The Day The World Broke

“The world stopped on August 9[th],” said the CEO of the then-solvent U.K bank, Northern Rock, Adam Applegarth. “It’s been astonishing. Look across the full range of financial products, across the full geography of the world, the entire system has frozen.”

From that day, the Federal Reserve realized they had lost control. Anything the central bank tried that would have encouraged market participants to reverse the disconnect had failed.

As Fed officials tried to understand what was wrong within the financial system, rumors spread about how most assets inside mortgage-backed securities (MBS) had become illiquid. Investors tried to appraise what they knew was worthless. But instead of everyone just throwing in the towel, they continued to trade MBS securities and accept it as collateral.

However, once investors saw that the federal government had refused to bail out Lehman Brother’s MBS losses, this created a panic that rippled through the financial system causing its near-collapse. The EFF-LIBOR spread, once again, blew out, revealing a mass panic and a complete separation between the Federal Reserve and the offshore market.

Why the financial system bifurcated may lie offshore in the Eurodollar system: an unregulated, secretive, and exclusive market only accessible to the big players in the finance world. It’s the most important capital market in the global financial machine, the shadow banking layer, the international waters where institutions create most of the global money supply out of thin air.

From the mid-2000s up to Lehman’s collapse, liquidity within the Eurodollar system grew exponentially due to the explosion of Subprime debt securitization where financial institutions packaged up millions of risky mortgages and sold them as financial products to willing investors.

On August 9th, 2007, we likely saw the “The Great Unwinding” of liquidity within the Eurodollar system that hit breaking point in late-2008. As Subprime securities had become the dominant form of collateral, when market participants realized these assets were about to go to zero, panic ensued. No one wanted to buy and everyone wanted to sell.

In a few weeks, MBS, the main funding source that allowed financial institutions to operate and make transactions worldwide, simply disappeared, leaving only “pristine collateral” in the form of U.S government bonds to make up the difference.

Fourteen years later, and mystery still surrounds “the event”. Apart from the Great Unwinding theory, we may never know what broke the mechanism that enabled the global financial machine to function correctly. As the Eurodollar system remains shrouded in secrecy, only a few insiders will know why August 9th, 2007 occurred.

But whatever it was, it has stayed with us ever since. Sadly, our economic health now relies on the Federal Reserve’s ability to prop up our liquidity-starved financial system. Each time the U.S central bank goes on vacation, like in 2016, 2018, 2019, markets start to fall apart. And even when we do see growth, money velocity still collapses, fraudulent activity keeps hitting record levels, and inequality skyrockets.

Ever since August 9th, 2007, both the global economy and the global monetary system have never reached their former glory. Instead, ever more bizarre methods of financial engineering paired with unlimited cheap money help fill in the gaps, covering holes in the financial dam, averting multiple crises such as the leverage unwind of Covid-19 and the 2019 repo market crisis.

Despite all this, however, the system remains stable. But it comes at a cost. As a broken yet stable system helps the financial elites prop up asset prices, increasing their wealth, while the real economy and its constituents endure financial repression, we’re likely not going to see a fix or a replacement anytime soon.