A decade ago, the financial world was alive. I don’t mean alive in the same way much of humanity was at the fall of the Berlin Wall or on VE Day in 1945. Rather, people at that particular moment had their eyes pulled opened just a bit for the first time in a very long time, maybe in the same way as an animal startled to realize that it is potentially prey. The burst of adrenaline not drawn from joy but instead terror.

Ten years ago this weekend, on Monday, January 21, 2008, the FOMC members and staff gathered at their various far flung locations spread across the United States to participate in an emergency conference call. It’s hard to go back in time to that point, to relive the conditions of early 2008 without having them colored after-the-fact but what eventually followed.

It was this call that perhaps began the crisis at least in the official sense. A little over a month before it (December 12, 2007), the Federal Reserve along with four other foreign central banks announced dollar swap lines (and still people didn’t get the sense this was an overseas dollar issue?). The FOMC had also voted for short-term liquidity, the Term Auction Facility (TAF), first offered on December 17 for a then-unheard of sum of $20 billion.

These were big things at the time,, radical departures from all prior experience; dollar swaps and extraordinary liquidity? At $20 billion? If you didn’t know something was really up before, there was really no other way to take it following. Things were just getting serious.

And there was two ways to take all that. There was the Greenspan way, the idea of sound policy being designed and adopted by capable technocrats responding rationally to the irrationality of emotional markets (toxic waste). On the other side, there was the less appealing idea that the Fed was at best way behind the curve, at worst way in over their heads.

On January 21, a holiday no less (MLK), the FOMC less than a month (December 21, 2007) after extending its TAF auctions into the foreseeable future and just two weeks after raising the allotment to $30 billion (January 4, 2008), the FOMC felt it had no choice but to do even more. Despite their efforts to that point, described in the media as considerable, conditions were still deteriorating.

What worried the Fed then wasn’t just subprime and OIS spreads. They were starting to see spillover, the one thing Bernanke had previously promised wouldn’t happen (subprime is contained). The economy for the first time (to them) appeared to be heading toward more serious trouble even though the Fed’s models at that moment still didn’t foresee any, even a mild recession. Long infatuated with stocks, the committee couldn’t help but notice the sharp selloff and what, for them, it might mean.
From the January 21 call transcript:

DUDLEY More important, the macro outlook and broader financial market conditions have continued to deteriorate quite sharply. The S&P 500 index, for example, fell 5.4 percent last week; it is down almost 10 percent so far this year. Today it fell another 60 points, or 4.5 percent, so that means that the cumulative decline in the S&P 500, if it opens near where the futures markets closed today, will be nearly 15 percent since the start of the year.

As I wrote above, this was the first time in the policy sense that the crisis had become something more than a niche issue with securitization and off-balance sheet exposures. It was now a system-wide alert.

To address the very broad dangers then being presented to them, the FOMC on that conference call was asked to vote affirmative for an emergency and extraordinary 75 bps cut to the federal funds target. This was even though a regular FOMC policy meeting was scheduled only nine days later. Chairman Bernanke practically pleaded for it:

CHAIRMAN BERNANKE We are currently at a very critical juncture. We are being watched very carefully. We have to demonstrate our willingness to address these very, very serious risks. I think we ought to go ahead and take this step, and I hope that you can support this action.

Despite some serious and legitimate reservations (being perceived as “trigger happy” and in service to the stock market), the vote was unanimous.

Then, at the regular meeting on January 29 and 30, 2008, the FOMC voted for another rate cut, this time 50 bps. In less than two weeks, the Fed had cut its federal funds target by a whopping 1.25%!

Despite mainstream descriptions of such “powerful” accommodation and those together being a “profound” statement of monetary commitment, things only got worse. The further deterioration culminated in the middle of March 2008 with the technical failure of Bear Stearns. It was a considerable and shocking blow to the system.

But it also seemed to represent a termination of sorts. Bear went down, absorbed by JP Morgan for $2 per share, and then things seemed to get better. For quite some time, it really looked like that failure would mark the low point in the affair; so much so, that officials, including Ben Bernanke, began to talk about everything in that way. They would be from there cautious but clearly optimistic.

At the June 24, 2008, FOMC meeting, Janet Yellen described the general mood:

YELLEN. The strong incoming data on spending eased my fears that we are in or are approaching a recession regime of the sort embedded in the last two Greenbooks. However, given the numerous large and worsening drags on spending, a couple of months of data aren’t enough to convince me that we are on a solid trajectory…

KC Fed President Tom Hoenig was more relieved if not upbeat, a feeling that prevailed at many times during the crisis even before Bear.

HOENIG More broadly, turning to the national economy, I have revised up my growth estimate for the first half of 2008, but it has made little change in my longer-run outlook. Compared with the Greenbook, I see somewhat stronger growth in the second half of this year and somewhat weaker growth next year and in 2010. I continue to judge that the potential spillover effects from the financial distress have understandably been overestimated in this Committee’s recent decisions and in Greenbook forecasts in recent months. [emphasis added]

In hindsight, Hoenig’s comment is downright hideous (overestimated, really?). At the time he made it, however, there did appear to be some basis for it. Many markets had remarkably improved between the failure of Bear Stearns and early summer 2008. Stocks that had so worried the FOMC in January looked to be on the road to recovering rather quickly.

Repo fails, spiking to incredible, unbelievable levels, eventually calmed right back down to normal after a month.

The bond market appeared to be into it, too, and in a big way. By the time Hoenig and Yellen were voicing their more solid sentiments that June, the 10s had retraced all the way back to 4.25% (BOND ROUT!!!). It was a rebound of nearly 100 bps above in yield the lows set on the dreadful Bear Monday in March.

In fact, at that particular point, long treasury yields had moved higher on the year.

Even GDP staged a comeback. On July 31, 2008, the BEA reported in its advance estimate that Q2 2008 real GDP growth was +1.9% after rising +0.9% in Q1 (the BEA has since revised Q1 2008 GDP much, much lower, all the way to -2.7% and further illustrating why you shouldn’t rely on a single indication or even statistic).

It really did, for many, seem like the world had dodged a bullet. There was some reasonable case to be made that the world was about to get a whole lot better, perhaps go right on back to growth as if “toxic waste” was nothing and Bernanke’s statement about it being contained was the right one after all. It was a market verdict as much as one drawn from inference and interpretation of economic statistics.

We all now know what came next. They were wrong, all wrong.

I bring all this up not to try to portray officials sympathetically, quite the contrary. They should have known better because other more important market indications, the weirder more esoteric stuff, were all screaming that the foreign parts of the system in particular were still experiencing tremendous strain and stress.

Markets are not efficient. They aren’t. It might be more palatable to say our ability to interpret market prices is often limited, biased, and obscured by human tendencies. That much has been proven time and again especially the last 10 years. Therefore, it is useful to periodically review these past cases, what happened during the worst to re-establish expectations if nothing else. There is often (much) more going on than any single or several market prices and trends can digest and divulge. 

Nobody has a crystal ball, so there is no such thing as a guarantee. Markets price out probabilities because of that intrinsic blindness. They can move often to extremes even when nothing of substance really changes. It was like that in the middle of 2008, where for a brief moment a lot of them moved toward the positive if for no other reason than determined disbelief; especially about the Fed and the utterly abhorrent possibility its officials had no idea what was going on or what to do about it (the truth).

Given the legacy of the maestro, and the heavy, heavy (so-called) accommodation Bernanke’s committee eventually unleashed early on in 2008, it all just had to work. Thus, in the natural ebbs and flows of complex systems, it’s not difficult to mistake a pause for an end.

When I write that nothing ever goes in a straight line, it isn’t meant to be bland cliché or some rhetorical flourish. It is the literal truth about everything, even the Panic of 2008. Markets will challenge your beliefs and all your assessments/opinions at some point, you can count on it – just like you can count on them doing so quite compellingly if not convincingly.

Would it have been easy in June 2008 to see the 10s breaking above the high for the year, then topping 4.25%, and conclude the worst was behind? Yep. As late as August 6, barely a month out from Lehman, the 10-year was still holding above 4% just as everything really started to crash all around.

There always has to be emphasis on corroboration and broad consistency, to start with and piece together a more global or holistic view of conditions (such as curves, curves, and more curves). Outliers are appreciated. Without all that it’s easy to fall in love, or hate, with a single market or market price.