All great monetary fiascos are forged upon a foundation of misperceptions and flawed premises. There’s always an underlying disturbance in money and Credit masked by supposed new understandings, technologies, capabilities and superior financial apparatus.
During the nineties “New Paradigm” period, exciting new technologies and “globalization” were seen unleashing a productivity and wealth miracle. The Greenspan Fed believed this afforded the economy an accelerated speed limit. With inflation and federal deficits believed conquered, there was little risk associated with low rates and an “asymmetrical” policy approach to support the booming economy and financial markets. The Fed significantly loosened the reins on finance precisely when they needed to be tightened.
The nineties were phenomenal from a financial perspective. Total system Debt about doubled to $25.4 TN. Remarkably, Financial Sector borrowings surged more than 200% to $8.2 TN. Outstanding Agency (GSE) securities ballooned from $1.267 TN to end the decade at $3.916 TN, for growth of 209%. Securities Broker/Dealers (liabilities) jumped 212% to $1.73 TN. “Fed Fund and Repo” expanded 112% to $1.655 TN. Wall Street “Funding Corps” rose 387% to $1.064 TN. Securities Credit surged 414% to $611 billion.
And the most incredible aspect of the nineties boom in “Wall Street Finance”? Pertinent to today’s backdrop, the 1990’s Bubble unfolded over years with barely a notice. Everyone was mesmerized by the Internet, exciting new technologies and the white-hot IPO market. I was fixated on what I was convinced was evolving into epic financial innovation and a historic Credit Bubble. Yet attempts to explain this backdrop to other financial professionals, academics, economists, journalists and even Fed officials went absolutely nowhere. Repeatedly I heard frustrating variations of “Doug, you don’t understand.” “Only banks create Credit.” “The Federal Reserve controls the money supply.” “Fannie and Freddie are only financial intermediaries – they don’t impact system Credit.” “Financial system borrowings don’t matter. Doug, you’re double-counting debt.”
Even back in the nineties, it was largely ideological. Everyone had adopted a doctrine of how finance worked and it was very rare that someone would take a deep dive into developments and the analysis and then challenge orthodoxy. As I’ve noted in the past, it was not until Paul McCulley coined “shadow banking” in 2007 that analysts and policymakers belatedly began to take notice.
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