Amreica's Economic Crisis, The Inside Story

1 ) Greenspan's Cheap Money

The financial collapse of 2008 has been described as an “economic 9/11” for the United States. How ironic, then, that the origin of the collapse can be traced, in part, to the federal government’s response to the 9/11 terrorist attacks themselves. While most Americans felt vulnerable and uneasy about the nation's safety and security, actions taken by the government, in particular the Federal Reserve, would eventually have a major effect on citizens' financial security, rather than their physical safety.

Greenspan Fears Economic Shock
In the days following September 11, 2001, Federal Reserve Chairman Alan Greenspan worried the tragedy would send shockwaves through the economy, which was already in a recession, following the burst of the technology stock bubble.

President Bush Urges Consumers To Spend
Fearing an even more serious slowdown, exactly one month after the attacks, President Bush encouraged Americans to spend in order to keep the country’s economic engine running.

Federal Reserve Cuts Interest Rates
Greenspan went a step further. Several steps further. On September 17, 2001, less than a week after 9/11, the Fed began a series of interest rate cuts that made it easier and cheaper to borrow money.

Cheaper Money Creates New Demand For Credit
The cuts continued for nearly two years, through June 2003, and created incredible new demand for mortgages, home equity loans, automobile financing, and other kinds of credit.

Economy Stablizes But Heads Down Risky Road
It was exactly what President Bush and Chairman Greenspan had hoped would happen. But it led to something they never expected.


2 ) The Great Housing Boom

As the cost of borrowing dropped, so did the cost of the American Dream. Falling mortgage rates fueled a new residential real estate boom across the country. Millions of buyers flooded the market, purchasing condos, townhouses, and single-family homes they previously might not have been able to afford.

Lower Rates Make American Dreams Come True
During the first years of his administration, President Bush heralded increasing home-ownership as a symbol of success, achievement, and dreams-come-true. He pushed federal agencies and private lenders to devise new ways of helping Americans buy homes.

The Rising Perception Of Wealth
At the same time, increased demand for real estate was driving home values higher, making property owners feel richer: their investment was paying off right before their eyes, their wealth (at least on paper) was growing, their homes were becoming potential piggy banks.

Refinancing Craze Lifts Mortgage Market
By 2003, millions of Americans were tempted to crack open those piggy banks by refinancing their mortgages at lower interest rates, thereby reducing their monthly payments. Others refinanced a different way, using the increased value of their home to get a bigger mortgage at lower interest rate, allowing them to extract equity. Then, they used that cash to remodel those homes, buy new cars, take vacations, or spend the windfall however they pleased.

Fannie Mae And Freddie Mac Play Crucial Role
Fannie Mae and Freddie Mac, the two mortgage companies known as Government Sponsored Entities (GSEs), play a huge role in the American housing market. They led the way in purchasing loans for the purpose of securitization. In buying those loans, Fannie and Freddie replenished the supply of capital that banks and non-bank lenders could use to generate new mortgages. Fannie and Freddie bought about 50% of the residential mortgages generated each year by thousands of lenders across the country.

Conforming Loan Standards Serve As Safety Net
For years, the mortgages Fannie and Freddie purchased were known as conforming loans--- they had to conform to certain lending standards and the borrowers needed to meet certain requirements. If they didn’t, Fannie and Freddie would steer clear of them. Those standards served as a safety net for Fannie and Freddie, their investors, the government and consumers. By 2005, after those standards were loosened, the safety net became a lot less safe.


3 ) Subprime Explosion

As home values rose and home ownership increased, some Americans were left out. But not for long. Before the boom, they didn’t make enough money or their credit score wasn’t high enough to get a mortgage. They didn’t qualify. Lenders wouldn’t loan these potential borrowers money because their risk of defaulting was too high, by most standards. When those standards started to change, an industry near extinction was reborn.

Strict Loan Standards Leave Some Buyers On Sidelines
For years, borrowers needed the Three C’s in order to get a mortgage: Credit, Collateral, and Character. It was accepted practice in the mortgage industry. Customers would have to document their income, their debts, and their credit history. Mortgage underwriters conducted exhaustive research on potential borrowers’ finances.

Lenders Relax Borrowing Requirements
In a quest to cash-in on the housing boom, many banks and non-bank lenders relaxed their long-standing rules. They lowered the standards borrowers needed to meet. They targeted potential customers who previously were unable to get mortgages.

Alternative Mortgages Open New Doors
These lenders created new types of mortgages that allowed borrowers with less-than-perfect credit to get mortgages. Using creatively-named loans such as Option ARMs and Hybrid ARMs, and hard-to-understand terms such as “piggyback” and “pay option negative amortization”, they triggered a subprime tsunami that would nearly drown the U.S. economy.

One State Leads The Subprime Trend
California became ground-zero for the subprime mortgage industry. The sheer size of the state, along with the demographics of its population, and lack of regulation of the mortgage-related businesses made it prime territory for subprime predators.

Subprime Hits Big Screen
By 2003, the biggest subprime lenders had set-up shop in the Southern California city of Irvine. Quick Loan Funding quickly became an active part of the industry. It’s founder, Daniel Sadek, is a Lebanese immigrant with a third-grade education. At the height of his subprime success, Sadek’s company was financing $200 million worth of mortgages a month, while Sadek was pocketing about $5 million a month in salary. He used some of that cash to finance a Hollywood film. The movie went bust, and eventually Sadek’s business did too.


4 ) Inflating The Bubble

The days when a bank issued a mortgage and held onto it for the life of that loan ended long ago. Mortgages had become huge profit-generators for investment banks, which bought the loans from other banks and non-bank lenders, packaged them together, sliced them up, and sold them as securities. In theory, as long as homeowners paid their mortgages, these securitized loan investments, also known as structured products, were relatively safe. But, theory and practice were two very different things.

Investors Take A Gamble They Believe Is Safe
Investors from Wall Street to Warsaw bought the securities with little or no knowledge they contained pieces of toxic loans made to high-risk borrowers--- loans that could default on homes that could go into foreclosure.

Ratings Agencies Provide Misleading Grades
Why didn’t investors at home and abroad know about the dangers of these securities? Because credit rating agencies gave them high grades, in many cases the valuable and respected AAA rating.

AIG Builds Risky Insurance Business
And, just in case something did go wrong with those securities, some investors bought insurance policies called Credit Default Swaps, issued by companies such as AIG. A CDS guaranteed an investor would not lose money, even on the riskiest asset, assuring a payment even if the underlying security defaulted. And by 2005, with expectations that home values would continue rising and homeowners would continue making their mortgage payments, AIG believed the CDS business was fail-safe.

International Appetite Grows For Mortgage Securities
As demand by consumers for mortgages continued to grow, so did demand by institutional investors for mortgage-backed securities. The most common form: Collateralized Debt Obligations, known as CDOs. Flush with billions, hedge funds and sovereign wealth funds gobbled up these CDOs. But the AAA credit ratings that helped lure investors were deceiving. They masked the underlying risk of those securitized subprime mortgages. One former Moody’s analyst says it was easy to “turn crap into Triple A.”

Reward Turns Into Risk
Several years later, in July 2007, Standard & Poor’s would downgrade billions in mortgage backed securities. In announcing the changes, S&P admitted it misjudged the risk of those products.

Fannie And Freddie Join The Party
Prior to the downgrade and the cloud that eventually hung over subprime securities, even Fannie Mae and Freddie Mac, once known for buying the safest kind of mortgages, got into the game. Following an accounting scandal that temporarily slowed down their mortgage-buying business between 2003-2005, Fannie and Freddie felt compelled to compete with Wall Street for a share of all those subprime loans being sold by their originators. So Fannie and Freddie lowered their standards, just as the lenders had done. They began buying lesser-quality mortgages, including subprime loans, exactly the kind they avoided years earlier.

Uncle Sam’s Subprime Surprise
The federal government, which created and supported Fannie and Freddie, had now gone into the subprime mortgage business. And eventually, taxpayers would pay a severe price.


5 ) Warning Signs

As the housing bubble inflated, few regulators took notice. If they did, many turned a blind eye. Even Federal Reserve Chairman Alan Greenspan acknowledged during a Fed meeting in November 2002 that “our extraordinary housing boom cannot continue indefinitely.” His words turned out to be drastic understatements and they would later come back to haunt him.

Greenspan Spots Froth In Housing Market
In a 2005 speech to the Economic Club of New York, Greenspan amplified his earlier remarks about the real estate boom, referring to "froth" in the housing market. It was his most significant acknowledgment that regional bubbles existed in certain parts of the country. But he refused to believe they posed a serious threat to the national economy.

The Bubble Keeps Growing
Despite his comments, Greenspan did nothing to discourage those local housing bubbles from growing even bigger. Looking back, he still maintains the Fed could have done little to stop it.

Keen Observers Raise Red Flags
About the same time, as early as 2002, a pair of lesser-known bureaucrats tried to raise a red flag about subprime mortgage dangers. Sheila Bair, who worked at the Treasury Department, and Ned Gramlich, a Federal Reserve Governor, noticed that half of all subprime mortgages were being made by non-bank lenders, which were poorly supervised and regulated.

Fed Ignores Subprime Concerns
Gramlich and Bair, who in June 2006 became Chairman of the FDIC, tried to convince the Fed to tighten regulation of subprime lenders. Their pleas fell on deaf ears.

Watchdogs Fall Asleep At The Switch
Greenspan felt new rules and regulations would be useless without proper enforcement. Although the Fed lacked enforcement powers, the Treasury Department and the SEC should have kept a much closer and more critical eye on the massive increase in securitization of subprime loans and the implications for unsuspecting investors. So, while Greenspan’s deep, undying belief in free markets may have blinded him to the financial catastrophe lurking in the shadows, other regulators were simply asleep at the switch.

Hedge Fund Manager Discovers Subprime Opportunity
Hedge fund manager Kyle Bass was anything but blind. His eyes were wide open and his instincts were dead right. By 2006, Bass predicted the subprime securitization crisis before just about anyone else.

Short-Seller Profits From Ticking Timebomb
As a short-seller known for doing his homework, Bass researched the mortgage and securitization industries top-to-bottom, inside and out. Bass discovered a ticking timebomb about to explode and by mid-2006 he figured out how to capitalize on it. Bass based his findings on three key pieces of research: the relationship of housing prices to income, inventory of unsold homes, and the lack of mortgage industry regulation.

American Dreams Become Nightmares
Homeowners like Arturo Trevilla proved Bass’ points. Trevilla and many others were living in houses they couldn’t afford. Their American dreams would soon turn into nightmares.


6 ) Housing Market Decline

By early 2006, America’s unprecedented real estate explosion was hitting a wall. The boom hadn’t turned to a bust, yet. But the housing market was slowing significantly. The evidence was clear: back-to-back quarterly drops in the median price of a home showed cracks in the armor of a market many experts believed would keep growing indefinitely.

Median Home Prices Begin Dropping
From the fourth quarter of 2005 to the first quarter of 2006, the median home price in the U.S. fell 3.3%, the second consecutive drop. Prices had already declined 1% from the third to fourth quarters of 2005.

Credit Tightens Up, Slowing Real Estate Market
Loose lending standards began to tighten and mortgage rates began to climb. It was becoming more difficult for borrowers without good credit to get mortgages. The fuel of credit that fanned the real estate flames since 2001 was starting to dry up.

Refinancing Become Much More Difficult
At the same time, many of those alternative mortgages designed to help borrowers afford the home of their dreams began to haunt them. Homeowners who expected to refinance their loans found it difficult or impossible to get a new mortgage. Those borrowers and many others suddenly faced significantly higher monthly payments. They were often shocked to learn of the increases, having never fully understood the terms of their adjustable rate loans. In some cases, borrowers didn’t read the fine print. In others, they misled lenders or falsified their income to get the mortgage. And, others simply put too much trust in their loan officer or mortgage broker.

Borrowers Shocked By Higher Monthly Payments
Now, huge numbers of homeowners faced a brutal new reality: bigger monthly mortgage payments on homes worth less than they had anticipated. Suddenly, much of the real estate wealth that had accumulated “on paper” was contracted instead of expanding--- depreciating instead of appreciating.

Homeowners Faced With Tough Choices
If they couldn’t make the new, larger payments, homeowners were faced with several, often difficult, choices. They could try to sell their property, perhaps at a loss, just to free themselves of the growing mortgage. They could stay and try to negotiate a compromise with their lender. Or, they could fail to make their payments, leading to defaults, foreclosures, and short sales.

Defaults and Foreclosure Begin Rapid Rise
In some cases, borrowers were stretched so thin--- so highly leveraged--- they had no choice but to default on their mortgages. By mid-2006, the escalating wave of defaults was creating a massive pool of toxic assets sitting on the balance sheets of banks and in the portfolios of investors around the world.


7 ) Banks Go Into Panic Mode

The ripple effects of the housing slowdown on Main Street were now reaching Wall Street, especially firms that invested heavily in subprime mortgages. The sudden collapse of two Bear Stearns hedge funds in June 2007 triggered the beginning of the panic among institutional investors, including investment banks, hedge funds, and sovereign wealth funds. Their voracious appetites for securitized mortgage products would soon come to an end.

Rating Agency Downgrades Mortgage Securities
In July 2007, three weeks after the Bear funds went bust, Standard & Poor’s downgraded the ratings on billions of dollars in mortgage backed securities. In making the change, S&P issued cryptic language that danced around the firm’s failure to correctly judge the risks of these investments. If you read between the lines, it’s an admission that S&P blew it--- failing to protect investors by failing to adequately assess the risk of CDOs made up of subprime mortgage backed securities.

Subprime Problems Fail To Slow Stocks
Despite the Bear hedge fund fiasco and the S&P downgrades, the stock market continued its upward climb through the summer of 2007. The subprime problems were bubbling under the surface of the investment community, but hadn’t become front page news. Subprime wasn’t a household word, yet. But it would soon become one.

Mortgage Meltdown Cripples Biggest Lender
The implications of the mortgage mess became much more apparent when the country’s biggest lender, Countrywide, received a rescue from Bank of America in August 2007. BofA took a $2 Billion equity stake in Countrywide, whose stock had just hit a 52-week low, losing about half its value in six months. Subprime-related defaults were hitting the lender hard and it needed to shore up its balance sheet. The CEOs of both companies heralded the deal, with Bank of America suggesting Countrywide was undervalued and Countrywide saying the BofA investment would position the lender for future growth and success.

Bank Of America Buys Countrywide
Five months later, with the subprime contagion spreading through the housing and credit markets, Countrywide was in much bigger trouble. The relationship with Bank of America proved to be a lifesaver, when Bank of America bought Countrywide in January 2008.

Dow Sets Record High 20 Years After Crash
In a prescient moment, the Dow’s amazing climb came to an end on October 9, closing at an all-time high of 14,164. The record came almost 20 years to the day since the market crash of October 1987.

Stock Market Takes Biggest Dive Ever
It would take nearly a year for the Dow to break another record--- it’s biggest one-day point drop in history--- at the height of the economic crisis.

Congress Looks At Housing Crisis
About the same time, in the fourth quarter of 2007, several Congressional committees took an interest in the housing crisis created by the mortgage mess. They held hearings, asked questions, and raised red flags well before the Federal Reserve, the Treasury Department, and the SEC. But no real action was taken until early 2008, when the subprime meltdown brought down one of the most legendary firms on Wall Street.


8 ) Financial Collapse
The uncertainly on Wall Street took a new, more ominous turn, and once again, Bear Stearns is at the center of the storm. It would overwhelm the firm, and during the course of just a few days, one of Wall Street’s most venerable names would be taken over by a rival, despite unprecedented government efforts to prevent the company from failing.

Bear Stearns Stock Drops On Wall Street Rumors
On Monday, March 10, Bear stock starts plummeting, as rumors escalate the investment bank is in danger of collapsing under the weight of massive exposure to risky subprime mortgage related investments. Bear denies the rumors and tries to stop the bleeding.

CEO’s Message Creates Unexpected Panic
For three days straight, Bear executives go on CNBC in a last-ditch effort to save the company and convince investors the firm will survive. The turning point is CEO Alan Schwartz’s interview with David Faber on Wednesday, March 12. It backfired—and magnified Bear's problems. Schwartz failed to convince Wall Street that investors had confidence in the company and that Bear's foundation was solid.

Federal Reserve Tries To Save Bear
The day after Schwartz’s interview with Faber, the damage was clear: Bear Stearns was now desperately scrambling to find a buyer. However, it was too toxic to touch. On Friday, March 14, after a series of overnight phone calls among Federal Reserve officials and Wall Street power brokers, the Fed announced a $29 Billion dollar loan to JPMorgan, which funneled the cash directly to Bear Stearns.

JPMorgan Buys Bear Stearns
At the end of a tumultuous week, Bear Stearns stock hovered around $30 a share, down from its all-time high of $171 in January, 2007. But the deal brokered by the Fed was too little, too late. Despite a frantic weekend of negotiations, Bear was all but dead. In close cooperation with the Treasury Department and the Federal Reserve, JPMorgan bought Bear Stearns, offering $2 per share.

Paulson Sends A Tough Message To Wall Street
The company had no choice but to accept the offer, which Treasury Sectretary Henry Paulson insisted should be intentionally low in order to send a sobering message about moral hazard. JPMorgan later increased the offer to $10 per share. But the damage was done. And it wasn’t over yet.

Trouble Spreads To Consumer Banking
While the Wall Street investment bank Bears Stearns was struggling, so was the Main Street retail bank Washington Mutual. For months, WaMu had been consolidating its mortgage operations, closing offices, and laying off thousands of employees. In June 2008, Washington Mutual CEO Kerry Killinger resigned. His departure marked the end of a tenure that included aggressive acquisitions of other financial institutions, a marketing campaign built around the slogan “Whoo Hoo”, and a strategy to become “the Wal-Mart of banking.”

Collapse Of A Few Affects Many More
The upheaval at Bear Stearns and Washington Mutual foreshadowed a global financial crisis that would erupt in the coming weeks and months. Many more well-known companies would collapse, the federal government would face unpredictable challenges, and Americans would lose their sense of prosperity that had accompanied rising home prices for much of the decade.


9 ) Global Recession

The ripple effects of the subprime securitization scandal continued simmering through the summer. It would soon boil up to become the greatest financial crisis since the Great Depression, with incredible economic, political, and social ramifications. More well-known firms would go out of business, others would be bought by competitors, or get bailed out by the government. Millions of workers across all industries and sectors would lose their jobs. And the perception of prosperity that many Americans enjoyed for years would become a bitter reality: we had spent, borrowed, and fooled ourselves into a false sense of security.

Government Seizes Fannie Mae And Freddie Mac
In July, hinting at more chaos to come, Treasury Secretary Henry Paulson asked Congress for the power to takeover mortgage giants Fannie Mae and Freddie Mac. Less than two months later, that’s exactly what happened. On September 9, the federal government seized control of Fannie and Freddie and ousted the CEOs of both firms.

Lehman Rocks Wall Street, Declares Bankruptcy
The seizure of Fannie and Freddie began what would turn out to be one of the most dramatic, traumatic, and historic periods in Wall Street history. One week later, just days away from the seventh anniversary of the 9/11 attacks, Lehman Brothers collapsed into bankruptcy. Once again, risky mortgage assets were the culprit. But this time, unlike the Bear Stearns collapse six months earlier, there was no rescue, no buyer, no white knight. Behind the scenes, the feds had pushed other banks to buy Lehman. Once again, the firm proved too toxic. Nobody made a bid without assurance of government support. The Treasury Department and Federal Reserve watched Lehman implode, unable to predict the scope of the global financial damage that would follow.

Merrill’s Herd Of Running Bulls Gets Caged
While Lehman Brothers failed to find a buyer, Merrill Lynch succeeded, just in time to prevent the firm from collapsing the way some of its rivals did. Like Bear Stearns and Lehman, Merrill had invested heavily in subprime mortgage backed securities and collateralized debt obligations (CDOs). They played the most significant role in the firm’s incredible earnings growth, driving Merrill to record profits of $7.6 Billion in 2006.

Merrill’s Mortgage Strategy Threatens Firm’s Survival
Merrill’s CEO Stan O’Neal was so fixated on the revenue generated by the mortgage business, he didn’t just want to securitize them, he wanted to originate them, too. So, in 2007, Merrill bought mortgage lender First Franklin. O’Neal’s goal of vertical integration was complete. But it would soon create chaos inside the firm, as borrowers began to default on subprime loans and the market for mortgage backed products began to stall.

Bank Of America Rescues Merrill From Extinction
By September 2008, Merrill Lynch was suffering huge mortgage-related losses. It’s amazing run of quarterly growth hit a wall. Merrill’s huge bet had backfired. And the company faced the same fate as its biggest Wall Street competitors. Merrill sold itself to Bank of America in a deal that came together the very same weekend that Lehman Brothers went belly up.

Bank Merger Goes Under Microscope
Although Bank of America’s purchase of Merrill ultimately saved the company, the transaction later came under intense scrutiny because of larger-than-expected losses and controversial year-end bonuses paid to Merrill executives. CEO Stan O’Neal resigned in disgrace. His replacement, former New York Stock Exchange CEO John Thain, lasted only 13 months in the job. He later came under fire for extravagant spending on office redecoration while Merrill was bleeding cash. And, Bank of America CEO Ken Lewis was called before Congress to explain his claims that the Federal Reserve and Treasury Department pressured BofA to close the Merrill deal. The Feds denied any pressure, but revealing email chains and Lewis’ testimony shed new light on the behind-the-scenes efforts to keep Merrill afloat.

“Too Big To Fail,” Feds Take Control Of AIG
Two days after Lehman’s bankruptcy, the crisis spread to insurance giant AIG. It was now on the verge of failing, too. AIG bet big on Credit Default Swaps, selling insurance policies on Collateralized Debt Obligations made from subprime mortgage securitizations. When the subprime mortgages defaulted, making all those CDOs worth much less, AIG was stuck with billions in liabilities. All those policy-holders wanted their insurance payments for the failed CDOs. In order to prevent an international financial calamity, the U.S. government took an 80-percent stake in AIG. Many experts called the company “too big to fail”--- with tentacles stretched around the world, deeply embedded in the global economy.

Popular Money Market Fund Hit Hard
As the week progressed, the domino effect continued. The Primary Reserve Fund, a popular money market fund, broke the buck, meaning each dollar invested was now worth only 97 cents.

Paulson And Bernanke Issue Dire Warning
The crisis escalated with lightning speed. Treasury Secretary Paulson and Federal Reserve Chairman Bernanke held an emergency meeting with members of Congress, warning that the worst economic collapse since the Great Depression was potentially just hours away. One attendee described a moment of stunned silence when “the air literally was sucked out of the room.” Paulson literally got down on bended knee and pleaded for support from Speaker of the House Nancy Pelosi.

Treasury Proposes Massive Stimulus Plan
In the days ahead, Paulson requested $700 Billion from Congress for a program intended to buy toxic assets from banks and infuse financial institutions with capital. The initial request was only three pages long and contained no rules and standards for oversight. Infuriated politicians greeted the proposal with skepticism, despite a historic meeting at the White House among President Bush and the two men battling to succeed him, Senators Barack Obama and John McCain.

Biggest Bank Failure In History: WaMu Goes Bust
At the same time as the White House gathering, another bank went bust. Washington Mutual, weighed down by mortgage-related losses, was seized by federal regulators and sold to JPMorgan Chase. It was the largest bank failure in U.S. history, caused by an old fashioned, Depression-like run on WaMu’s deposits, following rumors about the bank’s ability to survive. Worried account-holders flooded branches to withdraw their cash. The company that once bragged it would become “the WalMart of banking” ended up more like Woolworth’s--- out of luck, out of time, and out of business.

Market Madness As Dow Falls Record 778 Points
The following week, on September 29, Congress rejected the stimulus plan. Stunned investors watched the vote second-by-second, reacted to the failed vote, and sent the stock market on a wild ride. The Dow Jones Industrial Average plunged a record 778 points, its biggest drop in history.

Wells Fargo Wins Battle To Buy Wachovia
As the bailout battle consumed Washington, a takeover battle consumed Wall Street. Citigroup and Wells Fargo both had their eyes on Wachovia, another troubled bank in search of a buyer. Citigroup thought it had a deal, but Wells Fargo ultimately won the competition for Wachovia, swallowing yet another firm that dug its own grave by aggressively lending to subprime borrowers.

Congress Approves Financial Rescue Package
The following week, Congress acted again. This time, lawmakers approved the package, known as the Troubled Asset Relief Program. It included significantly greater oversight of the $700 Billion and more specific details on how it would be used to bolster the U.S. banking system. Treasury Secretary Paulson later forced the chief executives of the nine largest American banks to accept money from the fund, known as TARP (Troubled Asset Relief Program). Paulson’s “tough love” was a bitter pill for some bank bosses to swallow. But they all took the cash, some comparing it to an act of patriotism. In the following weeks and months, it would take much more than an act of patriotism to pull the country, and the world, from the grips of recession.


10 ) Massive Government Action

The initial $700 Billion economic stimulus plan authorized by Congress was only the tip of the bailout iceberg. Between October 2008 and June 2009, the U.S. government committed more than $10 Trillion dollars to economic recovery packages. In that nine-month period, the federal government took aggressive, unprecedented action, using new and existing powers to shore up the markets, thaw the credit freeze, and stop the economic free-fall. Recovery from this crisis was still a long way off, but signs of stability started to emerge.

Worried Americans Vote & Voice Their Frustration
On November 4, 2008, one month after Congress approved the stimulus legislation, Americans voiced their frustration over the struggling economy. It had become the dominant issue in the Presidential election, overtaking the war in Iraq as the top concern among voters. Because of its potential impact on the global financial crisis, this election became the most closely-watched Presidential race in decades, not only in the United States, but around the world.

Obama Makes History, Vows Economic Fix
Barack Obama won the White House by a 53% to 46% margin, defeating Sen. John McCain and becoming the nation’s first African-American President. He vowed to make sure a crisis of this magnitude never happens again. Obama wasted no time in tackling the troubled economy, laying out an ambitious agenda well before taking office. He seemed to be running the country’s financial rescue, even while George Bush remained in office for the final weeks of his Presidency.

Interest Rates Cut To Near Zero
One month after Obama’s election, the Federal Reserve made history by cutting interest rates to practically zero. The fed funds target rate ranged from 0 to .25%. It was the latest move in a series of drastic rate reductions that began in September 2007, when the Fed lowered rates for the first time in more than four years, in response to slowing economic conditions. During this same period, the Federal Reserve dramatically increased the money supply, known as the monetary base, by about a trillion dollars. This turned out to be a 180-degree change from the Fed’s previous anti-inflation policy.

New President Unveils Ambitious Agenda
Once sworn-in, President Obama and his economic team launched a rapid-fire series of plans and proposals designed to turn the ailing economy around. They knew it would not be a quick fix. They knew it would need public and private sector support. And they knew it would require bold ideas that had never been tried before.

Government Invests In Financial Institutions
By February 2009, the Obama administration announced the government would buy stock in dozens of banks under the Treasury’s Capital Purchase Program. Second, it unveiled a new Financial Stability Plan that included a public-private fund that would buy toxic assets from financial institutions. The FSP also expanded the Federal Reserve’s TALF program and ramped up efforts to prevent residential mortgage foreclosures.

Citigroup Struggles To Survive, Must Break Apart
The financial institution appearing to require the most federal help and the greatest government oversight was Citigroup. The massive “financial supermarket” created over the past decade had become too big for its own good. As CEO Vikram Pandit tried to sell assets and reorganize the company into a more manageable business, the government became its biggest shareholder, taking a 34% stake in the bank. In late February 2009, despite a $45 billion dollar government investment, Citigroup stock had dropped 78% since the beginning of the year. Citi shares fell to their lowest level since November 1990, at one point trading below one dollar per share. Federal regulators debated the fate of Pandit, wondering if he should be replaced with a new chief executive. FDIC Chairman Sheila Bair reportedly pushed for Pandit’s removal, while Treasury Secretary Tim Geithner reportedly lobbied to give Pandit more time to fix Citigroup.

Massive Federal Spending Aims To End Slump
On February 17, less than a month into his Presidency, Obama signed historic legislation known as the American Recovery and Reinvestment Act of 2009. The bill authorized massive government spending and targeted tax cuts in hopes of jump-starting the economy. The spending plan focused heavily on public works and infrastructure projects that would create thousands of jobs, while the tax cuts for workers making less than $250,000 put more money in consumers’ pockets.

As Banks Fail, Americans Wonder What’s Safe
Americans who chose to save that extra cash wondered where to put it: was their money safer in the bank or under their mattress? The question arose on May 27, 2009 when the FDIC revealed its quarterly “problem bank” list in late February. It had grown from 171 to 252. The FDIC also revealed 25 banks had failed in 2008, the largest number since 1993, during the Savings & Loan crisis. Three months later, in the FDIC’s next quarterly report, the number of “problem banks” increased again, from 252 to 305. And, the FDIC reported that 21 banks had failed in the first quarter of 2009, the most in a quarter since early 1992.

Homeowners Offered New Mortgage Help
Just one day after signing the Recovery and Reinvestment Act, the President announced a mortgage refinancing and foreclosure prevention initiative called The Homeowner Affordability and Stability Plan. It changed previous guidelines by allowing the refinancing of conforming mortgages owned or backed by Fannie Mae and Freddie Mac even if they exceeded 80% of a home’s value. And, it created a $75 Billion fund to encourage lenders to modify the terms of home loans in order to reduce borrowers’ monthly payments.

Treasury Increases Stake In Fannie & Freddie
Fannie and Freddie themselves needed more help, too. These GSEs, which had been seized by the federal government about six months earlier, announced massive losses. In 2008, Fannie lost $58.7 Billion, while Freddie lost $50.1 Billion. At the same time those losses were made public, the Treasury Department bought $45 Billion in Fannie and Freddie stock in order to help stabilize each company’s balance sheet.

AIG Bonus Outrage Adds Insult To Injury
The financial shocks during Barack Obama’s first 100 days were not over yet. AIG, the huge insurance conglomerate now 80% owned by the government, made headlines again. In early March, the Federal Reserve and Treasury restructured the government’s assistance to AIG, injecting another $30 Billion in TARP money. Much more controversial news about AIG broke two weeks later, when media reports revealed the company had paid $165 million in bonuses to executives, including members of the trading unit that caused the company’s collapse.

Money Recovered As AIG’s Volunteer CEO Departs
Outraged politicians, including President Obama, demanded the bonus money be blocked, forcibly recovered, or voluntarily returned. New York’s Attorney General even threatened to make public the names of AIG employees who received those bonuses. Interim AIG CEO Ed Liddy, who took the job as a gesture of goodwill at a salary of only $1 a year, was called to testify before a Congressional committee. Although he had nothing to do with the bonuses, he took the heat anyway. Eventually, by March 2009, most of the money was given back. And Liddy announced he was leaving AIG, saying the company needed a new Chief Executive who could chart the firm’s future.

Stress Tests Put Banks Under Microscope
Throughout the first five months of 2009, the Treasury Department continued investing in dozens of U.S. banks, buying shares of preferred stock under the department’s Capital Purchase Program, part of the TARP legislation passed late in 2008. Despite the government support, some of those banks, among the country’s 19 largest, were facing a new challenge: so-called “stress tests” to determine their ability to withstand a continuing economic downturn. The Treasury first announced the testing plan in February, and by May the numbers had been crunched and would soon be revealed. Nervous investors waited and wondered. Who would pass? Who would fail? Would the weaker banks become even more fragile? Would the stronger banks become even more dominant?

Test Results Reveal Stronger And Weaker Banks
Finally, the results were made public. The Treasury carefully choreographed the announcement, in hopes of avoiding an investor sell-off of bank shares or consumer runs on accounts at the less-stable banks. Of the 19 financial institutions put through the rigorous tests, the government concluded nine had adequate capital to withstand further shock, while ten needed to add a total of $185 Billion in order to buffer themselves for more adverse conditions. Each of the ten were given 30 days to develop a plan to raise the required capital.

Recession Leaves Automakers On Risky Road
In addition to banks, America’s automakers were also in the administration’s crosshairs. General Motors, Ford, and Chrysler had been in financial trouble for years, even decades. Now, the economic crisis triggered by the crash of the housing market had left the companies in critical condition. The recession meant few Americans could afford to buy a new car or truck. The unemployment rate was hitting multi-year highs, consumer spending was falling like a rock, and many Americans could barely buy groceries, much less a new set of wheels.

Big Three In Big Trouble, GM & Chrysler Bankrupt
The domestic automakers had been losing market share to foreign rivals for a long time, and by 2008 their sales went from bad to worse. The sales drop, coupled with huge payouts for employee and retiree health benefits, left the “Big Three” with no choice but to beg for help from the government. While all three struggled to stay in business, Ford looked the strongest. GM and Chrysler appeared on the verge of bankruptcy. Months earlier, in late 2008, their CEOs testified before Congress, laying out new business plans and asking for federal bailouts. Finally, President Obama and his Auto Task Force had lost their patience. In April and June 2009 the automakers’ road to ruin took a drastic detour as the government forced Chrysler and GM into Chapter 11 bankruptcy. It was a calculated strategy to help the companies emerge leaner, with fewer models, fewer legacy costs, and fewer financial hurdles to overcome.

Dramatic Changes Start To Take Effect
By the time 2009 was half-over, the automakers were poised to emerge from bankruptcy and some of the banks that received TARP funds were ready to repay the government. The housing market showed signs of a bottom, as low mortgage rates sparked a modest increase in sales. The stock market began to reverse its slide. President Obama proposed a complete overhaul of the country’s financial regulatory system. And the savings rate, which had declined for years, started to rise, indicating Americans had learned a painful, yet valuable lesson.

Economy Shows Signs Of Improvement
The crisis that began exactly two years earlier with the collapse of Bear Stearns hedge funds invested in subprime mortgages wasn’t over yet. But the phrases “glimmers of hope” and “green shoots” started appearing in our lexicon. Perhaps the worst of the boom that went bust was finally behind us.