On The Fed's 2007 Transcripts, Geithner's Leak, ABX Charts, and Gold Backed Money

The Fed released its 2007 transcripts for the history books. First, it's interesting that the Fed didn't have presentation slides on the ABX index, the subprime mortgage-backed security credit default swap index, until March 2007. On March 20-21, 2007, the Federal Open Market Committee's presentation materials included charts of ABX 06-2 BBB-, ABS CDS BBB- and Cash ABS BBB- spreads, as well as a chart showing every index in the ABX-06-2 series (via William Dudley, now NY Fed President). In the same PDF, former Fed official Vincent Reinhart put up a chart of 'Subprime Mortgage CDS Index Spreads' (A vs. BBB-). So they started to look at the most important measure of credit risk (and ultimately asset collapse risk) at approximately the wrong time, which ultimately led to hyper-deleveraging and the collapse of the financial system. The second chart was titled "Spread Widening Begins in ABX, then CDS, and Finally Cash".

Source: Federal Reserve (3/21/2007 - they should post the "presentation materials" with the minutes)

So it was already too late. The last billion dollar CDO deals were closed in the first half of 2007 before blowing up. The infamous $2 billion ABACUS synthetic CDO that Goldman sold to hedge fund Paulson & Co. (CDS) closed on April 26, 2007, three months before the two Bear Stearns credit funds blew up in July 2007. The ABACUS synthetic CDO lost $1 billion by January 2008 (read the GS/ACA/Paulson SEC case) and Bear Stearns got bailed out in March 2008 (see: Money, Power and Wall Street, Inside the Meltdown).

The Fed had no clue that investment banks, AIG, CDO managers, and mortgage arbitrage hedge funds were in the process of destroying the financial system and economy in hidden over-the-counter markets (articles at Propublica: 'The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going'; 'The ‘Subsidy’: How a Handful of Merrill Lynch Bankers Helped Blow Up Their Own Firm'). This is why all of these mortgage bonds and OTC derivatives need to be on exchanges. If nothing changes, these illiquid opaque markets will just get hijacked again by the same financial institutions. At least you can now track charts of consumer credit default rates and sector CDS spreads at S&P Indices. In an unfortunate move, Bloomberg.com took down all of their corporate and sovereign CDS quotes and charts.

Was the Federal Reserve seriously not monitoring the MBS CDS market before March 2007? The FBI said there was a "mortgage fraud epidemic" on September 17, 2004. Isn't the Federal Reserve supposed to be the most powerful, all-knowing financial institution in the world? We should have gone back on the gold standard in the late 1990s. Yes, the Fed backstopped the financial collapse in 2008-2009, but I'm thinking the financial crisis never would have happened if Alan Greenspan didn't lower the federal funds rate to 1% in 2003-2004 and we had gold backed money. Also, if anything happens to the OTC derivatives market, which has a total notional dollar value in the hundreds of trillions, the Federal Reserve would backstop that market (aka the banks again) as well.

Here is Jim Cramer saying the Fed knew nothing in 2007 (h/t NetNet with John Carney, Business Insider).

Lastly, if it's true that former New York Fed President Tim Geithner (now Treasury Secretary) and others at the Fed leaked sensitive interest rate decisions to bank CEOs in 2007, it was seriously one big inside job of failure. In the August 16, 2007 transcript, Richmond Fed President Jeffrey Lacker asked Tim Geithner if he told Ken Lewis about the upcoming discount rate cut.

"MR. LACKER. I have a question for anyone from the New York Bank or Governor Kohn. What do people expect banks to do in response to this? In particular, do we have an expectation or have we gotten information in New York or in Washington that any banks will make a particular announcement about the types of interventions they intend to undertake in these markets? If so, are those announcements going to say anything about us?

CHAIRMAN BERNANKE. Vice Chairman Geithner, can you respond?

VICE CHAIRMAN GEITHNER. Thank you, Mr. Chairman. Just to start a little further back, since the operations and the statement by the Board last week, we have—as you have, I’m sure—received a lot of questions from a range of market participants about what the Desk can take and what it’s not able to take, what is the law, what is discretion, and a whole range of questions around the discount window, too. Those questions reflected a range of interests from a bunch of institutions in thinking whether there are ways in which, if somehow the stigma were reduced for coming to the window, they might be able to take advantage of that source of liquidity and act so that the help might relax some of the constraints in other markets. They have informed us that they are contemplating making an announcement tomorrow—in fact, I think they were prepared to do it earlier. They are thinking about coming in and announcing that they would consider buying substantial amounts of specific types of highly rated asset-backed paper. Although they had lots of clarification about what is permitted now under current policies at the discount window, they obviously don’t have any idea that we’re contemplating a change in policy or what might be possible and what we might say or not say going forward. They obviously can’t and understand that they can’t say anything about us. They might say that they’re prepared to take advantage or make appropriate use of their access to the discount window in this context. I think that they’re searching for something that, again, would help reduce the risk by that act—which, of course, they can do now or could have done over the past ten days or so—and that will reduce the stigma associated with it. I have been interested in hearing from them whether doing so would, in effect, change their behavior in a way that might be helpful to confidence in markets now. That’s the extent of what I think is relevant from those conversations.

MR. LACKER. If I could just follow up on that, Mr. Chairman.


MR. LACKER. Vice Chairman Geithner, did you say that they are unaware of what we’re considering or what we might be doing with the discount rate?


MR. LACKER. Vice Chairman Geithner, I spoke with Ken Lewis, President and CEO of Bank of America, this afternoon, and he said that he appreciated what Tim Geithner was arranging by way of changes in the discount facility. So my information is different from that.

CHAIRMAN BERNANKE. Okay. Thank you. Go ahead, Vice Chairman Geithner.

VICE CHAIRMAN GEITHNER. Well, I cannot speak for Ken Lewis, but I think they have sought to see whether they could understand a little more clearly the scope of their rights and our current policy with respect to the window. The only thing I’ve done is to try to help them understand—and I’m sure that’s been true across the System—what the scope of that is because these people generally don’t use the window and they don’t really understand in some sense what it’s about.

Zero Hedge showed that S&P futures spiked a few hours before that meeting. The FOMC announced a 50 basis point cut in the discount rate the next morning. Crazy times.

Related blog posts and articles:
Fed official alleges Geithner may have alerted banks to rate cut (Reuters) *w/Lacker's statement
Presenting The S&P500's 50 Point Surge Courtesy Of The Illegal "Geithner Leak" (Zero Hedge)
Jim Cramer Was Right—They Knew Nothing! (CNBC NetNet with John Carney)
2007 Fed Not As Informed About 2008 As 2013 Critics (DealBreaker)
Records Show Fed Wavering in 2007 (WSJ)
Days Before Housing Bust, Fed Doubted Need to Act (New York Times)
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