Dow in September 2008 - down 12.07% from Sept 1 high to September 18 panic low
Whispers are beginning to come in as to what exactly happened to our financial system during the chaotic weeks of September 2008 – especially the week of September 15th, 2008. What is emerging is a picture of an economic state that almost ended up in what would have really been a second 1929 in terms of losses and in terms of the sort of immediate impact it would have on America. The day that almost lived in infamy was September 18th, 2008. On that day, if one source in particular is to be believed, the American financial system was quite literally hours away from collapse. Some events swirling around this day back this up, others are nearly indistinguishable from the wild volatility that dominated that month. This post will be an attempt to analyse what was going on during that period of time to at least give this some back story, as the comments drift around the internet to reactions of “…woah”.
We’ll start with the video in question…
That is Rep. Paul Kanjorski (D-PA) on C-SPAN talking about the upcoming second round of bailouts for the banking system and the economic stimulus package that is currently making its way through Congress. A caller had, in essence, asked about how bad things really had been the last time a bailout was proposed – which would become the Troubled Asset Relief Program – TARP. The basic premise of the plan, whether or not it would work, would be to “unclog the system” and get lending flowing again between banks, which various reports had hinted as all but coming to a dead halt. While it was generally understood that the situation was bad, the full extent was never really known until potentially now.
The following ominous quote occurs at about 2:20 in the video:
On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous draw-down of money market accounts in the U.S., to the tune of $550 billion was being drawn out in the matter of an hour or two. The Treasury opened up its window to help and pumped a $105 billion in the system and quickly realized that they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts and announce a guarantee of $250,000 per account so there wouldn’t be further panic out there.
If they had not done that, their estimation is that by 2pm that afternoon, $5.5 trillion would have been drawn out of the money market system of the U.S., would have collapsed the entire economy of the U.S., and within 24 hours the world economy would have collapsed. It would have been the end of our economic system and our political system as we know it.
September 2008 was the death of Lehman Brothers
That quote really caught my eye. I did a little digging to figure out just where we were that week, since so much has happened since then it’s easy to forget.
After a weekend of panic and negotiations arranged by the U.S. Federal Reserve, it was decided that Lehman Brothers would be allowed to go bankrupt and pretty much disappear from the financial landscape. At the start of the month you could have bought Lehman Brothers for $17.53 per share. By September 15th, the day the company went bankrupt, the stock traded at $0.15. By the near-panic of September 18th the price had fallen to $0.05 – a decline of 99.71%.
AIG failed the same week as Lehman
As if this wasn’t enough, insurance giant American International Group (AIG) also failed the same week – which brought the concept of “systemic risk” into the market – meaning that something unstoppable was upon us.
The death of Lehman combined with that “systemic risk” fear to produce another result, however. As the financial world saw that governments would not endlessly bail them out, they all at once became much more frugal with their lending – to the point at which lending all but stopped. Just because lending stopped doesn’t mean that people needed money, however. If what Mr. Kanjorski said is true, this all came to a head on the morning of September 18th, with what probably started as a fairly steady flow of withdraws from these money market accounts. Money market accounts, for those who don’t know, basically are savings accounts with a relatively high interest rate that do not require notice for withdraws. In the end, this was money in the banking system – the same banking system you and I use.
So as this flow worsened, banks probably contacted the Federal Reserve for help. The Fed was probably overwhelmed by the number and dollar size for the requests, and was quite concerned when $105bn dollars in a matter of hours wasn’t enough to help stem the tide. A panic was upon us. Exactly how long would it be before the public found out about the massive withdraws and began taking part in it theirselves? Exactly how long would it be before a customer went to a bank, asked for their life savings, and would be told “we can’t withdraw this amount at this time”. What then?
Citigroup from September peak to September 18 panic-low: -38.66%
One of the things that probably saved us at that moment in time is that these funds were being taken out electronically – no lines outside of banks, nothing for the news cameras to look at. The evidence of something extremely wrong was, however, becoming very visible in another place – the stock market. What were bank stocks that were taking a beating because of the prevailing economic news suddenly found the floor ripped from under them, with a state of near panic-selling arriving as the prices in these extremely large corporations began moving by 10 – 20% per day, more to the downside than up. Citigroup, at left, lost almost 40% of its value from September 8 to September 18th. As stocks like these fall, those who are losing money must cover for it somehow – this is accomplished by selling other stock or perhaps withdrawing their own funds from these money market accounts – thus making the situation worse and bringing systemic risk into play.
Goldman Sachs from September peak to September 18 panic-low: -49.95%
Even seemingly-to-this-day correctly run Goldman Sachs and companies of a like calibre were getting absolutely destroyed – with that company losing almost 50% of its value in the same period of time as Citigroup.
It is entirely possible that if nothing was done that day or the next, the market would have had a 1929-style crash, perhaps to the same level the dow is at today (7,888). Assuming the Dow kept its same opening price on September 18th (10,609.69), a decline of that magnitude would have been 2,720.81 points, or 25.64%. Per the rules at the New York Stock Exchange, the entire stock market would have been forced into a midday close for an hour once falling 10%, and another hour once falling 20% – depending on the time.
The news headlines that Americans would have come home to that night would have done nothing but instilled massive amounts of fear in the public for the next day. With the stock market down almost 26% and the root cause being massive runs on the banks by mostly rich people, would Americans have begun lining up at ATM machines that night and banks the next morning? How many people would have taken the day off of work to go stand in line at the bank to try and withdraw their life savings? Assurances from the government that the FDIC insured deposits to (then) $100,000 would have offered little comfort as the somewhat obscure nature of the rules for money market accounts (for the average person) would have made one think “if the rich are getting out, I’m sure not going to be left behind!”.
None of this happened. The Dow did not mark a 2,720 point decline – it instead only got down 205.91 points (1.94%) before rocketing for the next three days to the tune of 10% – as the sudden announcement from the Federal Reserve of the intent – not the final plan but the intent – to do something about the mess seemed to put a stop to what would have otherwise been a financial disaster that would defy description.
So what else happened around that time?
September 15th:
- Fannie Mae, Freddie Mac bailed out
- Lehman Brothers files for bankruptcy (pdf)
- TED Spread surpasses 2% – generally any number over 2% means lending has stopped, or at least is terribly restricted
- Washington Mutual debt downgraded to “junk”
September 16th:
- Russian stock market closed after falling 17%
- One of the … largest money market funds has put a seven-day freeze on redemptions after the net asset value of its shares fell below $1. Primary Fund [from The Reserve] … $62 billion fund … the value of the fund’s share is 97 cents.
- Federal Reserve bails out AIG
September 17th:
- Report of housing starts at lowest level since 1991 – and crashing
- Russian stock market closed again on crashing Ruble prices – 25% of all value gone in two days
- TED Spread rises to 2.76%
- Large money market funds attempt to calm stunned investors
September 18th:
- 455,000 more people unemployed
- Bank of Canada, Bank of England, European Central Bank, Bank of Japan, Swiss National Bank, U.S. Federal Reserve engage in coordinated move to pump billions into markets, hoping to stave off disaster
- Two more very large money market funds blasted by losses
- Washington Mutual tries to sell itself and nobody bids
- SEC bans short selling
September 19th:
- Treasury moves to insure money market funds
- Congress stunned by financial warnings: Senator Christopher J. Dodd [said] the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”
…just how close we really were to the end of it all…
One last note: in this article I suggested what it would be like if the Dow had the losses from September 18 – today all in one day, and how big of a shock that would be. The fact that whether it took a day or three months for these losses to occur, they still did occur. The question it leaves in my mind – are we the frog sitting in the slowly boiling pot, not aware of our situation until it’s too late? Can a contrary argument be made that perhaps the absolute shock of all this happening in a day actually being a good thing? Or are talking about the difference between nervous conversations at the family dinner table and at the office vs. riots in the streets, if all this happened overnight.
