Central Bank to the World

Last week, I came across a news article that made me gasp with amazement. http://www.nytimes.com/2010/12/02/business/economy/02fed.html

It is easy for everyone to forget too quickly how close we all got to the end of the global financial system. This article lay it bare for any one with an understanding of how global finance works to realize how lucky we managed to get off the hook; and who we have to thank. The United States Federal Reserves.

Put simply, in early autumn on 2008 the global financial system froze. There was no more money in the system because no one trusted anyone else anymore. The market for commercial papers which operate like a gigantic overdraft facility for corporations needing short term cash flow were empty. No commercial company - no matter how large or solid or profitable - was considered safe. No bank would trust another bank.

Financial and non-financial corporations holding on to securities/collateral in return for loans suddenly found no takers for what they were holding. Without a ready and liquid market, the value of most instruments were plunging quickly towards zero for all intents and purposes. As their value diminished, lenders call in more security or call in the loans which choke off the oxygen for the commercial borrowers.

Companies like Caterpillar, Harley-Davidson, General Electric, McDonald’s, Toyota and Verizon were gasping for air as everyone was pulling in their liquidity. It was a run on the banks except they are corporates.

It was not just American corporates who found their oxygen cut off. Banks from all over the world were lining up in the firing line. Royal Bank of Scotland, Barclays, UBS of Switzerland; Mizuho Securities of Japan; and BNP Paribas of France all joined Citigroup, Merrill Lynch, Goldman Sachs and Morgan Stanley.

Who else could step in but the Fed? One can complain ceaselessly about their ridiculously unfair power to create US$ out of thin air - and doing so seemingly at will - but in this case, they lived up to the great responsibility that came with this unique ability. It's quite astounding when you consider the time pressure with which they had to act and the reckless courage with which they acted. Any delay or second-guessing and the falling dominos will turn into an avalanche. Warren Buffet in his recent article "Thanking Uncle Sam" said as much.

The Fed stepped in as the buyer of last resort for these markets and provided obscene amounts of liquidity in return for whatever assets the borrowers could show up with. Like a paramedic, the Fed was pumping the chest and administering CPR and giving its blood to everyone else.

In total, the Fed stepped in with US$1500 billion into the commercial papers market and US$9000 billion in short term loans to financial institutions. Not only that, the Fed extended US$2000 billion in swap lines to other central banks. The European Central Bank drew the most but nine other central banks also made use of them: Australia, Denmark, England, Japan, Mexico, Norway, South Korea, Sweden and Switzerland.

The cumulative total sum that the Fed bet on the survival of the global financial system is more than $12 Trillion or about the size of the US Federal debt or 22% of the GLOBAL GDP. All of that, and relentlessly so, within a matter of months. And fortunately, it got all the money back with interest as the underlying borrowing corporations are fundamentally sound and the actions kept the dominoes standing. The fact that it worked is clear from the often dismissive attitude some people have begun to take to the financial crisis of 2008.

You might have heard of people accusing that the seriousness of the 2008 crisis was over-stated. No, the fact is that it was vastly under-stated. Vastly. Were the Fed a little slow, a little hesitant, a little less courageous, a little unlucky, a little picky about who gets the money or a little more self-interested (after all, the US is gambling with its own net-worth to save everyone in the system) the global economy - Europe, China, India, SE Asia, Latin America, Japan - would very well have cratered into a downward spiral. In that world, people would be praying for what we have right now.

So credit where credit is due. No pun intended.