What did the Fed say or do to cause the deleveraging?

[thriftybob]

If you recall, they raised rates 1/4 point at a time, many, many times, even though the economy basically sucked except homebuilding and associated housing/credit bubble.

IMO, the mistake was creating the bubbles, not popping them...

But, given all the nasty news late 07 into 08, why did commodities peak in June/July of 08? Then crash. Thats the one that I can't understand. CRB index dropped from high 400's to 100's in the deleveraging panic. I'm trying to figure out why that happened or what tells preceded it that I can see if it were to start again.

 

[trendlover]

Quote from thriftybob:

Oil went to $140

Goldman came out with a $200 number

Gas prices were going to the moon

And then the deleveraging began...... And the crash.....

I assume the Fed said or did something in reaction to what was perceived as the beginnings of hyperinflation. But I don't recall them saying or doing anything. DOES ANYONE KNOW? OR HAVE A GOOD IDEA?
----------------------------------------------------------------------------------
Go to page 82 in this link. ("Event Logbook")


"In the period August 1–9, 2007, many quantitative hedge funds, which use
trading strategies based on statistical models, suffered large losses, triggering
margin calls and fire sales. Crowded trades caused high correlation across quant
trading strategies (for details, see Brunnermeier, 2008a; Khandani and Lo, 2007).
The first “illiquidity wave” on the interbank market started on August 9. At that
time, the perceived default and liquidity risks of banks rose significantly, driving up
the LIBOR. In response to the freezing up of the interbank market on August 9, the
European Central Bank injected €95 billion in overnight credit into the interbank
market. The U.S. Federal Reserve followed suit, injecting $24 billion.
To alleviate the liquidity crunch, the Federal Reserve reduced the discount
rate by half a percentage point to 5.75 percent on August 17, 2007, broadened the
type of collateral that banks could post, and lengthened the lending horizon to
30 days. However, the 7,000 or so banks that can borrow at the Fed’s discount
window are historically reluctant to do so because of the stigma associated with
it—that is, the fear that discount window borrowing might signal a lack of creditworthiness
on the interbank market. On September 18, the Fed lowered the federal
funds rate by half a percentage point (50 basis points) to 4.75 percent and the
discount rate to 5.25 percent."
http://www.tinbergen.nl/ti-events/tilectures2009/brunnermeier.pdf

 

[Wallace]

while i understand little of what and how the 'financial crisis' occurred i don't believe
the Fed to be directly responsible before or after the event, only another nail
what i believe to have provided the foundation for it all was the -
'Commodity Futures Modernization Act of 2000'
http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000
see also http://en.wikipedia.org/wiki/Panic_of_1907
and, describes some of the 'how' - not a useful title - google to download ppt:
''The Role of Information Failures in the Financial Meltdown''

 

[Martinghoul]

Quote from peilthetraveler:
Dont you hate those jack asses like startraitor & Martainghoul that dont know the answer and try to make you feel stupid for not knowing the answer too?

Firstly, my young friend peil, pls do me the courtesy of spelling my name here correctly (that's at the very least; I am not even asking you to be able to write "jackass" correctly). Secondly, I know exactly what happened, 'cause I was there, right in the middle of it (as I have mentioned in other threads). Finally, judging by your "explanation", you have absolutely no idea what you're talking about.

As to the OP's question, the deleveraging that happened and is still happening had nothing to do with the Fed. There's a lot of ink spilled on the subject, so there's no need for me to go into detail. Barry Ritholtz's book is pretty good and there are a few others, such as "13 Bankers" by Johnson and Kwak.

 

[trefoil]

From my perch what I saw was long-term funding not being rolled over, forcing everyone to fund themselves short-term, which lasted for a while until even that wasn't available anymore once Bear Stearns and then Lehman (especially Lehman) went belly-up, and that of course made all the fun stuff that happened after that necessary.
As Bagehot observed more than a hundred years ago, in a crisis, no one trusts anyone else, and that of course means the entire system seizes up.
The root of it all was mortgages that should never have been made going bad, of course. The Fed was complicit in that to the extent of not adequately regulating banks' exposures, which is part of their job. Of course, the same could be said of all the other banking regulators, in the US and Europe, and the private credit rating agencies.
As a point of info, I know there were plenty of these mortgages that were bought by the Chinese as well as part of the dollar assets they bought to keep their currency fixed. One wonders just how much they lost on that agency debt.

 

[JamesL]

Quote from Gubinec:

Good thread.

Though I've read a lot on the crisis, I was always left with a lingering question.

The root of this crisis was the low interest rate and lack of proper regulation on the big money.

The shit hit the fan when the fed incrementally but quite suddenly raises the interest rate to 6% in a short period of time, causing those millions of people with Adjustable Rate Ms to default, etc, etc, and every other problem spiraling out from then on.

So, looking back, it seems that this crisis could've been avoided had the Fed extended the period of time during which it raises the rate, or never raises it that high at all, and if there were proper regulations in place to avoid the big money messing up.

In other words, lack of proper regulation + ease of borrowing capital = our economy catches a cold. Add in globalization to that formula, and the whole world gets sick along with America.

5 1/4% - Fed Funds rates are what determines mortgages and other consumer related interest products, not discount rate.

http://library.hsh.com/read_article-hsh.asp?row_id=88

 

[trefoil]

Actually, no.
The 10 year bond is what a 30 year fixed will be priced off of, as most people will own their homes for about that time on average.
ARMs will get priced off other indexes.
Fed Funds is an overnight rate, and no one would use that to price a mortgage. So too is the discount rate.
Fed Funds is the rate for overnight interbank lending. The discount rate is the rate you can borrow from the Fed for overnight, and in normal times is of merely academic interest, as most banks won't go to the Fed for money because of the stigma. Generally it's taken as meaning you couldn't get enough from the interbank market, and that's not supposed to be a good sign.

 

[Larson]

Quote from trendlover:

Quote from thriftybob:

Oil went to $140

Goldman came out with a $200 number

Gas prices were going to the moon

And then the deleveraging began...... And the crash.....

I assume the Fed said or did something in reaction to what was perceived as the beginnings of hyperinflation. But I don't recall them saying or doing anything. DOES ANYONE KNOW? OR HAVE A GOOD IDEA?
----------------------------------------------------------------------------------
Go to page 82 in this link. ("Event Logbook")


"In the period August 1–9, 2007, many quantitative hedge funds, which use
trading strategies based on statistical models, suffered large losses, triggering
margin calls and fire sales. Crowded trades caused high correlation across quant
trading strategies (for details, see Brunnermeier, 2008a; Khandani and Lo, 2007).
The first “illiquidity wave” on the interbank market started on August 9. At that
time, the perceived default and liquidity risks of banks rose significantly, driving up
the LIBOR. In response to the freezing up of the interbank market on August 9, the
European Central Bank injected €95 billion in overnight credit into the interbank
market. The U.S. Federal Reserve followed suit, injecting $24 billion.
To alleviate the liquidity crunch, the Federal Reserve reduced the discount
rate by half a percentage point to 5.75 percent on August 17, 2007, broadened the
type of collateral that banks could post, and lengthened the lending horizon to
30 days. However, the 7,000 or so banks that can borrow at the Fed’s discount
window are historically reluctant to do so because of the stigma associated with
it—that is, the fear that discount window borrowing might signal a lack of creditworthiness
on the interbank market. On September 18, the Fed lowered the federal
funds rate by half a percentage point (50 basis points) to 4.75 percent and the
discount rate to 5.25 percent."
http://www.tinbergen.nl/ti-events/tilectures2009/brunnermeier.pdf

Bingo! This was the first warning, few heeded it at the time.

 

[Martinghoul]

Actually, the account above is not quite correct, not from what I recall...

The problems in the money mkts started when a couple of BNP money mkt funds that were invested in all sorts of toxic sh1te suspended redemptions. That happened on the 9th of August 2007. On the 13-15th of August the Canadian ABCP conduit Coventree blew up. Rest is history, as they say.

 

[Random.Capital]

Quote from thriftybob:

If you happen to know of a chronological summary of actions and events posted someplace, that would help a lot.

0. Economy becomes highly leveraged by historical standards
1. Oil goes to the moon
2. $750B times multiplier of US economic activity goes to petro-heaven
3. Slowing growth leads to cascading defaults

Don't really see that the fed has a whole hell of a lot to do with either the cause or the solution.