Financial Crisis of 2008

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  • It has been proposed that this page, Financial Crisis of 2008, be titled, "Recession of 2008".

The Financial Crisis of 2008 is an ongoing worldwide financial crisis that many observers believe is the worst the world has seen since 1933 with the Great Depression. The National Bureau of Economic Research, a private organization that follows its own standards as set by eminent economists such as Milton Friedman, has declared that the peak of the last expansion took place in December 2007, and the overall economy has been in decline ever since.[1] The economic difficulties will probably be officially classified as a recession when the next quarterly data is released as it is believed that there will have been another quarter of negative growth.

Negative economic news has spread outward from financial institutions to depress housing, construction, automobiles, retail sales, state and local government, and other sectors. 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.


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. The negative effects by October began spreading to all other sectors of the economy, and forecasts for the next year show little likely of a quick recovery anywhere.

Oct 11, 2008 editorial; cartoon by Horsey stresses the global collapse

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 losses" of many trillions. U.S. stocks are down 50% from their peak in 2007.[2] Paper losses for owners of stock in major financial institution have been over 70%, and owners of some have lost 99% as major banks 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.

In late September the crisis focused on liquidity--financial companies owned hundreds of billions of dollars of "toxic" securities, mostly based on U.S. mortgages; 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.

Tom Toles cartoon lampoons Federal bailout efforts as a badly designed bridge to nowhere, Dec. 1, 2008

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.[3] 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.

The Bush administration undertook a "bailout" 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 bailed out the largest bank, Citigroup.

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.

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.

Causes

In 2000 Howard Husock warned that the Community Reinvestment Act of 1977 and the expansion in 1995 would prove expensive; President Bush strongly endorsed the program. Despite widespread misunderstanding they did not cause the great crisis since CRA loans comprised only about 6% of the toxic mortgages. [4]

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.[5] 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.

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'[6] 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 declines in value, they would not be able to repay those loans. To minimize the risk, companies sold insurance called "credit default swaps" (CDS) to guarantee payment of the CDOs. The largest seller was American International Group (AIG), the world's largest insurance company. The CDOs and CDS were especially attractive because they were not regulated by the government; experts are not sure how many trillions of dollars are involved.

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.

Bubble bursts

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. Foreclosures 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.

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.

2008 crises

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.

On September 7, 2008, the government took control of the two largest mortgage holders, "Fannie Mae"[7] and "Freddie Mac"[8]. 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 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.

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.


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.[9] 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.

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.[10] 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.[11]


European crises

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.

Fortis

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 Belgian, 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).

Germany

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.

Central banks

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.

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. [12]

Britain

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, dividends and lending activities. The money involved is about a third of Britain's annual GDP (comparable to $5 trillion in the U.S. economy.)

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.[13]

Switzerland

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.

Asia

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.

$700 billion bailout

"We're in the midst of a serious financial crisis," President Bush warned the nation on Sept. 25, 2008.:

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.[14]

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 bailout was needed, Bush said, to avert a major disaster for the economy. Most (but not all) Democrats signed on to the bailout 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.

Conservatives were split on what to do. Many agreed with Bush that the bailout proposed by Treasury Secretary Henry M. Paulson was urgently needed. Large banks and corporations strongly endorsed the bailout. 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."[15] 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. Believers in the market economy insisted that the market should run its course, and opposed the bailout.[16]

A compromise bailout 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 an expanded bailout 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, designed to reassure ordinary depositors. Both Obama and McCain voted for this version of the bill.

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 Bush administration has refused to allow the money to be used to help the automobile industry. The price of bank stocks has fallen sharply since the bailout passed. The world's largest bank, Citigroup, was on the verge of collapse in late November and received a second bailout of $20 billion (in addition to $25 billion in October), and a federal guarantee to cover most of its toxic investments.

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.[17] 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.

Hedge funds are private investment companies with $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.[18]

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.[19] 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 bailouts and loan guarantees exceeded $7 trillion dollars, but the economy nevertheless continued to slip downward.[20]

Deepening recession

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%.[21] 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.[22]

Jobloss.jpg

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.

Collapse of #6 and #4 largest banks, rescue of #1

Washington Mutual collapses

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.[23]

Wachovia collapses

Meanwhile the #4 U.S. bank, Wachovia, burdened by $120 billion in toxic securities,[24] 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

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. [25]

Largest bank rescued

Citigroup, the world's largest bank was tottering in late November despite its receipt of $25 billion in TARP bailout money. 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 bailout yet, including $20 billion in new cash, and guarantees of toxic assets by the Treasury, FDIC and Federal Reserve.

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.

Despite two federal bailouts 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.[26]

Crisis in Auto industry

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.), which prevents lower prices. 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 is underway 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 has 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 elect Obama and Democrats in Congress have demanded the Big Three come up with a highly specific plan with some chance of long-term viability, with the expectation that Congress will address the issue again in January 2009.

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.

Intense debate in December 2008 focused on allowing bankruptcy or injecting billions more of federal aid in a massive bailout; 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 sue the fuel-efficiency loans to help with the immediate problem. It passed the Hosue but Senate Republicans brioke 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 pensionsand medical benefits to retired workers. Bush then acted unilaterally and decided to use TARP money to bail out GM and Chrysler, on December 19. GM and Chrysler will get $13.4 billions in loans they can use to pay their suppliers.[27] GM can receive another $4 billion in February, but by then the Obama adminsitration will be in charge, and it is emphasizing the need for a long-range solution.[28]

Bankruptcy scenario

Bankruptcy of the Big Three would be very expensive to the economy as a whole and the federal government. It would mean loss of 240,000 very high paying jobs at the Big Three, a loss of 980,000 high-paying jobs at the suppliers and local dealers, and 1.7 million additional jobs throughout the economy. It would cause a decline in personal income of $151 billion the first year, and $398 billion over three years. The federal, state and local governments would lose tax revenue and spend on welfare programs a total of $156 billion over three years.[29]

See also

References

  1. See "Text of the NBER's statement on the recession and FAQ's" 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 Rex Nutting - MarketWatch
  2. 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
  3. 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." Fox news report
  4. 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) online
  5. 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.
  6. That is, homeowners were obligated to pay the debts and the collateral behind them was the physical house.
  7. Federal National Mortgage Association (FNMA)
  8. Federal Home Loan Mortgage Corporation (FHLMC)
  9. 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.
  10. Barry Meier and Mary Williams Walsh, "A.I.G. to get Additional $37.8 Billion," New York Times, Oct. 8, 2008
  11. See Joe Nocera, "36 Hours of Alarm and Action as Crisis Spiraled," New York Times (Oct. 1, 2008)
  12. Carter Dougherty, Nelson Schwartz and Floyd Norris, "Financial Crises Spread in Europe," New York Times, Oct 6, 2008; Gregory Viscusi, "EU Nations Commit 1.3 Trillion Euros to Bank Bailouts," Bloomberg.com Oct. 13. 2008
  13. "Financial crisis: HBOS and RBS 'to be nationalised' in £50 billion state intervention," 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.
  14. see Bush speech online
  15. Elizabeth Williamson, "Big Business Wants Deal, Setbacks and All," Wall Street Journal Sept. 26, 2008
  16. See comments from a range of economists at Peter S. Goodman, "Credit Enters a Lockdown," New York Times Sept. 25, 2008
  17. Theo Francis, "Obama to Nominate New York Fed Chief Timothy Geithner as Treasury Secretary," Business Week Nov. 21, 2008
  18. Louise Story, "Citadel Chief denies rumors of trouble" New York Times, Oct 24, 2008
  19. "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.
  20. Maya Jackson Randall, "Paulson Says Treasury Actively Mulling New Rescue Programs," Wall Street Journal Dec. 1, 2008
  21. Stephanie Rosenbloom, "In November, Shoppers Cut Spending Even More," New York Times Dec. 2, 2008; Nick Bunkley, "Another Month of Miserable Auto Sales," New York Times Dec. 2, 2008.
  22. Ylan Q. Mui, "Retailers Report a Crisis in All Aisles: November Sales Slump as Shoppers Stow Credit Cards," Washington Post Dec. 5, 2008
  23. 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.
  24. 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). explanation of pay-option loans
  25. Gretchen Morgenson, "Countrywide to Set Aside $8.4 Billion in Loan Aid," New York Times Oct. 6, 2008
  26. Eric Dash and Julie Creswell, "Citigroup Pays for a Rush to Risk," New York Times,’’ Nov. 22, 2008
  27. 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.
  28. David E. Sanger, David M. Herszenhorn and Bill Vlasic, “Bush Aids Detroit, but Hard Choices Wait for Obama,” NewYork Times Dec. 19, 2008
  29. CAR Research Memorandum. "The Impact of the U.S. Economy of a Major Contraction of the Detroit Three Automakers" (Nov 2008) online edition