to say, I have praised her forecasting abilities on several occasions, and she was calling the housing bubble from 2005 on.
3) In terms of the behavior of the Fed at the time of the crash, there had been some preparations for it, mostly by people at the New York Fed, and indeed the various alternative entities the Fed rolled out temporarily after the hard crash were cooked up in advance by them. However, the most important thing the Fed did remains widely unknown and unadvertised, although I have posted on it previously, and it has been publicly reported on, it not on front pages anywhere ever. That would be the half a trillion dollar save the Fed did for the European Central Bank, taking a bunch of very bad assets onto the Fed balance sheet, which were then gradually and quietly rolled off over the next six months to be replaced by Mortgage Backed Securities. The euro was crashing, and the ECB was facing the threat that both BNP Paribas and Deutsche Bank were in danger of failing. This was the immediate danger that could have led to a full blown global financial crash of a 1931 level or worse. This save was probably the most important thing the Fed did to keep the crisis from bringing about another Great Depression, although it remains not well known, partly because both the Fed and the ECB did not want it advertised. A good account of this can be found in Neil Irwin’s book, _The Alchemists_.
There is so much more I have to say about all this, but these are a few items that either were not well known at the time or have been largely forgotten since.