The summer of 2007 was a time of intense stress in the financial markets.
Credit-rating agencies had begun to mark down large amounts of asset-backed securities and collateralized debt obligations linked to subprime mortgages. Quant funds spent about a week in meltdown mode. The subprime market was being roped off as a toxic wasteland. But the problems that began in subprime had spread to Alt A and parts of the prime mortgage market. Stocks were shaky. Certain companies — Countrywide and Bear Stearns, especially — we being talked about almost in the past-tense. Corporate credit was "infected," with high-yield bond and loan spreads moving way out.
It was in this atmosphere that Jim Cramer gave his famous "they know nothing" speech. The transcripts of the Federal Open Market Committee of the Federal Reserve released Friday show that Cramer was absolutely right. (Please see Note 1 below.)
Here's what Cramer said:
I have talked to the heads of almost every one of these firms in the last 72 hours and he has NO IDEA what it's like out there. NONE! And Bill Poole, he has NO IDEA what it's like out there. My people have been in this game for 25 years and they're LOSING THEIR JOBS and these firms are gonna GO OUT OF BUSINESS and it's nuts. They're NUTS! They know NOTHING! This is a different kinda market. And the Fed is ASLEEP. Bill Poole is a shame, he's SHAMEFUL! He oughta GO, and READ the Accredited Home document, at least I READ the darn thing.
At the time, this was widely mocked. But the transcripts of the 2007 Federal Open Market Committee released Friday make it clear: Cramer was right.
Prior to Cramer's speech, the last time anyone had heard from the Fed officially was after the meeting that concluded on June 28, 2007. At that time the Fed had kept its rate target at 5 percent and noted that its primary concern remained inflation. The minutes of that meeting, which were released the following July, seemed to show that the Fed was not concerned about anything dramatic happening in the markets or the broader economy.
Thanks to the transcript, we now know that one of the primary things informing the Fed's thinking at that June meeting was a sell-off in Treasury bonds, for which, as the Fed's William Dudley said, "there is one very compelling explanation — market participants generally believe that the downside risks to growth have diminished."
When the Fed's Open Market Committee met again in August, just a few days after Cramer's speech, they were greeted by very different facts. Financial-market turbulence was undeniable.
What wasn't undeniable was whether this would have serious repercussions for the economy. In fact, this was heavily denied at that meeting, according to the official transcript.
Here's Philadelphia Fed chief William Poole:
My own bet is that the financial market upset is not going to change fundamentally what's going on in the real economy. First of all, bank capital is not impaired. So unlike in some past cases, when losses on real estate impaired bank capital and thus affected the lending in areas that had nothing to do with real estate, I don't think that's the case this time…Obviously, that could change, but it seems to me that the best information that we now have is that this financial market upset is going to settle out and not have major repercussions on the real economy, putting the housing part aside.
That is pretty much the opposite of what happened.
Atlanta Fed President Dennis Lockhart actually referred to Cramer's speech in the course of one of his comments, eliciting laughter from his fellow central bankers. (By the way, I'm sorry these quotes are so long. That's just the way central bankers speak, even in private. I'm going to add emphasis to aid your skimming the quotes.)
In the past few days, I have had substantive conversations with some well-positioned credit market observers, including managers of large investment portfolios, suggesting that the skittishness of financial markets is not likely to abate until later this fall. They have suggested that the choppiness in financial markets will be the rule in the near term and, very important, that the threshold for what constitutes a shock is now much lower than usual. I believe that the correct policy posture is to let the markets work through the changes in risk appetite and pricing that are under way, but the market observations of one of my more strident conversational counterparts — and that is not Jim Cramer [laughter] — are worth sharing. This party sees problems in the subprime structured debt market spreading to the CLO leveraged-loan market and, in a knock-on effect, to repo and commercial paper markets as well as to investment-grade corporate credit. This party points to nonprice rationing, commercial paper rollover risk, and general CDO contagion caused by the damaged credibility of rating agencies and contraction of collateral values. This party argues that treating the widening of credit spreads as normalization ignores substantial subsurface potential dislocations as evidenced by the collapse of American Home Mortgage Corporation. All that said, another counterpart noted a large pool of money now on the sidelines that is ready to provide financing for reasonable deals if prices fall low enough. Importantly, a large portion of this money comes from reliable long-term sources of investment, pension funds and insurance companies. Notwithstanding some descriptive rhetoric, this is not the credit crunch of the late 1980s, when the traditional financial intermediaries were strained for capital. The traditional investors are still out there with substantial liquidity, and they are just temporarily on the sidelines for understandable reasons and, barring further shocks, should return to the markets in force later this fall. The dislocations in the financial markets call for a posture of vigilant monitoring of developments but nothing more for now.
As we now know, "this party" was far better informed than "another counterparty" or Poole himself. This was not the credit crunch of the late 1980s — it was something much more extreme.
Here's the statement that emerged from this meeting:
The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent. Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.
Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.
Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.
Got that? Inflation was still the "predominant policy concern." Financial-market volatility, tighter credit conditions, and the housing correction are noted and then dismissed as concerns for the Fed by the word "nevertheless."
No wonder markets freaked out. Cramer had been right. The guys at the Fed just didn't know what was going on. Communicating this message was probably one of the biggest policy mistakes the Fed had made in years.
A few days later, on Aug. 10, the Fed held an emergency meeting by conference to announce that it would provide additional liquidity to the market. Then they held another emergency meeting on Aug. 16. The purpose of these meetings was to undo the policy mistake at the earlier meeting. That is, the Fed needed to show that it was actually paying attention.
As you know, financial markets have been fragile. They appeared to continue to be quite fragile overnight. There are difficulties with commercial paper funding and other short-term funding and a lot of concerns about counterparty risk. This morning the Desk, responding to a situation with the federal funds rate trading well above the target, did a large early operation and announced that to the markets. They are prepared to come back throughout the day to continue providing reserves as needed to keep the federal funds rate at our target.
And here's what they said to the public in the official statement after the Aug. 10 meeting:
Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.
In other words, the Feds were admitting it: they knew nothing. Actually, judging by the transcript of the Aug. 10 call, they still didn't know very much. But at least they knew this wasn't some fit of turbulence that could be dismissed with "nevertheless."
But this wasn't enough. What the Fed quickly learned was that it had already blown its credibility as a communicating crisis fighter. It now needed to pour actual funding at the problem. So it announced a new discount window program on Aug. 16, eliminating much of the penalty rate for borrowing directly from the Fed. One month later, the Fed began the cuts in its Fed Funds target that would eventually become our current zero-interest rate policy.
Looking back now, it's very clear that Cramer had a far clear view of what was happening than all those folks inside the Fed.
- Look. I know I work for the same network as Jim Cramer. If you want, go ahead and say that this is self-serving or that I'm trying to suck up to the powers-that-be. Conclude that some nameless bureaucrat instructed me to write this. None of that's true. If anything, I bet they'd all wish I'd just keep quiet about this. But this was such a striking vindication of a guy roundly mocked in 2007 that I thought it needed saying.
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