“… the ongoing assurances of central bank liquidity seem to ensure an eventual crisis beyond the liquidity capacity of central banks”

Doug Noland, one of the few financial analysts that foresaw the 2008 crisis before it happened, this week, in his weekly Credit Bubble Bulletin, “celebrates” the 25th anniversary of the October 1987 crash. The complete article here, some excerpts here:

“Portfolio insurance played an important role in the precipitate sell orders that overwhelmed and helped crash the market.”

“The “twin deficits” were a major concern.”… “Our Current Account deficit jumped to $39bn in 1983, $94bn in 1984, $118bn in 1985, and $147bn in 1986.  By 1987, the U.S. was running quarterly Current Account shortfalls the size of its annual deficit from only four years earlier.”

“I’ve often contemplated where I might “officially” pinpoint the beginning of the prolonged U.S. and global Credit Bubble.  … I’ll instead propose October 20, 2012 as the 25 Year Anniversary of the Great Credit Bubble.   It was, after all, 25 years ago, on the Tuesday following “Black Monday,” that a statement changed history:  “The Federal Reserve, consistent with its responsibilities as the Nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.””

“Federal Reserve largess ensured that fledgling areas of excess throughout the system actually gathered critical momentum.  These included the Drexel Burnham junk bond scheme, the Wall Street “Gordon Gekko” M&A boom, and real estate lending excesses, especially on both coasts. ”

“When that Bubble phase eventually burst in the early nineties, eighties period excesses were referred to as “the decade of greed.”  In the name of fighting the scourge of deflation and depression, the Greenspan Fed responded even more aggressively.  The Fed went from guaranteeing marketplace liquidity to ensuring a steep yield curve (short-term rates pegged significantly below market bond yields).”

“Furthermore, the Fed’s activist policies spurred rampant growth in non-bank Credit, including MBS, ABS, GSE balance sheets, “repos” and Wall Street finance more generally.”

“The Greenspan Fed’s 1987 promise of market liquidity was the precursor for today’s zero rates, the Fed’s almost $3 TN balance sheet, and recent promises of “open-ended” quantitative easing (QE).”

“Especially after the ’87 Crash, the Federal Reserve and other regulators should have moved decisively to nip the derivatives boom in the bud, especially in the area of the dynamic hedging of myriad market risks…  Instead of the Crash destroying this market fallacy, the Fed’s day-after statement validated the view that derivative contracts could be written and risk-strategies pursued on the belief that policymakers would be there to counterbalance market illiquidity and neutralize “tail risks” and system shocks.  This fundamentally changed finance, the pricing and trading of risk instruments, and risk-taking more generally.  The unprecedented proliferation of market risk insurance took the world by storm and played a pivotal role in runaway Credit excesses and associated global imbalances and economic distortions.”

“The Fed’s statement on October 20, 1987 commenced 25 years of serial (and escalating) booms and busts around the world.  We’re nowadays in the midst of “melt-up” Credit debasement, a “blow-off” top in global speculative excess, and complete policy capitulation in hope of holding the downside of the global Credit cycle at bay.  For a few years now, I’ve referred to the “global government finance Bubble” as the granddaddy of them all.  What started as excesses at the fringes of U.S. bank and junk bond finance back in the late-eighties eventually made its way to terminally infect Treasury and related debt at the core of our entire monetary system.  Global excesses, having fueled precarious Bubbles in Japan, SE Asia, Europe and the emerging economies over the years, afflicted China with its estimated population of 1.3 billion.   Today’s historic Bubble phase risks the loss of market trust in sovereign debt.  The current global “inflationist” policy regime risks being completely discredited.  And the historic Chinese Bubble risks a precarious post-Bubble day of reckoning. ”

“Unlike the 80’s and 90’s, there’s no longer any attempt at a coordinated strategy to deal with global excesses and imbalances.  Policymakers have thrown in the towel – and these days have no strategy beyond reflation and Bubble perpetuation.  U.S. policymakers pay little more than lip service to incredible federal deficits.  This, however, is actually more than is paid to the massive Current Account Deficits that have been the root cause of now deep structural global imbalances and economic impairment.  More than 25 years later, our nation’s policy prescription for unmatched global imbalances is even looser monetary policy and added stimulus for all nations, everywhere, all-the-time.”

“And the way I see it, the Fed, ECB and global central bankers today fight a losing battle.  The mountain of global debt, securities, and derivatives, along with this destabilizing global pool of speculative finance, just inflate larger by the year – and after each policy response.  And the more outrageous the policy measures implemented to try to resolve each crisis, the more these desperate measures further inflate the global Bubble.  Ironically, the ongoing assurances of central bank liquidity seem to ensure an eventual crisis beyond the liquidity capacity of central banks.  Happy 25th Anniversary..”


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