On this day 5 years ago, the global economic crisis began. The trigger was the decision by BNP to suspend redemptions from funds that were linked to the US housing market. Those of us who had been expecting a debt-deflationary crisis
and warning about it
for some time (see also here and here) could never have picked the trigger itself—that would have been prophecy, not prediction—but very rapidly it was clear that this was it.
BNP’s decision triggered a liquidity crisis in the overnight funds market: suddenly you couldn’t sell a bond to anyone for any price. The flavour of the day is well captured in this piece—published on Banking Day—by Graham Hand, who was then an executive of the State Bank of New South Wales and Colonial First State:
August 9, 2007: “We can’t roll over your paper this morning”
It was the early evening of Thursday, 9 August, 2007, when I received a phone call at home from a Citibank dealer in London.
For many years, my organisation had been issuing short-term notes in the Euromarkets to finance a geared fund, and some notes routinely rolled over almost every night. It was an excellent source of inexpensive funding, sometimes swapping into Australian dollars at below the domestic bank bill rate.
We posted issuing levels at the end of each Australian day and the London dealers could transact at those spreads without further reference. At the time of the call, we had over a billion dollars on issue in Europe, and this night A$50 million was maturing.
“We can’t roll over your paper this morning. There are no bids in the market,” the dealer said.
At first, while unusual, this was not alarming, as pricing levels between issuer and dealer are subject to negotiation and posturing. I asked for more details, and said we were willing to pay a few points more if necessary.
“You don’t understand,” he said. “It’s not a matter of price. There are no bids on anything.”
And that night, five years ago today, the Global Financial Crisis started.
I immediately turned on my laptop, and a quick scan of financial websites confirmed what had spooked the market. BNP Paribas had suspended redemptions on two of its money market funds, and to quote them:
“The complete evaporation of liquidity in certain market segments of the US securitisation market has made it impossible to value certain assets fairly, regardless of their quality or credit rating… We are therefore unable to calculate a reliable net asset value (NAV) for the funds.”
The US sub-prime crisis had come to Europe. The entire billion dollars of notes matured over the following months without a single rollover at any price. If ever confirmation was needed of the merit of diversified funding sources, this was it.
Initially, there was no way of knowing if the crisis would last a week or a year. The remaining $4 billion of our $5 billion borrowing program was onshore Australia, including short-term notes issued into the market, and direct bank lines. These sources proved more resilient for a familiar Australian name, but spreads widened dramatically, and the local note issuing program halved in size.
It’s no surprise that the Australian Prudential Regulation Authority and Australian borrowers have subsequently focused more on building domestic funding bases, while the foreign panic supports the need for a decent retail bond market in this country.
Amazingly, while the debt markets were in turmoil, the equity markets continued to rally for some months. We knew either the bond or the equity market was wrong, but we were not sure which.
I recall talking to a bond fund manager who was gobsmacked by the rising equity markets, as he had sold every stock he owned. The collapse of Lehman Brothers was not until September 2008, over a year later. Hedge funds had plenty of time to short everything they could find, and soon Lehman disappeared, Merrill Lynch was rescued by Bank of America, and the US Federal Reserve bailed out JP Morgan Chase and AIG, which, in turn, saved Goldman Sachs. So much for the free market bastions of Wall Street.
At the five-year anniversary this week, the debt markets are open for good-quality borrowers, but issuing levels remain historically wide.
Major Australian banks issue term deposits at 150 points over the bill rate, a level never seen before.
If anything, the financing problem is even more intractable, as it has spread to some of the (formerly) best sovereign names in the world. While countries can borrow to save their banks, who can borrow to save the countries?
I expect that five years from now we’ll still be trying to sort out the mess.
* Graham Hand is a former executive of the State Bank of New South Wales and Colonial First State. He is the author of the banking history, Naked Among Cannibals.
Article By: By Graham Hand*
Graham’s comment above that “there was no way of knowing if the crisis would last a week or a year” indicates how surprised financial markets were at the time, and how little they understood the dynamics of credit—even though extending credit was their business.
As someone who had discovered Hyman Minsky’s Financial Instability Hypothesis some 20-years earlier, and having realized that private debt had reached unprecedented levels, I fully expected this deleveraging crisis to be measured in decades, as Graham now does.
Today marks the half-way point to the first decade of the Lesser Depression (to use the very accurate phrase Paul Krugman coined to describe it). It began, as I predicted, when the rate of growth of private debt began to slow down. There had been bigger slowdowns in the rate of growth of the debt ratio in earlier recessions—see Figure 3.
But since debt was so much larger relative to GDP than it had ever been before, the slowdown this time caused a dramatic drop in aggregate demand—see Figure 4.
So it’s “Many Happy Returns?” to the economic crisis, and before I consider how many more years it could be with us, it’s time for a laugh. By sheer accident this week I rediscovered the “Monster Crash” put together by the Telephonics 4 years ago, and I’ve yet to find anything else that so well satirises the folly that led to this crisis, and the folly that has followed as largely clueless politicians, bureaucrats and conventional economists insist on replaying the 1930s. Have a listen—the music and the lyrics are priceless.