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This is the run we care about 59 as henry paulson

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Unformatted text preview: This is the run we care about. 59 As Henry Paulson recounts in his book On the Brink, following the announcement in mid-July 2008 that the Treasury had acquired emergency powers to deal with Fannie and Freddie’s problems: “ From the moment the GSEs' problem hit the news, Treasury had been getting nervous calls from officials of foreign countries that were invested heavily in Fannie and Freddie. These calls ratcheted up after the legislation (granting powers to the Treasury to put GSEs into conservatorship but also to extend unlimited support to them). Foreign investors held more than $1 trillion of the debt issued or guaranteed by the GSEs, with big shares held in Japan, China and Russia. To them, if we let Fannie or Freddie fail and their investments got wiped out, that would be no different from expropriation. They had bought these securities in the belief that the GSEs were backed by the U.S. government. They wanted to know if the U.S. would stand behind the implicit guarantee – and what this would imply for other U.S. obligations, such as Treasury bonds.” Metaphorically, seeing foreign institutions and governments lining up outside the Board of Governors of the Federal Reserve System at 20th Street and Constitution Avenue in Washington, DC, “to not be the mug left without savings”, would spell an important moment in U.S. financial history and indeed globally, as it would mean the end of the greenback’s status as the reserve currency of the world. There would be no turning back, no closing of Pandora’s Box. Fannie and Freddie therefore were too-big-to-fail; and, with everyone in private markets knowing this and many in government promoting them, Fannie and Freddie grew ever larger, with their debt effectively ending up being a significant fraction of the U.S. government debt. 4.1.4 Fire Sales During the holiday season of 2008, Saks Fifth Avenue in New York City dropped 70% off the price on all of its luxury line of clothes. It was an unheard of practice to conduct fire sales prior to the Christmas holiday. Madison Avenue boutiques were in an uproar. Luxury designers were outraged. How could they sell $500 Manolo Blahnik shoes – the ones made famous in the “Sex in the City” television series - for just $150? Well, in the economy of the winter season of 2008-2009, they were $150 shoes, and many Madison Avenue boutiques went under, literally almost overnight. A walk down Madison Avenue in February 2009 would have shown one closed store after another. And similarly this was the case for the illiquid securities held by the banking sector in the fall of 2008. Banks had gorged themselves on illiquid mortgage-backed securities that carried some possibility of default. For taking this liquidity and credit risk, they received a nice 60 premium over their funding rate. And, in normal times, they pocketed it as profits. Now, in the economic crisis, it had come back to bite them, and the securities had become very impaired....
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This is the run we care about 59 As Henry Paulson recounts...

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