Difference between revisions of "Financial Crisis of 2008"

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The '''Financial Crisis of 2008''', continuing into 2009, is an ongoing worldwide financial crisis that is the worst the world has seen since 1933 with the [[Great Depression]]. Drastic measures to confront seemingly insurmountable financial calamity resulted in the creation of '''TARP''' (Troubled Assets Relief Program), $700 billion safety net by the U.S. Government.  The National Bureau of Economic Research<ref>NBER is a private organization that follows its own standards as set by eminent economists such as [[Milton Friedman]]; its dating of business cycles is widely accepted by conservatives.</ref> has identified the peak of the last expansion in December 2007; the U.S. economy has been in decline ever since.<ref>See "Text of the NBER's statement on the recession and FAQ's" [http://www.usatoday.com/money/economy/2008-12-01-recession-nber-statement_N.htm ''USA Today'' Dec 1, 2008]. "The U.S. economy entered a recession in December 2007, a committee of economists at the private National Bureau of Economic Research said," at [http://www.marketwatch.com/news/story/US-recession-began-December-2007/story.aspx?guid={7DCF90E4-D61A-4014-83CE-45E938CD632C} Rex Nutting] - MarketWatch</ref>  [[Image:CRASH08.JPG|thumb|330px|Oct 11, 2008 editorial; cartoon by Horsey stresses the global collapse]]  The crisis has caused the [[Recession of 2008]], which reached bottom in summer 2009, causing a worldwide economic decline that is the most severe since the 1930s.  Proponents of [[free market]] capitalism declare that  [[Federal Reserve]] Chairman [[Ben Bernanke]] should not have bailed out failing firms and instead should have allowed free market capitalism to quickly recover as it did in the depression of 1920 without government intervention (free market capitalists assert that government intervention merely drags out recessions and depressions).<ref>http://www.youtube.com/watch?v=zzTXaAXusiI</ref><ref>http://www.youtube.com/watch?v=czcUmnsprQI</ref>  A 2005 study found that government corporate bailouts are often done for mere political considerations and the economic resources allocated exhibit significantly worse economic performance than resources allocated using purely business considerations.<ref>http://papers.ssrn.com/sol3/papers.cfm?abstract_id=676905</ref>
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The [[International Monetary Fund]] (IMF) calculates that the global financial crisis will produce $3.4 trillion in losses for financial institutions around the world between 2007 and 2010.<ref> Peter Dattels and Laura Kodres, "Global Financial System Shows Signs of Recovery, IMF Says," [http://www.imf.org/external/pubs/ft/survey/so/2009/RES093009A.htm ''IMF Survey Magazine'' Sept. 30, 2009]</ref>
 
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==Overview==
 
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Negative economic news has spread outward from financial institutions to depress housing, construction, office buildings, automobiles, retail sales, state and local government, and vitually every other sector of the economy. Consumer spending has plunged, and banks have been very reluctant to loan money. Major banks and corporations have gone bankrupt.
 
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The recession is worldwide.  In recent months governments across the world have spent huge sums of money to reverse the crisis, but thus far the results have been inconclusive and the declines continue. The U.S. government provided cash bailouts of several hundred billion dollars and long-term loan guarantees of over $7 trillion dollars (compared to a GDP of $15 trillion a year in the U.S.).  Conservatives have been as dismayed and baffled by the crisis as everyone else.  Rush Limbaugh, for example, blames Obama.
 
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Unlike crises in the mid 1970s and early 1980s, this one began in the financial sector with devastating effects on many very large financial companies worldwide, especially in September 2008.  The negative effects by October 2008 began spreading to all other sectors of the economy, and forecasts for the next year show little likely of a quick recovery anywhere. For the effects on the broader economy (outside of finance and autos) see [[Recession of 2008]].
 
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The crisis originated in the United States and Western Europe, and has impacted every country in the world. Banks and financial companies have reported losses of over one trillion dollars; investors have suffered [[paper loss|"paper losses"]] of many trillions. U.S. stocks are down 50% from their peak in 2007.<ref> For most people the loss is a "paper" loss because they still own the stock and it might go up, or down. If they bought stock in 2003 for $1000, watched it go to $1500 in 2008, then drop to $1000 again in 2008, their "paper loss" is $500 but their real loss is zero since they are back where they started. People who bought at $800 still have made a $200 paper profit. People who bought at $1200, say, have a paper loss of $200. The paper loss or gain becomes real when they finally sell the stock. See [[Paper loss]] for more details</ref> Paper losses for owners of stock in major financial institution have been over 70%, and owners of some have lost 99% as major [[bank]]s closed down. The [[stock market]] has declined 50-70% in major countries and [[pension]] funds have large paper losses.  Paper losses in real estate have been in the trillions; the average price of American houses fell 20%, with 30% and higher declines in California and Florida.  However, thus far ordinary depositors with cash in the bank have suffered no losses. Owners of stocks in the 5000 largest U.S. corporations have paper losses of $10 trillion dollars in 2008, dropping to $10 trillion in October from $20 trillion in late 2007.
 
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In late September the crisis focused on liquidity--financial companies owned hundreds of billions of dollars of "toxic" securities, mostly based on U.S. [[mortgage]]s; they could not sell the toxic securities because no one knew how much they were worth, and large scale loans between major institutions stopped flowing as the system lost liquidity and froze up. A $800 billion rescue plan became law in the U.S. October 3, but its impact will not be clear for a while. Meanwhile Europe's economic crisis continues to deteriorate, as trillions of dollars in losses accumulate there and in Russia, China and India and in many smaller countries.  International agencies such as the International Monetary Fund are arranging emergency bailouts for medium-sized countries, like Pakistan and Ukraine.  All around the world people are sending their money to the U.S. and Japan because the banks there are safer than their own banks.  The price of oil, which reached $145 a barrel in the summer, plunged to under $50. That plunge eased the gasoline crisis, helped commuters, and helped the airline industry.
 
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[[Image:BRIDGE.JPG|thumb|400px|Tom Toles cartoon lampoons Federal bailout efforts as a badly designed [[bridge to nowhere]], Dec. 1, 2008]]
 
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Both parties have expressed anger at the crisis, and have promised extensive new regulations of the financial industry. However the Republicans have blocked additional bailout aid to General Motors, which is on the verge of bankruptcy.<ref> Treasury Secretary Paulson told Congress on Nov. 18 that the Bush administration remains "firmly opposed" to using any of the $700 billion financial bailout fund to help rescue Detroit's Big Three, "no matter how badly they need the help." [http://www.foxnews.com/politics/2008/11/18/paulson-rejects-bailout-money-automakers-senate-considers-legislation/ Fox news report] </ref> Democratic Congressional leaders and President-elect [[Barack Obama]] have pushed for a [[bailout]] of the auto industry and are expected to move it forward in January, 2009.
 
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The Bush administration undertook a program in which it took control of several of the largest financial institutions (Fannie Mae, Freddie Mac, and AIG insurance), forced the mergers of others, purchased $125 billion of ownership in the 9 largest banks in the U.S., and provided relief to the largest bank, Citigroup.
 
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Until October the crisis had little impact on the non-financial sectors of the world economy, but then negative impacts started appearing.  Companies could not borrow money for expansion or in some cases for routine operations, and had to cut back. Consumer spending fell and unemployment started to rise sharply.  By November pessimistic reports were coming in daily from practically every sector of the  American economy. There were no bright spots, and with tax revenues down, state governments began large-scale cutbacks, especially in New York and California.
 
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By late October it appeared the financial crisis was slowing down the economies of all countries of the world, leading perhaps to a serious recession with widespread unemployment and loss of business. The major countries have been taking aggressive steps to dissolve the liquidity freeze and get money flowing again, and to stimulate economies that are headed downward.
 
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==Causes==
 
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As hundreds of billions of dollars poured into the U.S. from abroad, financiers looked for imaginative ways to make a profit. They turned to [[real estate]], with the philosophy "Buy high--sell higher!"  The higher price paid for a house the more profit would be made when it was resold ("flipped") in six or 12 months; prices were certain to keep going up and up. Salesmen made big money by phoning prospective buyers, promising to get them Bog Money Quick.  People who owned a house whose value had doubled could and did refinance their mortgage for the higher amount, and keep the difference.  In the early 2000s, U.S. interest rates were low and demand for housing was high, as housing prices soared, especially in California, Florida, Nevada and Arizona. Mortgage companies and banks were very eager to lend, especially to people with mediocre [[credit]] who would not previously have been eligible for mortgages and to speculators. Speculators were ordinary people who already had a house and who were hoping to make a large profit on the purchase and quick resale ("flip") of another house or condominium, which no one ever lived in.<ref> The only money the speculators had at risk was a down payment; sometimes the construction company paid for the down payment and closing costs, so the risk to the speculator was zero.  Mortgages in the U.S. are "non-recourse" which means that borrowers cannot be sued for stopping payments.</ref>  The expectation was that continuously rising house prices would cover the mortgage payments through refinancing. Many of the mortgages involved very low down payments and low monthly payments for the first year or two, after which the payments would start soaring. Sometimes the monthly payment at first was zero.
 
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Both the Bush and Clinton administrations made it a national priority to encourage more people to buy houses, assuming this social engineering would be good for everyone. In 2000 [[Howard Husock]] warned that the [[Community Reinvestment Act]] of 1977 and its expansion in 1995 would prove expensive; but President Bush strongly endorsed the program. Despite widespread misunderstanding they did not cause the great crisis since CRA loans to poor neighborhoods comprised only about 6% of the toxic mortgages. <ref>[http://www.city-journal.org/html/10_1_the_trillion_dollar.html The Trillion-Dollar Bank Shakedown That Bodes Ill for Cities], Howard Husock, ''City Journal'', Winter 2000; Governor Randall S. Kroszner, "The Community Reinvestment Act and the Recent Mortgage Crisis," (December 3, 2008) [http://www.federalreserve.gov/newsevents/speech/kroszner20081203a.htm online]</ref>
 
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"Option adjustable rate mortgages" (nick-named "Pick-A-Pay") allowed borrowers to vary their monthly payments; they could be so so small they did not cover their interest charges. That meant the total principal grows over time, compared to normal mortgages where the debt owed shrinks over 30 years to zero and the borrower owns the house free and clear. By 2008 banks sold these dangerous "option adjustable rate" mortgages to two million customers.  They made sense if and only if the price of houses kept going up and the borrower could sell it in a year ot two at a huge profit. But if house prices declined, the borrower could stop paying and the bank was left with the loss.
 
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Timeline video showing Democrats opposing regulating housing market financing. President Bush, Senator McCain and Alan Greenspan all predicting financial  collapse and offering regulation. [http://www.youtube.com/watch?v=cMnSp4qEXNM&NR=1 See video]
 
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The [[NYTimes]] says Senator [[Charles Schumer]] D-NY, is the most responsible for Wall Street's collapse. <ref>[http://www.nytimes.com/2008/12/14/business/14schumer.html A Champion of Wall Street Reaps Benefits] NYTimes, December 13, 2008</ref> Schumer as a member of the Banking and Finance Committees, led efforts to regulate credit-rating agencies, shield financial institutions from government oversight and tougher regulations, and saved key industry players billions of dollars in taxes and fees.
 
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===Selling mortgage packages to big investors===
 
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Americans owed some $10 trillion on their mortgages, most of which were sound with payments made on time. However financiers bundled the mortgages into very complicated packages called "'''collateralized debt obligations''''<ref> That is, homeowners were obligated to pay the debts and the collateral behind them was the physical house.</ref> or CDOs. Hundreds of billions of dollars worth of CDO's were sold to banks, pension funds and financiers in the U.S. and Europe. Generally they borrowed cash to buy the CDOs.  The risk was that if the CDO's declined in value, they would not be able to repay those loans.  The CDOs were especially attractive because they were not regulated by the government; experts are not sure how many trillions of dollars are involved.
 
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Many mortgages were held by mortgage companies like [[Countrywide]] and [[Washington Mutual]], as well as investment banks such as [[Bear Stearns]], [[Merrill Lynch]], [[Lehman Brothers]], [[Morgan Stanley]] and [[Goldman Sachs]], as well as commercial banking chains like [[Wachovia]] and [[Bank of America]], which have thousands of local offices.
 
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===Commercial real estate===
 
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The speculative real estate bubble went far beyond individual homes, it infected as well as  kinds of commercial real estate, such as office buildings, shopping centers, apartment complexes, hotels, casinos and even and empty lots. People bought high expecting to  sell higher, and were stunned when the market collapsed. People who loaned money to real estate firms were confident of a 20% return, but more likely lost 25%. The value of office buildings plunged 43% after the peak in Nov. 2007.  Most investors who bought in 2007 probably lost all their investment.
 
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For example, in 2006 at the top of the market Tishman Speyer Properties and BlackRock Realty invested $5.4 billion to buy the largest apartment complex in the country, in downtown New York City. Stuyvesant Town and Peter Cooper Village, with 110 buildings and 11,227 apartments housed middle class families. The plan was to spend billions in upgrades and as tenants moved out to raise the rents.  The plan was wildly overoptimistic and the monthly rent did not cover the debt payments. In Jan. 2010 Tishman Speyer and BlackRock turned over the property to creditors, taking a 100% loss.<ref>Charles V. Bagli, "Huge Housing Complex in N.Y. Returned to Creditors," [http://www.nytimes.com/2010/01/25/nyregion/25stuy.html?hp ''New York Tomes'' Jan. 25, 2010] </ref>
 
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===Misuse of Credit Default Swaps===
 
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Another key contributing factor to the credit market meltdown was the misuse of Credit Default Swaps, or CDSs, which are contracts between entities designed to mitigate against risk of a credit default.  A CDS is essentially an insurance policy designed to protect the insured party against excessive losses in a separate financial transaction.  However, by structuring the contract as a derivative swap instead of a traditional insurance policy, companies other than regulated insurers could offer them.  This created two critical risk exposures to the insured companies, and collectively to the overall market.  First, traditional insurers are required to maintain a sufficient level of capital to pay on losses, while companies issuing CDSs were not.  Since investments in pooled mortgages were viewed as unlikely to devalue or fail, major issuers of CDSs like AIG and Lehman Brothers found themselves over-exposed to losses.  The second risk was that CDSs issued by one firm were typically hedged, or backed up financially, by CDSs with other companies.  The strategy of minimizing risk by dividing it into collections of smaller exposures with other companies is a sound practice, but when the original risk is overexposed that overexposure is then spread across the companies that participate in the secondary risk markets. 
 
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[[AIG]], the world's largest insurance company, was a major player in the financial crisis because it sold $441 billion in unhedged and undercapitalized insurance on securitized debt, much of it tied to mortgage values.  Normally an insurance company "lays off" some of the risk by taking out insurance with another company.  AIG neglected to do this because it never expected the securities to turn toxic, which they did.  Either someone paid the insurance or the nation's financial system would colapse, so the government stepped in, seized AIG, and paid the insurance. 
 
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The effect of these risks manifested themselves in two key ways.  First, when major players in the CDS market like Bear Sterns and AIG were found to be insolvent, or failed outright like Lehman Brothers, the default conditions that were tied to the risk-spreading CDS's were triggered, and many companies found themselves obligated to pay out on contracts they never expected to.  These sudden exposures led to capital and liquidity shortages at scores of firms involved in the secondary credit markets, and the default pattern started repeating on itself in an echo-like manner.  Since the complex, interdependent nature of the CDS market made it difficult for firms to assess their true exposure to loss in this unprecedented market, they refrained from both short-term and long-term lending to guard against further losses.  This essentially led to a freezing up of credit in the marketplace, as lenders refusing to give credit to other lenders translated into businesses and consumers being unable to get short-term operating loans, or borrow for homes, autos, student loans or credit-card accounts as before. 
 
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This freezing of the markets to avoid loss was the primary incentive for the U.S. government's Troubled Asset Relief Program (TARP), which injected billions of dollars of government-backed funds into the credit markets to restore trust and liquidity.
 
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==Bubble bursts==
 
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[[File:Houses$.jpg|thumb|300px|Left|Crash of U.S. housing prices in 2007-09]]
 
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The housing "bubble" burst in 2006-07, as prices plunged downward in the Sunbelt. Many speculators and homeowners could not meet their payments, especially those who had "[[sub-prime]]" mortgages because their income was too low to support the eventual monthly payments, or who had adjustable rate mortgages where the monthly payments started small then escalated.  [[Foreclosure]]s skyrocketed. With housing prices falling few people risked buying a new house (because it would soon be worth less than they paid for it). Construction firms had built millions of new houses that could not be sold but which glutted the market.  By late 2008 half the home sales in the U.S. were by banks selling houses they had foreclosed on at low prices.
 
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The problem was that no one could figure out what CDOs were now worth, so very few were willing to buy them.  One major investment bank, Merrill Lynch, sold its CDOs for 22 cents on the dollar--a "[[fire sale]]" price that was less than they were worth in the long run, because in the long run the great majority of people will make their scheduled mortgage payments.
 
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==2008 crises==
 
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Multiple crises started pulling down major financial players.  Countrywide, which originated 20% of all American mortgages in 2006, collapsed and was bought up by Bank of America.  Bear Stearns, a large investment bank, went under; the government arranged a sale to JPMorgan Chase; stock holders lost about 90% of their investment, and the confidence in other banks was undermined.
 
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On September 7, 2008, the government took control of the two largest mortgage holders, "[[Fannie Mae]]"<ref> Federal National Mortgage Association (FNMA)</ref> and "[[Freddie Mac]]"<ref>Federal Home Loan Mortgage Corporation (FHLMC) </ref>. The two had lost $15 billion on the $5.4 trillion in mortgages they owned, and their notes were widely held in [[China]] and many other countries.  The fear was that if the Treasury did not act the world's confidence in the US financial system would collapse.  However the rest of the world was in trouble too.  The stock markets in China and [[Russia]] plunged 50%, and the [[United Kingdom|British]] Treasury had to take over its largest mortgage company, [[Northern Rock]].  Vast sums of money flowed into the US because it was safer there than anywhere else.
 
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[[Image:PANIC08.jpg|thumb|300px|Panic in Wall Street, Sept. 2008; the "bull" is the symbol of optimism on Wall Street and the "bear" is the symbol of pessimism.  Here the bull panics.]]
 
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By September the major banks were no longer lending money and most reported huge losses as they wrote down the value of the CDOs and other assets. Short sellers sold large amounts of stock in threatened companies, causing further panic and driving down share prices.<ref>The short sellers did not own the shares; the practice was stopped on Sept. 19, 2008, by the [[Securities and Exchange Commission]] because it destabilized markets.</ref> [[Lehman Brothers]], one of the oldest and largest banks in New York, went bankrupt on Sept. 15 with no one to rescue it.  The collapse of Lehman with its $639 billion in assets had a multiplier effect worldwide, severely weakening other big banks and sharply increasing the level of fear and distrust inside the system that caused bankers to sharply reduce their lending.  Many large firms and hedge funds had borrowed billions of dollars from lenders and had pledged assets they owned as collateral. When the value of their collateral plummeted, the lenders demanded more collateral to make up the difference, so the borrowers had to sell assets to raise emergency cash.  The price of the assets they sold was falling, and large additional sales further depressed prices, creating a downward spiral.
 
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Merrill Lynch was sold to Bank of America for $50 billion, about half its value a few months before. Investors realized that AIG could no longer honor the insurance policies it wrote. It lost $13 billion in the first half of 2008 and its shares fell 95% in value. AIG was "too big" to be allowed to fail, so it was given an $85 billion loan from the government; in return the government received 80% of its stock. The government had to add another $38 billion to the AIG rescue in October.<ref> Barry Meier and Mary Williams Walsh, "A.I.G. to get Additional $37.8 Billion," [http://www.nytimes.com/2008/10/09/business/economy/09insure.html?_r=1&ref=business&oref=slogin ''New York Times,'' Oct. 8, 2008] </ref>  In effect AIG, along with GSE (government-sponsored enterprises) Fanny Mae and Freddy Mac were nationalized.  The Federal Reserve, with $800 billion in assets, was assisted by the Treasury, which gave it more funds.<ref> See [http://www.nytimes.com/2008/10/02/business/02crisis.html?_r=1&hp=&adxnnl=1&oref=slogin&pagewanted=all&adxnnlx=1222952525-cWL0bOgQjxNvxNo+OH1qAw Joe Nocera, "36 Hours of Alarm and Action as Crisis Spiraled," ''New York Times'' (Oct. 1, 2008)]</ref>
 
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===European crises===
 
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Heavy borrowing by European banks meant the crisis immediately affected Britain and other countries as well, as the British housing bubble burst about the same time as the U.S. The British government had to take over major mortgage lenders, including Northern Rock in February, 2008.  Northern Rock's loans (£25 billion) and guarantees (£30 billion) extended by the Bank of England, together with the value of the company's mortgages (£55 billion), or £100 billion in all, were added to the British national debt.  Bradford & Bingley, half the size of Northern Rock, held £40 billion in toxic mortgages, and was nationalized in late September.
 
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====Fortis====
 
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In late September, the Fortis bank, the world's 20th largest business, was partially nationalized by three governments who injected $16 billion in emergency funds. In 2007 Fortis borrowed heavily for its $100 billion takeover of rival bank ABN Amro; the deal came at the market’s peak, and Fortis now cannot pay its debts. The [[Belgium|Belgian]], [[Netherlands|Dutch]] and [[Luxembourg]] governments tried to inject capital but as consumer confidence plunged, Netherlands nationalized the Dutch wing of the company and the rest was sold in early October to the French bank BNP Paribas for €14.5 billion euros ($19 billion dollars).
 
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====Germany====
 
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In [[Germany]] Hypo Real Estate was given €50 billion euros ($68 billion dollars) bailout by the government.  The government of [[Iceland]] took over its large banks, as the entire island economy verged on bankruptcy because it depended so much on large foreign loans. Most of the European countries hurriedly announced guarantees of personal bank deposits to avert further drop in consumer confidence and runs on the banks.  Stock markets around the world continue to decline as pessimism worsens.
 
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====Central banks====
 
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The European Central Bank aggressively lent money to banks trying to ensure that banks would have adequate cash. The moves have not reassured savers or investors, and European stock markets have fallen even further than the American stock markets, as have the stock markets in China and Russia. 
 
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On October 13, France, Germany, Spain, the Netherlands and Austria committed €1.3 trillion euros ($1.8 trillion dollars) to guarantee bank loans and take stakes in banks, in an emergency effort to head off the collapse of their financial systems. <ref>Carter Dougherty, Nelson Schwartz and Floyd Norris, "Financial Crises Spread in Europe," [http://www.nytimes.com/2008/10/06/business/06markets.html?_r=1&hp&oref=slogin ''New York Times,'' Oct 6, 2008]; Gregory Viscusi, [http://www.bloomberg.com/apps/news?pid=20601087&sid=azerJ573HcbI&refer=home "EU Nations Commit 1.3 Trillion Euros to Bank Bailouts," ''Bloomberg.com'' Oct. 13. 2008]</ref>
 
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====Britain====
 
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Britain on October 8 announced a gigantic £400 billion ($680 billion) rescue plan for its banks; the government would partially own them.  Prime Minister [[Gordon Brown]] said banks would still be run by their old managers, but that the government would have to be "satisfied" on matters of salaries, [[dividend]]s and lending activities.  The money involved is about a third of Britain's annual [[Gross Domestic Product|GDP]] (comparable to $5 trillion in the U.S. economy.)
 
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On October 13, Britain announced it would spend £50 billion ($85 billion) to nationalize two of the five largest banks, HBOS (Halifax Bank of Scotland) and RBS (Royal Bank of Scotland), while taking partial ownership of a third, Lloyds TSB. A fourth, Barclays will remain private if it can raise an additional £7 billion. The fifth, HSBC is based in Hong Kong and will remain private.<ref>"Financial crisis: HBOS and RBS 'to be nationalised' in £50 billion state intervention," [http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3185120/Financial-crisis-HBOS-and-RBS-to-be-nationalised-in-50-billion-state-intervention.html?source=EMC-new_12102008 London ''Telegraph'' Oct 13, 2008] The existing stockholders were not bought out. They will continue to hold shares in the banks, but they will be outvoted by the new stock owned by the government.</ref>
 
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====Switzerland====
 
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In October 2008, the Swiss central bank and the big UBS bank reached an agreement to transfer as much as $60 billion of troubled securities and other assets from UBS’s to a separate entity. UBS will put up $6 billion in equity. The Swiss central bank will control the new entity and loan it $54 billion.
 
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===Asia===
 
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The crisis swept across the Middle East and Asia as well, with South Korea especially hard hit.  China, which had been the world's major growth machine in recent years, seemed to slow down. In November China's government announced it would spend 4 trillion yuan ($586 billion) through the end of 2010 to stimulate its economy. It specifically targeted people's livelihood in an effort to offset the impact of slowing global demand for its exports and unlock the spending power of its vast population.
 
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==Troubled Asset Relief Program (TARP) ==
 
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"We're in the midst of a serious financial crisis," [[George W. Bush|President Bush]] warned the nation on Sept. 25, 2008.:
 
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{{QuoteBox|Major financial institutions have teetered on the edge of collapse, and some have failed. As uncertainty has grown, many banks have restricted lending. Credit markets have frozen. And families and businesses have found it harder to borrow money....without immediate action by Congress, America could slip into a financial panic, and a distressing scenario would unfold: More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. Foreclosures would rise dramatically. And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs. Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And ultimately, our country could experience a long and painful recession.<ref>see [http://www.whitehouse.gov/news/releases/2008/09/20080924-10.html Bush speech online]</ref>}}
 
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On September 19, 2008, the Treasury and Federal Reserve proposed a major rescue plan--the largest government intervention in the economy since [[World War II]]. The plan was for the Treasury to purchase $700 billion of the CDOs. The buyout was needed, Bush said, to avert a major disaster for the economy.  Most (but not all) Democrats signed on to the plan, adding provisions for Congressional oversight and caps on CEO compensation; but at the last moment on Sept 25, 2008 House Republicans said no, and GOP presidential nominee [[John McCain]] held off endorsement. 
 
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Conservatives were split on what to do.  Many agreed with Bush that the program proposed by Treasury Secretary [[Henry M. Paulson]] was urgently needed. Large banks and corporations strongly endorsed the it.  The [[American Bankers Association]] and the [[Mortgage Bankers Association]] are fighting against any amendment that would reduce mortgage obligations for people in bankruptcy, while directing all the government funds to the banking industry.The U.S. Chamber of Commerce, normally an outspoken advocate of big corporate interests, instead stressed the crisis's impact on small and midsize businesses. "We're looking at an economy that was slipping toward recession even before this crisis culminated in a market lockup last week," said Chamber economist Martin Regalia. The debate in Congress, he said, "is costing every American taxpayer money, directly."<ref>Elizabeth Williamson, "Big Business Wants Deal, Setbacks and All," [http://online.wsj.com/article/SB122238988380577457.html ''Wall Street Journal'' Sept. 26, 2008]</ref>  Democratic nominee Senator [[Barack Obama]] endorsed the plan, as amended by Congressional Democrats. On the other hand, ordinary taxpayers and "Main Street", that is businessmen who operated at the local level, were highly suspicious of [[Wall Street]]. McCain, blaming the crisis on "the corruption and manipulation of our home mortgage system", rejected the bailout as a favor for Wall Street and little help to Main Street. Advocates of the market economy insisted that the market should run its course, and opposed the government intervention.<ref> See comments from a range of economists at [http://www.nytimes.com/2008/09/26/business/26assess.html?ref=business Peter S. Goodman, "Credit Enters a Lockdown," ''New York Times'' Sept. 25, 2008]</ref>
 
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A compromise was agreed to by leaders of both parties but the "Emergency Economic Stabilization Act of 2008" (EESA)  was voted down in the House on Sept. 29.  Democrats favored the Bush bill 60%-40%, but Republicans voted no by  65-35%. The stock market lost a trillion dollars in value in one day as uncertainty reigned.  Finally a large majority passed a more expensive bill, that added $100 billion in new subsidies to the original $700 billion, plus tax breaks and a rise in FDIC insurance to $250,000 from $100,000, intended to reassure ordinary depositors. Both Obama and McCain voted for this version of the bill.
 
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The Treasury TARP program proved erratic and had to be radically modified several times. The Treasury dropped the original plan to buy toxic securities and instead has used $250 billion to prop up major banks. In October Paulson and Bernanke used their new powers to take an ownership stake in the nine largest U.S. banks, of $7 to $25 billion each. These banks are now partly owned and controlled by the government. However those banks are keeping the money and not lending it out. The price of bank stocks has fallen sharply since the relief program was passed. The world's largest bank, Citigroup, was on the verge of collapse in late November and received a second loan of $20 billion (in addition to $25 billion in October), and a federal guarantee to cover most of its toxic investments.
 
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In mid-December Bush announced that $17.4 billion of TARP funds would be given to the automobile industry in the form of bridge loans<ref name=bushremarksautobailout>http://blogs.wsj.com/autoshow/2008/12/19/bushs-remarks-on-the-auto-rescue-plan/ Wall Street Journal, "Bush’s Remarks on the Auto Rescue Plan", December 19, 2008</ref>, just enough to prevent the companies from going bankrupt for a few weeks<ref>http://online.wsj.com/article/SB122969367595121563.html Wall Street Journal, "U.S. Throws Lifeline to Detroit", December 20, 2008</ref>. Bush defended the move by saying "if we were to allow the [[free market]] to take its course now, it would almost certainly lead to disorderly bankruptcy and liquidation for the automakers."<ref name=bushremarksautobailout />
 
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By mid-November the market had lost confidence in Treasury Secretary Paulson, who indicated he was baffled and would let the incoming Obama administration handle the unspent $450 billion.  The stock market jumped 6% on the news that Obama had picked New York banker [[Timothy Geithner]] to replace Paulson.<ref>Theo Francis, "Obama to Nominate New York Fed Chief Timothy Geithner as Treasury Secretary," [http://www.businessweek.com/election/2008/blog/archives/2008/11/obama_to_nomina.html?chan=top+news_top+news+index+-+temp_top+story ''Business Week'' Nov. 21, 2008]</ref>  In late November the Federal Reserve announced it will buy up to $600 billion in mortgage-related assets from Fannie Mae and Freddie Mac, hoping to restart the housing and credit markets.  Under the new "Term Asset-Backed Securities Loan Facility", or '''TALF''', the Federal Reserve will loan up to $200 billion to financial companies that hold securities backed by consumer and small-business loans.
 
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Hedge funds are private investment companies with a combined $1.7 trillion in assets. They have lost $180 billion since July and some are near collapse. Investors are demanding their money back, and Wall Street in late October is bracing for a shake-out in the industry.<ref> Louise Story, "Citadel Chief denies rumors of trouble"  [http://www.nytimes.com/2008/10/25/business/25hedge.html?ref=business ''New York Times,'' Oct 24, 2008]</ref>
 
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In late November the government announced an $800 billion plan to boost consumer credit and the market for mortgage-related securities. Plans call for the Federal Reserve in early 2009 to extend up to $200 billion in non-recourse loans to holders of asset-backed securities backed by highly-rated consumer and small business loans.<ref> "Non-recourse" loans means that if they are not paid back the borrowers cannot be sued for their other assets. Mortgages fall in this category, so that if people default they just walk away from the debt and never have to repay it. However it damages their credit rating.</ref> Treasury will contribute $20 billion in funds through its Troubled Asset Relief Program (TARP). The Federal Reserve also announced it will purchase up to $100 billion in GSE (government-sponsored enterprises, especially Fannie Mae and Freddy Mac) debt through a series of competitive auctions starting in December, 2008. The Federal Reserve starting in December will purchase up to $500 billion in mortgage-backed securities backed by GSEs such as Fannie Mae and Freddie Mac. Federal Reserve Chairman Ben Bernanke said the Fed is preparing to launch new liquidity programs to support the economy in addition to further slashing interests rates.  The total commitments by the government in relief and loan guarantees exceeded $7 trillion dollars, but the economy nevertheless continued to slip downward.<ref>Maya Jackson Randall, "Paulson Says Treasury Actively Mulling New Rescue Programs," [http://online.wsj.com/article/SB122816189458369851.html?mod=rss_Politics_And_Policy ''Wall Street Journal'' Dec. 1, 2008]</ref>
 
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===Deepening recession===
 
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By early December the entire economy was heading downward with no bright spots. The recession that began in Dec. 2007 intensified, as retail sales plunged. In November 2008 Americans, their confidence shaken, saved their money and sharply reduced their credit card purchases. Auto sales were down 37% in November (compared to Nov. 2007) to the lowest rate in 26 years. GM sales fell 41% Ford fell 31% and the foreign cars were down just as much, with Toyota down 34%, Nissan down 42% and Honda down 32%.<ref> Stephanie Rosenbloom, "In November, Shoppers Cut Spending Even More," [http://www.nytimes.com/2008/12/03/business/economy/03shop.html?ref=business ''New York Times'' Dec. 2, 2008]; Nick Bunkley, "Another Month of Miserable Auto Sales," [http://www.nytimes.com/2008/12/03/business/03sales.html?ref=business ''New York Times'' Dec. 2, 2008].</ref> Retailers rang up the lowest November sales in more than 30 years, as holiday shopping not only failed to lift the economy but showed that the crisis is further distressing everyday consumers. Thirty major companies -- including Macy's, Sears, Abercrombie & Fitch and Target -- posted sales declines; Wal-Mart, anchoring the bottom of the price chain, sawincreased sales.  Retail sales in November fell 2.7 percent compared with the same month last year.<ref> Ylan Q. Mui, "Retailers Report a Crisis in All Aisles: November Sales Slump as Shoppers Stow Credit Cards," [http://www.washingtonpost.com/wp-dyn/content/article/2008/12/04/AR2008120404347.html?hpid=topnews ''Washington Post'' Dec. 5, 2008]</ref>
 
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[[Image:Jobloss.jpg|thumb|300px]]
 
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The Federal Reserve reported on Dec. 3, 2008, that every region reported sales declines, drops in manufacturing activity, weakening real estate markets, tighter lending, and deteriorating labor marketsThose sectors that had been strong until recently -- especially as agriculture and energy -- also softened as commodity prices declined.  November saw 533,000 jobs disappear in the worst one-month decline in 34 years.
 
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==Collapse of #6 and #4 largest banks, rescue of #1==
 
−
===Washington Mutual collapses===
 
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On Sept. 25, Washington Mutual, the 6th largest bank in the US with $310 billion in assets, went [[bankrupt]] after a run in which depositors withdrew $17 billion in a few days. Its stockholders lost all their money, the US government took it over (through the [[FDIC]], which insures ordinary bank deposits), and resold it the same day to the biggest New York bank, JPMorgan Chase. It was the largest commercial bank failure in American history, by far.<ref>In the [[Great Depression]], only one major bank failed (New York's Bank of United States, in late 1930), although over 6000 small neighborhood and rural banks went under; depositors eventually received on average 85% of their deposits.</ref>
 
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===Wachovia collapses===
 
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Meanwhile the #4 U.S. bank, Wachovia, burdened by $120 billion in toxic securities,<ref> At the height of the bubble in 2006 Wachovia purchased  Golden West Financial, a California lender specializing in "pay-option" mortgages that enabled speculators to buy houses and pay very little a month for a year or two (at which time they expected to sell it for a profit). [http://www.brokeroutpost.com/reference/22657.htm explanation of pay-option loans]</ref> was bought out by Citigroup on Sept. 29 in a deal engineered by the FDIC.  However Wachovia then broke its deal and merged into Wells Fargo. The result is that four major banks now dominate the American economy (Bank of America, Citibank, JP Morgan Chase, and Wells Fargo), along with dozens of regional chains and thousands of small local banks.
 
−
===Bank of America renegotiates mortgages===
 
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In early October, Bank of America, the new owner of Countrywide, reached a settlement with 11 states that sued it over fraudulent practices. The state of Illinois accused Countrywide of relaxing underwriting standards, structuring loans with risky features, and misleading consumers with hidden fees and fake marketing claims, like a false promise of a "no closing costs loan." Countrywide gave special incentives to its brokers for selling impossible loans by paying higher commissions on them. In reviewing one Illinois mortgage broker’s sales, the Illinois complaint said the "vast majority of the loans had inflated income, almost all without the borrower’s knowledge."  Bank of America did not deny the charges and instead agreed to pay out $8.4 billion to 400,000 Countrywide customers. Countrywide will reduce principal balances for some people and cut interest rates for others. Rates for some people could decline to as low as 2.5% and remain at that level for five years.  Fannie Mae, Freddie Mac and IndyMac, now all owned by the federal government, have begun their own programs to modify mortgage terms for some hard-pressed borrowers.
 
−
<ref> Gretchen Morgenson, "Countrywide to Set Aside $8.4 Billion in Loan Aid," [http://www.nytimes.com/2008/10/06/business/06countrywide.html?ref=business ''New York Times'' Oct. 6, 2008]</ref> 
 
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===Largest bank rescued===
 
−
Citigroup, the world's largest bank was tottering in late November despite its receipt of $25 billion in TARP funding. Its value on the stock market plunged to $21 billion, down from $244 billion two years ago.  Round after round of layoffs have ended 75,000 jobs in 2008 out of 375,000 employees a year ago.  Very heavy exposure to toxic mortgages is the main culprit.  The government stepped in with the largest relief effort yet, including $20 billion in new cash, and guarantees of toxic assets by the Treasury, FDIC and Federal Reserve.
 
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At all times Citigroup used elaborate mathematical risk models that looked at mortgages in particular geographical areas, but never included the possibility of a national housing downturn, or the prospect that millions of mortgage holders would default on their mortgages. The prevailing approach at Citigroup and the other big banks was to make money as fast as possible (generating annual bonuses of $10 to $30 million for senior executives), which assigning zero to the risk of a system-wide downturn. Such a downturn came with disastrous consequences for Citigroup and its rivals on Wall Street.  Even after Bear Stearns ran into serious trouble in summer 2007, Citigroup decided the possibility of trouble with its CDO’s was so tiny (less than 1/100 of 1%) that they excluded them from their risk analysis. 
 
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Despite two federal efforts Citigroup is still wobbly. It holds $20 billion of mortgage-linked securities that have been marked down to between 21 cents and 41 cents on the dollar. It has billions of dollars of giant buyout and corporate loans of dubious value. And it also faces a potential massive losses on auto, mortgage and credit card loans as the economy worsens.<ref>Eric Dash and Julie Creswell, "Citigroup Pays for a Rush to Risk," [http://www.nytimes.com/2008/11/23/business/23citi.html?ref=business&pagewanted=all ''New York'' Times,’’ Nov. 22, 2008]</ref>
 
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By the end of 2009 most big banks were in much better shape and the Treasury expects to recover all but $42 billion of the $370 billion it lent to ailing companies, with the portion lent to banks actually showing a slight profit.  Meanwhile over 120 small and medium banks have been shut as insolvent; in most cases the FDIC picks up the losses and another bank takes over the operations and branches.<ref>Jackie Calmes, [http://www.nytimes.com/2009/12/07/business/07tarp.html?_r=1&hp=&adxnnl=1&adxnnlx=1260187849-MV96Nnjzom3OwAchzjIqrg "U.S. Forecasts Smaller Loss From Bailout of Banks," ''New York Times'' Dec. 6, 2009]  </ref>
 
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==Auto stimulus==
 
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In 2008 a series of damaging blows drove the "Big Three" (GM, Ford and Chrysler) to the verge of bankruptcy. Part of the cause was very high labor costs (much higher than the foreign plants in the U.S.), and lack of consumer demand for their products. The Big Three had in recent years stressed expensive, fuel-guzzling SUVs and large pickups. They were much more profitable than smaller, fuel-efficient cars. When gasoline prices shot past $4 in 2008, Americans stopped buying the big cars, and the Big Three saw their sales plummet.  The Financial Crisis played a role as no one was willing to loan GM the money to buy Chrysler. Consumer credit has tightened and it became much harder for people with average or poor credit to obtain a bank loan to buy a car, so sales fell further.  Stock prices plummeted as shareholders worried about bankruptcy; GM's shares fell to 1946 levels. Intense debate ensued about a massive bailout, that would be in addition to a $25 billion loan Congress passed in September 2008 to assist in increasing fuel efficiency. President Bush proposed changing the terms of that loan so it could be used to cover daily operating expenses, but Congress rejected that. Republicans in Congress in mid-November blocked Democratic proposals to underwrite a new bailout of the auto industry, as industry leaders made an unconvincing case before Congress.  President Obama and Democrats in Congress have demanded the Big Three come up with a highly specific plan with some chance of long-term viability. Critics claimed the proposals would lead to unnecessary job loss.
 
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In addition to the Big Three hundreds of large suppliers of parts are in financial crisis as well; most would go under if the Big Three go bankrupt.
 
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Intense debate in December 2008 focused on allowing bankruptcy or injecting billions more of federal aid; it would be in addition to a $25 billion loan Congress passed in September 2008 to assist in increasing fuel efficiency.  The Democrats in Congress supported president Bush's proposal to use the fuel-efficiency loans to help with the immediate problem. It passed the House but Senate Republicans broke with Bush and it failed.  The opponents called for a bankruptcy that would allow GM to get out of its contracts to pay union members high wages, as well as generous pensions and medical benefits to retired workers.  Bush then acted unilaterally and decided to make TARP loans to  GM and Chrysler, on December 19. GM and Chrysler will get $13.4 billions in loans they can use to pay their suppliers.<ref> GM and Chrysler will receive $4 billion each when they sign the loan agreements with the Treasury. GM will have access to an addition $5.4 billion on Jan. 16 and another $4 billion on Feb. 17 provided that Congress has released the remaining $350 billion for the Treasury’s TARP rescue program. </ref> GM can receive another $4 billion in February, but by then the Obama administration will be in charge, and it is emphasizing the need for a long-range solution.<ref>David E. Sanger, David M. Herszenhorn and Bill Vlasic, “Bush Aids Detroit, but Hard Choices Wait for Obama,” [http://www.nytimes.com/2008/12/20/business/20auto.html?hp ''New York Times'' Dec. 19, 2008]</ref>
 
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===Bankruptcy scenario===
 
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Bankruptcy of Chrysler and GM took place in the second quarter of 2009. Chrysler's sale to Italian automaker Fiat has been finalized. GM received billions more dollars to prevent bankruptcy but fell none-the-less. In addition, GM will require $30 billion in the first stage of bankruptcy. The Obama Administration is the single largest shareholder with the UAW second at 17% ownership. Also, many auto dealerships have been shuttered, thousands of workers have been [[laidoff]], assembly plants closed, and product lines dissolved or sold.
 
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==Obama Administration==
 
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[[Image:Geithner1.jpg|thumb|330px|Critics feared Geithner's vague plans would crash]]
 
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The [[Obama Administration]], taking office on Jan. 20, 2009,  moved to handle the crisis on two fronts.  Working with Democrats in Congress (and three moderate Republican Senators), it passed the "[[American Recovery and Reinvestment Act of 2009]]", calling for $500 billion of new spending and nearly $300 billion in new tax cuts. The new law began operations in mid-February, 2009, and supporters hoped it would slow and turn around the nosediving economy.  Conservative critics feared it would be ineffective in the short run and add to the national debt and tax burdens in the long run. As of late March no results are visible.
 
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With major banks on the verge of failure, Treasury Secretary [[Timothy Geithner]] unveiled yet another massive [[bailout]] program in mid-February. Trillions would be spent to move toxic assets out of the banks, but few details were provided. The widespread reaction was very negative, and Geithner lost more of his credibility as a problem solver.  Geither finally came back with a plan on March 23 that will not need additional funding or approval by Congress.  The Treasury will use $100 billion from the Troubled Asset Relief Program (TARP), as well as new capital from private investors, in order to generate $500 billion in purchasing power to buy toxic loans and assets. The program could potentially expand to $1 trillion over time.
 
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===Criticisms===
 
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:The nations banks now lend 25% less than when the financial bailout was announced.
 
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: The USA relies on China to buy our U.S. Treasury bonds to fund the increased spending.
 
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:America is a debtor nation, we spend more than we save. The dollars value has plummeted against world currencies. Gold prices remain at record levels.The money that we don't have, but spend, will be a debt that future generations will have to worry about. This has brought rise to the term 'Generational Theft' in describing Obama policies.
 
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:"It's time to terminate the TARP program," Rep. Jeb Hensarling, R-Texas, told reporters on Monday. "TARP is increasingly not being a vehicle for economic stability and taxpayer protection but is evolving into 700 billion dollar revolving slush fund that the administration can use to advance economic, social and political agenda items far and apart from what Tarp was ever designed to do." <ref>[http://www.foxnews.com/politics/2009/06/08/house-republican-moves-terminate-tarp/ House Republican Moves to 'Terminate the TARP'] Fox News,  June 08, 2009</ref>
 
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In the view of 51 mostly conservative economists polled by the ''Wall Street Journal'' in July 2009, the Obama administration's performance is problematic. President Obama and Treasury Secretary Geithner both got an average grade of 70 out of 100 for their handling of the financial crisis, but those grades varied widely. Former President Bush and ex-Treasury chief Paulson got average grades of 50 and 60, respectively, when economists were asked how they handled the crisis while in office. By contrast, Fed chairman Bernanke scores much better, with an average grade of 85; in addition 93% of respondents said he should be reappointed by Obama when Bernanke's term expires early next year.<ref>Phil Izzo, "Few Economists Favor More Stimulus," [http://online.wsj.com/article/SB124708099206913393.html ''Wall Street Journal'' July 10, 2009] </ref>
 
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==See also==
 
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*[[Recession of 2008]]
 
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*[[Henry M. Paulson]]
 
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*[[Paper loss]]
 
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*[http://ow.ly/3klF The Bailout In Images]
 
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==External links==
 
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*John Samples, [http://www.cato.org/pubs/pas/pa660.pdf Lawless Policy:TARP as Congressional Failure], ''Policy Analysis'' No. 660, [[CATO Institute]], February 4, 2010.
 
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*[http://baselinescenario.com/2010/03/15/senator-kaufman-fraud-still-at-the-heart-of-wall-street/ Senator Kaufman:Fraud Still At The Heart Of Wall Street]
 
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*[http://baselinescenario.com/2010/04/18/john-paulson-needs-a-good-lawyer/ The Baseline Scenario]
 
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*[http://www.chartingstocks.net/2009/02/great-depression-quotes-1929-vs-2008-have-we-learned-anything/ Great Depression Quotes 1929 vs 2008: Have We Learned Anything?]
 
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==Further reading==
 
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* Posner, Richard. ''A Failure of Capitalism: The Crisis of '08 and the Descent into Depression'' (2009), by a leading conservative
 
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* Taylor, John B. ''Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis'' (2009), 92pp; by a leading conservative
 
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====References====
 
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<references/>
 
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[[Category:Finance]]
 
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[[Category:Business]]
 
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[[Category:Economic history]]
 
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[[Category:Obama Administration]]
 
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[[Category:Obama Presidency]]
 
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[[Category:Featured articles]]
 

Revision as of 19:03, December 28, 2010

At least he knows range blocks

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