10 Years Ago Today Money Markets Seized Up, The ECB Bailed Out BNP Paribas, And The Crisis Started

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by Tyler Durden
Wednesday, Aug 09, 2017 - 9:35

On this day 10 years ago, money markets started to seize up, requiring heavily-coordinated central bank action that launched an extraordinary period of central bank activity that is still in full swing today.

As DB's Jim Reid reminds us, the announcement by BNP Paribas that they were closing three funds linked to US mortgages became the catalyst for the collapse of trust in money markets over the coming days and weeks. Just over a month later we had the bank run on Northern Rock. As an example of the impact BNP's announcement had - and how rigged Libor had been throughout the days preceding the crisis to telegraph stability - 3 month dollar Libor, which hadn't moved all year, spiked 20bps in the ensuing 48 hours. Also on this day 10 years ago all the major central banks were forced to inject liquidity, with the ECB doing so for the first time since 9/11, effectively ushering in what would later become known as the Great Financial Crisis.

As Bloomberg continues this less than marry stroll down memory lane, the ECB's €95 billion emergency loan to banks on Aug. 9, 2007, "was the initial response to a financial crisis that would force the Frankfurt-based institution to expand its balance sheet by trillions of euros."

The ECB - together with international peers such as the Federal Reserve and the Bank of England - took center stage in an unprecedented battle against bank failures, recessions and sovereign-debt turmoil that changed the economic landscape and forced a complete rethink of what monetary policy can and should do.

Here is the blow by blow of events on that fateful day: on August 9, 2017 years ago, ECB President Jean-Claude Trichet was in St. Malo, northwest France, for a sailing holiday when the U.S. subprime crisis reached Europe in full swing, forcing French bank BNP Paribas SA to halt withdrawals from three investment funds. Using faxes and telephones, he and his colleagues crafted the central bank’s response - a statement that officials were monitoring money-market tensions, followed by a pledge to lend financial institutions as much money overnight as they asked for.

Demand for the so-called fine-tuning operation exceeded the 69.3 billion euros given on the day after the Sept. 11 terror attacks. The ECB made three similar offerings in the days through Aug. 14.

However, in a harbinger of the difficulties it would face in the coming years, the ECB’s would be hampered by an incomplete currency zone weighed down by infighting and paralysis. Ironically, just days earlier then presidents of the ECB, Jean-Claude Trichet, and BOE, Mervyn King, had their own "subprime is contained" moment:

Trichet had warned of a repricing of risks since 2005, but in the summer of 2007, he didn’t heed the signs of trouble, and neither did his peers. Just one week earlier, the Frenchman had summoned the press to an impromptu briefing to telegraph that an interest-rate increase was imminent. Mervyn King, Bank of England governor at the time, was also sanguine, declaring on the day before the market turmoil struck:


“So far what we have seen is not a threat to the financial system,” he said. “It’s not an international financial crisis.”

It was - and it turned out to be the biggest international financial crisis in history. And Looking back exactly one decade later at what this day unleashed, James Nixon a former economist at the central bank, who now works for Oxford Economics in London said that “the ECB has literally thrown the kitchen sink at the crisis,” adding that “they are deep, deep into non-standard monetary policy, and getting back from there is a process that’s going to take a decade. It’s going to be extraordinarily protracted.” One look at the chart below shows how deep inside bizarro world the central bank with the negative interest rates has gone:

For those traders who were active at the time, and who enjoy visual trips down the memory hole, here are ten charts from Goldman recapping the ten years of the crisis:

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Ten years on, Bloomberg adds, as the world’s central banks slowly unwind the unprecedented stimulus their economies came to rely on, the ECB is a different institution... or so it would like to believe.

Policy makers of the old school have been replaced by a new generation, Trichet’s insistence to never pre-commit gave way to Draghi’s forward guidance, and the Governing Council’s remit was expanded to include banking supervision. Draghi, who took over the ECB baton from Trichet in late 2011, may signal his future course of policy in Jackson Hole, Wyoming, where he will attend the Fed’s annual symposium on Aug. 24-26.

Looking optimistically ahead, "with the recovery finally holding up after years of stimulus and hard-fought economic reforms", Bloomberg writes that central bankers have started to contemplate a return to more normal policies. One of many milestones on that path is expected in the fall, when ECB President Mario Draghi may offer an outline of a gradual exit from a 2.3 trillion euro bond-buying plan.

This will take place at a time when the market is habituated to not only ultra-low interest rates, but over $10 trillion in asset purchases by central banks over the past decade. Whether it will work remains to be seen.

And while we wait for the climax to the greatest monetary experiment in human history, Jim Reid notes that one of the great ironies of the period since is that returns in major global assets have been very healthy albeit with some major exceptions.

Of the 38 major global assets we usually track for this purpose 27 are higher and 11 lower in dollar adjusted terms. Top of the pack is the S&P 500 (+106%) followed by US HY (+95%) and Gold (87%). Other DM fixed income markets are generally in the 35%-80% range. The Dax (+38%) leads the way in an underperforming European equity story. The Stoxx 600 is up 22% and the FTSE 100 only 12% higher in Dollar terms largely due to a 36% fall in Sterling over the period. Of the 11 assets that has seen negative dollar returns over the last 10 years the highlights are Greek equities (-82%), Stoxx Euro Banks (-54%), Portuguese equities (-42%), the CRB commodity index (-42%), Italian equities (-33%), and Oil (-32%). EM equities were up 29% but Chinese (-2%), Brazilian (-26%) and Russian (-32%) bourses were selective under-performers.

Ironically, as even Deutsche Bank admits, while there has - so far - been little economic impact from this unprecedented decade of central bank interventions, with central banks lamenting daily the lack of (wage) inflation, so critical to erase the record $217 trillion in global debt...


... this unprecedented takeover of capital markets by central planners has led to record asset price inflation over the last decade, even if it hasn't been universally seen across the board.

"There have been clear winners and losers" Jim Reid notes, and asks "were you the one who during late afternoon on August 8th 2007 decided to switch out of their portfolio of Greek equities to buy the S&P 500 and then go on a 10 year sabbatical? If you were then I have nothing but respect, admiration and jealousy towards you. If you did the reverse trade then I suspect you might not be reading this now but you have my sympathies!!"

Finally, when previewing the question of what we will be writing about on August 9, 2027, the jury is still out: as UBS chief European economist Reinhard Cluse writes, “If you look at all the pain which the ECB had in rolling out these facilities - the crises, the politics, the time it took them to start QE - perhaps this was also necessary in the ECB’s growing-up process. But now that these policy tools have been invented and implemented, the effect could be that in the future - even after having normalized - we will reach for these instruments again and that they might not have been as extraordinary as we once believed them to be.”

Reach for them we will, and if this time they fail to achieve the same "stabilizing" results which have come at a tremendous cost to efficient markets, then our expectation that we will be writing on this day ten years from today, may prove to be overly optimistic...