In a book called Firefighting – The Financial Crisis and its Lessons written by Ben S Bernanke, Timothy F Geithner and Henry S Paulson published by Penguin Books, NY, 2019. The book offers lessons from a crisis. The 3 authors were the lead news daily in 2008 through 2010 as the financial industry went through losses, destabilization, recession and recovery. The 3 people had to come up with a variety of tools to fight the fires and to allow for recovery. In all industries including finance, regulations are there for the last crisis not the current one. If the crisis is worse this time, the regulations are less effective because all industry change from the last crisis. Finance is always a little different because much of finance is about confidence. Banks lend money, they have to have a level of confidence the counterparty will repay. When the confidence falls, investors run will their money to something safer. When money goes to something safer, it effects regulatory levels.

Not surprisingly, the 3 authors noted the system is more complex than ever and when they tried to do something, they quickly realized the tools in the toolbox were not sufficient for the job and needed to persuade politicians to give them better tools.

In the spring of 2007, it was clear the housing boom was over and the subprime mortgage market was tanking. But other economic indicators were good such as job market was still strong and bank capital levels seem strong.

Our assumption that the carnage in subprime would bring some healthy discipline to a chaotic sliver of the credit markets without much broader damage seemed reasonable, given what we knew at the time. We did not foresee how the complexity and opacity of mortgage-backed securities would lead creditors and investors to run from anything and anyone associated with mortgages and not just subprime mortgages. Fear turned into panic. Subprime was a problem, but it would have been a problem just for subprime borrowers and subprime lenders. More than 50% of the US housing losses would happen after the failures and near-failures of September 2008. Without the panic, the problems would have been contained. Fear turned those sparks into an inferno.

Crisis do not announce themselves as either small brush fires that will burn themselves out or systemic nightmares with the potential to burn down the core of the financial system. Policymakers need to figure it out as they go along.

The first phase, the Policymakers said no to providing help and the Federal Reserve responded the traditional manner by injecting liquidity into the market. Treasury had very limited financial authority, most of the early action came from the Fed. The injection of liquidity is known as the discount window – it allows a commercial bank facing a cash crunch to access money to meet withdrawals by private creditors without having to sell assets in a fire sale.

Countrywide Financial, a $200 billion firm that originated 1 of every 5 mortgages in 2006. It was also overreliance on lower-quality mortgages and relied on short-term financing. Countrywide issued commercial paper and used repo financing. The policymakers forced Countrywide to draw down its credit line, upgrade its collateral and be sold to Bank of America. The troubling signs the policy makers saw was the $1.2 trillion commercial paper market and $2.3 trillion repo market could be vulnerable to runs.

The next step was to force all the banks to raise capital by selling equity to sovereign wealth funds in Middle East and Asia.

The TAF (Term Auction Facility) a program designed to overcome the stigma of the discount window by lengthening the terms of the loans but actioning them to eligible banks, rather than lending at a fixed rate.

The TSLF (Term Securities Lending Facility) an innovative program that would extend liquidity to nonbanks, allowing nonbanks, including 5 major investment banks, the ability to swap less liquid for more liquid collateral.

When Bears Stearns, the country’s 17th largest institution ran into problems as its cash reserves fell from $18 billion to $2 billion in 4 days, the policymakers had a problem there was a limit to what they could do. The Fed was limited to lending against solid collateral; Treasury need congressional authorization to do more; neither the Fed or Treasury had the powers to guarantee obligations, invest capital or buy illiquid assets to stop a run on a bank. The Fed did not have a standing facility to help an investment bank, it dealt with banks. The solution was for the Fed to lend $30 billion to Maiden Lane which would buy $30 billion of securities from Bear so JPMorgan Chase could buy Bear for $2 a share, down from $130 a few weeks earlier.

The good news for the Fed, since it lent to Bear, it had access to the power to examine the other large investment banks books and run stress tests. It was not good news, all were vulnerable to runs and the Fed pushed all firms to increase their funding or raise capital.

In a crisis, the policymakers must have an attitude to do whatever it takes. We all felt extraordinary times justified extraordinary actions. This lead to the nationalization of Freddie and Fannie. They had hoped it would show the markets that the government was willing to prevent chaotic failures and the result would calm the markets. The markets concluded there was more uncertainty and would happens if a business does not have federal charters? Fear continued.

Linking to dividend paying stocks, one of the reasons you invest in these stocks is they have been through many economic cycles and they have cash and credit in the bank. This credit allows when a sector or competitor has a crisis, they can buy assets at reduced prices and merge them into the company to produce continuing profits. Crisis happen, companies will the ability to access credit can capitalize on it, but only if it has been through the business cycles. As investors, hopefully the crisis does not affect you, but your company can broaden its size and scope at low prices. In the last crisis what did the company do?

There are more questions than answers, till the next time – to raising questions.