United States policy responses to the Great Recession

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United States policy responses to the late-2000s recession explores legislation, banking industry and market volatility within retirement plans.

Contents

The Federal Reserve, Treasury, and Securities and Exchange Commission took several steps on September 19, 2008, to intervene in the crisis caused by the late-2000s recession. To stop the potential run on money market mutual funds, the Treasury also announced that same day a new $50 billion program to insure the investments, similar to the Federal Deposit Insurance Corporation (FDIC) program. [1] Part of the announcements included temporary exceptions to section 23A and 23B (Regulation W), allowing financial groups to more easily share funds within their group. The exceptions would expire on January 30, 2009, unless extended by the Federal Reserve Board. [2] The Securities and Exchange Commission announced termination of short-selling of 799 financial stocks, as well as action against naked short selling, as part of its reaction to the mortgage crisis. [3]

Market volatility within US 401(k) and retirement plans

The US Pension Protection Act of 2006 included a provision which changed the definition of Qualified Default Investments (QDI) for retirement plans from stable value investments, money market funds, and cash investments to investments which expose an individual to appropriate levels of stock and bond risk based on the years left to retirement. The Act required that Plan Sponsors move the assets of individuals who had never actively elected their investments and had their contributions in the default investment option. This meant that individuals who had defaulted into a cash fund with little fluctuation or growth would soon have their account balances moved to much more aggressive investments.

Starting in early 2008, most US employer-sponsored plans sent notices to their employees informing them that the plan default investment was changing from a cash/stable option to something new, such as a retirement date fund which had significant market exposure. Most participants ignored these notices until September and October, when the market crash was on every news station and media outlet. It was then that participants called their 401(k) and retirement plan providers and discovered losses in excess of 30% in some cases. Call centers for 401(k) providers experienced record call volume and wait times, as millions of inexperienced investors struggled to understand how their investments had been changed so fundamentally without their explicit consent, and reacted in a panic by liquidating everything with any stock or bond exposure, locking in huge losses in their accounts.

Due to the speculation and uncertainty in the market, discussion forums filled with questions about whether or not to liquidate assets and financial gurus were swamped with questions about the right steps to take to protect what remained of their retirement accounts. During the third quarter of 2008, over $72 billion (~$100 billion in 2023) left mutual fund investments that invested in stocks or bonds and rushed into Stable Value investments in the month of October. [4] Against the advice of financial experts, and ignoring historical data illustrating that long-term balanced investing has produced positive returns in all types of markets, [5] investors with decades to retirement instead sold their holdings during one of the largest drops in stock market history.

Loans to banks for asset-backed commercial paper

How money markets fund corporations Money market fund.png
How money markets fund corporations

During the week ending September 19, 2008, money market funds had begun to experience significant withdrawals of funds by investors. This created a significant risk because money market funds are integral to the ongoing financing of corporations of all types. Individual investors lend money to money market funds, which then provide the funds to corporations in exchange for corporate short-term securities called asset-backed commercial paper (ABCP). However, a potential bank run had begun on certain money market funds. If this situation had worsened, the ability of major corporations to secure needed short-term financing through ABCP issuance would have been significantly affected. To assist with liquidity throughout the system, the US Treasury and Federal Reserve Bank announced that banks could obtain funds via the Federal Reserve's Discount Window using ABCP as collateral. [1] [6]

Federal Reserve lowers interest rates

Federal reserve rates changes (Just data after January 1, 2008)
Date Discount rate Discount rate Discount rate Fed funds Fed funds rate
PrimarySecondary
rate changenew interest ratenew interest raterate changenew interest rate
October 8, 2008*-0.50%1.75%2.25%-0.50%1.50%
April 30, 2008-0.25%2.25%2.75%-0.25%2.00%
March 18, 2008-0.75%2.50%3.00%-0.75%2.25%
March 16, 2008-0.25%3.25%3.75%
January 30, 2008-0.50%3.50%4.00%-0.50%3.00%
January 22, 2008-0.75%4.00%4.50%-0.75%3.50%

–→ * Part of a coordinated global rate cut of 50 basis point by main central banks. [7]

– See more detailed US federal discount rate chart: [8]

Legislation

The Secretary of the United States Treasury, Henry Paulson and President George W. Bush proposed legislation for the government to purchase up to US$700 billion of "troubled mortgage-related assets" from financial firms in hopes of improving confidence in the mortgage-backed securities markets and the financial firms participating in it. [9] Discussion, hearings and meetings among legislative leaders and the administration later made clear that the proposal would undergo significant change before it could be approved by Congress. [10] On October 1, a revised compromise version was approved by the Senate with a 74–25 vote. The bill, HR1424 was passed by the House on October 3, 2008, and signed into law. The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. [11]

In January 2009, the Obama administration announced a stimulus plan to revive the economy with the intention to create or save more than 3.6 million jobs in two years. The cost of this initial recovery plan was estimated at 825 billion dollars (5.8% of GDP). The plan included 365.5 billion dollars to be spent on major policy and reform of the health system, 275 billion (through tax rebates) to be redistributed to households and firms, notably those investing in renewable energy, 94 billion to be dedicated to social assistance for the unemployed and families, 87 billion of direct assistance to states to help them finance health expenditures of Medicaid, and finally 13 billion spent to improve access to digital technologies. The administration also attributed of 13.4 billion dollars aid to automobile manufacturers General Motors and Chrysler, but this plan is not included in the stimulus plan.[ citation needed ]

Federal Reserve response

In an effort to increase available funds for commercial banks and lower the fed funds rate, on September 29, 2008, the U.S. Federal Reserve announced plans to double its Term Auction Facility to $300 billion (~$417 billion in 2023). Because there appeared to be a shortage of U.S. dollars in Europe at that time, the Federal Reserve also announced it would increase its swap facilities with foreign central banks from $290 billion to $620 billion. [12]

On November 25, 2008, the Fed announced it would buy $800 billion (~$1.11 trillion in 2023) of debt and mortgage backed securities, in a fund separate from the 700-billion dollar Troubled Asset Relief Program (TARP) that was originally passed by Congress. [13] According to the BBC, the Fed used the fund to buy $100 billion in debt from Fannie Mae and Freddie Mac and $500 billion in Mortgage-backed securities. [14] The fund would also be used to loan $200 billion to the holders of securities backed by various types of consumer loans, such as credit cards and student loans, to help unfreeze the consumer debt market. According to a Des Moines Register editorial, it is not clear whether bodies that oversee the TARP will oversee Paulson's control of the Fed's $800 billion loan and bond actions. [15]

As of December 24, 2008, the Federal Reserve had used its independent authority to spend $1.2 trillion on purchasing various financial assets and making emergency loans to address the financial crisis, far beyond the $700 billion authorized by Congress from the federal budget. This included emergency loans to banks, credit card companies, and general businesses, temporary swaps of treasury bills for mortgage-backed securities, the sale of Bear Stearns, and the bailouts of American International Group (AIG), Fannie Mae and Freddie Mac, and Citigroup. [16]

In May 2013, as the stock market was hitting record highs and the housing and employment markets were improving slightly, [17] the prospect of the Federal Reserve beginning to decrease its economic stimulus activities began to enter the projections of investment analysts and affected global markets. [18]

Related Research Articles

The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less.

<span class="mw-page-title-main">Subprime mortgage crisis</span> 2007 mortgage crisis in the United States

The American subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the 2007–2008 global financial crisis. The crisis led to a severe economic recession, with millions of people losing their jobs and many businesses going bankrupt. The U.S. government intervened with a series of measures to stabilize the financial system, including the Troubled Asset Relief Program (TARP) and the American Recovery and Reinvestment Act (ARRA).

The subprime mortgage crisis impact timeline lists dates relevant to the creation of a United States housing bubble and the 2005 housing bubble burst and the subprime mortgage crisis which developed during 2007 and 2008. It includes United States enactment of government laws and regulations, as well as public and private actions which affected the housing industry and related banking and investment activity. It also notes details of important incidents in the United States, such as bankruptcies and takeovers, and information and statistics about relevant trends. For more information on reverberations of this crisis throughout the global financial system see 2007–2008 financial crisis.

<span class="mw-page-title-main">Federal takeover of Fannie Mae and Freddie Mac</span> Action by the U.S. Treasury to lessen the subprime mortgage crisis

In September 2008, the Federal Housing Finance Agency (FHFA) announced that it would take over the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. Both government-sponsored enterprises, which finance home mortgages in the United States by issuing bonds, had become illiquid as the market for those bonds collapsed in the subprime mortgage crisis. The FHFA established conservatorships in which each enterprise's management works under the FHFA's direction to reduce losses and to develop a new operating structure that will allow a return to self-management.

This article provides background information regarding the subprime mortgage crisis. It discusses subprime lending, foreclosures, risk types, and mechanisms through which various entities involved were affected by the crisis.

The U.S. central banking system, the Federal Reserve, in partnership with central banks around the world, took several steps to address the subprime mortgage crisis. Federal Reserve Chairman Ben Bernanke stated in early 2008: "Broadly, the Federal Reserve’s response has followed two tracks: efforts to support market liquidity and functioning and the pursuit of our macroeconomic objectives through monetary policy." A 2011 study by the Government Accountability Office found that "on numerous occasions in 2008 and 2009, the Federal Reserve Board invoked emergency authority under the Federal Reserve Act of 1913 to authorize new broad-based programs and financial assistance to individual institutions to stabilize financial markets. Loans outstanding for the emergency programs peaked at more than $1 trillion in late 2008."

A toxic asset is a financial asset that has fallen in value significantly and for which there is no longer a functioning market. Such assets cannot be sold at a price satisfactory to the holder. Because assets are offset against liabilities and frequently leveraged, this decline in price may be quite dangerous to the holder. The term became common during the financial crisis of 2007–2008, in which they played a major role.

The Emergency Economic Stabilization Act of 2008, also known as the "bank bailout of 2008" or the "Wall Street bailout", was a United States federal law enacted during the Great Recession, which created federal programs to "bail out" failing financial institutions and banks. The bill was proposed by Treasury Secretary Henry Paulson, passed by the 110th United States Congress, and was signed into law by President George W. Bush. It became law as part of Public Law 110-343 on October 3, 2008. It created the $700 billion Troubled Asset Relief Program (TARP), which utilized congressionally appropriated taxpayer funds to purchase toxic assets from failing banks. The funds were mostly redirected to inject capital into banks and other financial institutions while the Treasury continued to examine the usefulness of targeted asset purchases.

The government interventions during the subprime mortgage crisis were a response to the 2007–2009 subprime mortgage crisis and resulted in a variety of government bailouts that were implemented to stabilize the financial system during late 2007 and early 2008.

The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector that was passed by Congress and signed into law by President George W. Bush. It was a component of the government's measures in 2009 to address the subprime mortgage crisis.

The interbank lending market is a market in which banks lend funds to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate. A sharp decline in transaction volume in this market was a major contributing factor to the collapse of several financial institutions during the financial crisis of 2007–2008.

The Term Asset-Backed Securities Loan Facility (TALF) is a program created by the U.S. Federal Reserve to spur consumer credit lending. The program was announced on November 25, 2008, and was to support the issuance of asset-backed securities (ABS) collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA). Under TALF, the Federal Reserve Bank of New York authorized up to $200 billion of loans on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans. As TALF money did not originate from the U.S. Treasury, the program did not require congressional approval to disburse funds, but an act of Congress forced the Fed to reveal how it lent the money. The TALF began operation in March 2009 and was closed on June 30, 2010. TALF 2 was initiated in 2020 during the COVID-19 pandemic.

The Subprime mortgage crisis solutions debate discusses various actions and proposals by economists, government officials, journalists, and business leaders to address the subprime mortgage crisis and broader 2007–2008 financial crisis.

<span class="mw-page-title-main">Public–Private Investment Program for Legacy Assets</span>

On March 23, 2009, the United States Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, and the United States Treasury Department announced the Public–Private Investment Program for Legacy Assets. The program is designed to provide liquidity for so-called "toxic assets" on the balance sheets of financial institutions. This program is one of the initiatives coming out of the implementation of the Troubled Asset Relief Program (TARP) as implemented by the U.S. Treasury under Secretary Timothy Geithner. The major stock market indexes in the United States rallied on the day of the announcement rising by over six percent with the shares of bank stocks leading the way. As of early June 2009, the program had not been implemented yet and was considered delayed. Yet, the Legacy Securities Program implemented by the Federal Reserve has begun by fall 2009 and the Legacy Loans Program is being tested by the FDIC. The proposed size of the program has been drastically reduced relative to its proposed size when it was rolled out.

The subprime mortgage crisis reached a critical stage during the first week of September 2008, characterized by severely contracted liquidity in the global credit markets and insolvency threats to investment banks and other institutions.

Maiden Lane Transactions refers to three limited liability companies created by the Federal Reserve Bank of New York in 2008 as financial vehicles to facilitate transactions involving three entities: the former Bear Stearns company as the first entity, the lending division of the former American International Group (AIG) as the second, and the former AIG's credit default swap division as the third. The name Maiden Lane was taken from the street on the north side of the Federal Reserve Bank's Manhattan location.

In the United States, the Great Recession was a severe financial crisis combined with a deep recession. While the recession officially lasted from December 2007 to June 2009, it took many years for the economy to recover to pre-crisis levels of employment and output. This slow recovery was due in part to households and financial institutions paying off debts accumulated in the years preceding the crisis along with restrained government spending following initial stimulus efforts. It followed the bursting of the housing bubble, the housing market correction and subprime mortgage crisis.

<span class="mw-page-title-main">2007–2008 financial crisis</span> Worldwide economic crisis

The 2007–2008 financial crisis, or Global Economic Crisis (GEC), was the most severe worldwide economic crisis since the Great Depression. Predatory lending in the form of subprime mortgages targeting low-income homebuyers, excessive risk-taking by global financial institutions, a continuous buildup of toxic assets within banks, and the bursting of the United States housing bubble culminated in a "perfect storm", which led to the Great Recession.

An asset-backed commercial paper program is a non-bank financial institution that issues short-term liabilities, commercial paper called asset-backed commercial paper (ABCPs), to finance medium- to long-term assets.

References

  1. 1 2 Anand, Diya Gullapalli and Shefali. "Bailout of Money Funds Seems to Stanch Outflow - WSJ". WSJ. Retrieved 2024-04-01.
  2. ↑ "Board approves two interim final rules in connection with its initiative to provide liquidity to markets". Board of Governors of the Federal Reserve System. 2008-09-19. Retrieved 2023-05-18.
  3. ↑ "SEC temporarily suspends short selling". The Mercury News. 2008-09-19. Retrieved 2024-04-01.
  4. ↑ Rosenwald, Michael S.; Landy, Heather (2008-12-26). "Investors Flee Stock Funds". washingtonpost.com. Retrieved 2010-01-21.
  5. ↑ Trejos, Nancy (2007-01-15). "Retirement Wreck". washingtonpost.com. Retrieved 2010-01-21.
  6. ↑ Bull, Alister. "Fed says to make loans to aid money market funds", Reuters, September 19, 2008.
  7. ↑ "Central banks cut interest rates". BBC News. October 8, 2008. Retrieved 2008-10-19.
  8. ↑ "Historical Changes of the Target Federal Funds and Discount Rates – Federal Reserve Bank of New York". Newyorkfed.org. Archived from the original on December 21, 2008. Retrieved 2008-10-19.
  9. ↑ Herszenhorn, David M. (2008-09-20). "Administration Is Seeking $700 Billion for Wall Street". New York Times. Retrieved 2008-09-25.
  10. ↑ House of Representatives Roll Call vote results. Library of Congress THOMAS website. Retrieved on September 29, 2008.
  11. ↑ Wu, Yan Wendy; Wilson, Linus (December 29, 2009). "Common (Stock) Sense about Risk-Shifting and Bank Bailouts". SSRN.com. SSRN   1321666.{{cite journal}}: Cite journal requires |journal= (help)
  12. ↑ "Fed Pumps Huge Wads of Cash Into System- page 2 of 2 - TheStreet.com". Thestreet.com. 2008-09-29. Retrieved 2008-10-19.
  13. ↑ "Fed's $800 billion package aims to unlock lending - USATODAY.com". usatoday30.usatoday.com.
  14. ↑ "US Fed announces $800bn stimulus". 2008-11-25. Retrieved 2024-04-01.
  15. ↑ "Opinion article". www.desmoinesregister.com. 2008.
  16. ↑ "Fed's spending is risky business". Marketplace. 2008-12-22. Retrieved 2009-01-12.
  17. ↑ "Housing and Jobs Data Suggest Steady Growth". The New York Times. Associated Press. May 23, 2013. Retrieved May 24, 2013.
  18. ↑ Nathaniel Popper (May 23, 2013). "Fed Fears Shake Global Markets but Fade on Wall St". The New York Times. Retrieved May 24, 2013.
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