Thank you so much sir for the intriguing reference.

Thank you once again sir.

As Chief US Economist at Bear Stearns I lived the sub-prime crisis first-hand. The origin of the crisis was primarily a combination of ultra-easy US monetary policy and deregulation (especially the dismantling of the separation between commercial and investment banking). Easy US money flooded the global economy with liquidity that ended up in China's FX reserves and were recycled into the US bond market. The result was low long-term yields that left investors looking for other fixed-income assets. At the same time, the profitability of the pure investment banks (Bear, Lehman etc.) was impaired by competition from the newly expanded commercial banks (JP Morgan, Citi etc.). The investment banks did not have access to lender of last resort facilities at the Fed. The crisis began to percolate in August 2007 but really boiled when my firm faced an exodus of liquidity forcing it to merge with JPM. The Fed opened the discount window to the other investment banks via the PDCF but, at this point, it was too late. Falling house prices pressured the solvency of Fannie, Freddie, some banks and ultimately Lehman. The decision to allow Lehman to fail in a disorderly manner completely upended the interbank market and froze any short-term credit. The CDS positions and Lehamn's failure triggered a downgrade of AIG and the rest, as they say, is history.

The recession was deep and global and transmitted through trade credit, which froze with the interbank market causing global trade flows to plunge. Look, for example, at Japan's GDP (Q/Q annualized) in 2008 Q4, -12.5%, and 2009 Q1 -15.2% to show the impact of the collapse in trade. Japan were not big investors in US MBS and only the trade impact can explain the plunge in Japanese output.

The effects of the crisis, though diminished, persist. Housing is recovering with the rental market playing a significant role. House prices are increasing. Banks have recapitalized. But the banks are suffering a intense regulatory oversight and litigation issues (look at the $20 billion or so that JPM was fined in various settlements over the last year). Obviously on the global scene, the second financial crisis (Eurozone) has had a severe impact as well.

However, at the end of 2013, there were some signs of stronger growth in the US economy and the Fed has begun to scale back its five-year long programs of emergency interventions. The next hurdle will be the renormalization of monetary policy and potential distortions that have arisen from the multiple rounds of QE combined with 0% rates.

The causes of the 2008... financial crisis are deeply rooted. It is quite clear that a crisis of this proportion requires several causes that grow in importance over a long period of time. It will be too long to detail them here but you could consult:

http://www.cirano.qc.ca/pdf/publication/2009RB-02.pdf

This crisis has triggered responses from governments, central banks, regulators and so on, that have been so extreme and untested that the consequences are still being felt and will be for a few years to come.

One of the most difficult questions is: how are central banks going to extricate themselves from the ultra low interest rates they have engineered and reabsorb the liquidities they have injected in the world economy.

In that sense we are still feeling the spillover of the subprime crisis

Robert you are quite correct and, as the last sentence in my previous post show, I am in complete agreement. The Fed is shifting to think that it can avoid selling assets bought under QE and reabsorb $2 1/2 trillion or more of excess liquidity through reverse repos. Technically the Fed can probably raise rates through interest on excess reserves but whether the reserves can really be neutralized is a very open question. I would prefer a faster exit from QE and then a plan to sell assets.

Thank you so much Mr.Ryding and Mr.Amzallag...this has put things in perspective...also I am curious to know as to why Eurozone crisis,which was of same magnitude did not have major impact on Asia unlike subprime crisis.

That one is simple I think. When Lehman was allowed to collapse in a disorderly manner the entire interbank market froze. Trade credit froze. Asia, being very trade dependent, so massive drops in trade volumes. The Eurozone crisis was largely a European problem. Central banks were already supporting the liquidity of the interbank system and had shown they would do what was needed. SoEuropean problems largely contained to European banks. who owned the debt. There were a few global ripples, MF Global in the US, but they were minor.

Thank you sir

John,

I agree with you on the various mechanisms and strategies that the fed could use.

My interrogation at this stage is which path is really feasible.

If we start with liquidity, the size of the assets accumulated (as highlighted by your answer) is such that a straightforward sale program does not seem feasible to me. Who would be the buyer? How far would the prices fall (and therefore interest rates rise) if any open market sale was attempted?

Keeping the assets on the fed B/S does not seem much better as the liquidity in the market will remain excessive for a long time. A close look at the stock markets and especially in the US already shows the effects of the vast worldwide liquidity with micro bubbles appearing in various sectors within a global swell of valuations.

I feel the fed is betting (praying) for an economic recovery which combined with a a substantial deficit reduction or even a surplus , would progressively alleviate the problem.

What would be the odds of this scenario unfolding before another major bubble burst is the question.

As for the interest rates, the distortions are also quite sizeable as you pointed out.and potentially debilitating for the economy.

At this stage the manipulation of rates to favour the stock and real estate markets at the expense of savers, pension funds etc in order to create a wealth effect and promote consumption has had mixed results. The above mentioned markets have risen but with a lot of suspicion and seem ready to fall at the first hint of interest rate potential rise. As for the wealth effect it did occur in the higher income srata but is not presently trickling down.

The fed might then be even more restricted in raising interest rates than in controlling liquidity. What would the consequences be?

John,

I agree with you on the various mechanisms and strategies that the fed could use.

My interrogation at this stage is which path is really feasible.

If we start with liquidity, the size of the assets accumulated (as highlighted by your answer) is such that a straightforward sale program does not seem feasible to me. Who would be the buyer? How far would the prices fall (and therefore interest rates rise) if any open market sale was attempted?

Keeping the assets on the fed B/S does not seem much better as the liquidity in the market will remain excessive for a long time. A close look at the stock markets and especially in the US already shows the effects of the vast worldwide liquidity with micro bubbles appearing in various sectors within a global swell of valuations.

I feel the fed is betting (praying) for an economic recovery which combined with a a substantial deficit reduction or even a surplus , would progressively alleviate the problem.

What would be the odds of this scenario unfolding before another major bubble burst is the question.

As for the interest rates, the distortions are also quite sizeable as you pointed out.and potentially debilitating for the economy.

At this stage the manipulation of rates to favour the stock and real estate markets at the expense of savers, pension funds etc in order to create a wealth effect and promote consumption has had mixed results. The above mentioned markets have risen but with a lot of suspicion and seem ready to fall at the first hint of interest rate potential rise. As for the wealth effect it did occur in the higher income srata but is not presently trickling down.

The fed might then be even more restricted in raising interest rates than in controlling liquidity. What would the consequences be?

Khushboo,

I think John is absolutely right. The European crisis has, and is still unfolding, at a much slower pace than the US one. The European economy is weak at best. The ripple effects on the far east are and will be felt but will not be dramatic as the US economy is back on the growth path (as a result of extraordinary measures that create their own problems as discussed above) and the Far East itself remains dynamic.

Thank you sir once again...

Robert You raise some fantastic questions that thousands of traders and trillions of dollars are trying to figure out. I think the Fed's Operation Twist and third round of QE have done little to help growth and may have hurt it. Depressing the riskless long-run rate has significant consequences on pension funds, savers, and those entering retirement and. to me, it is an open question if the need to save more (the income effect) is outweighed or outweighs the stimulus to borrow (the substitution effect). Housing has rebounded, but it may have done so anyway. Those who argue that the economy is improving therefore QE3 worked may be guilty of the sin of 'post hoc ergo propter hoc.' I find myself in the camp of Dallas Fed President Fisher and his first rule of monetary holes 'when in a hole, stop digging.' After all, the deeper we are in it, the harder it is to climb out.

John,

I fully agree with your conclusion. We are in an economic unstable equilibrium.

Getting out of he hole while on stilts is going to be an interesting feat.

https://www.researchgate.net/publication/286256177_Global_Financial_Crisis_Exploring_the_Special_Role_of_US_Banks_and_Regulations

Article Global Financial Crisis: Exploring the Special Role of U.S. ...