2008 Review

05 November 2012

2008 in Review:
In the last 12 months, the face of the global economy has forever changed. Gone forever are investment banks, the secondary credit market, and an unregulated financial market. In its place are government ownership of banks, while central banks around the world are propping up the banking system. In September, we came very close to total economic collapse, and we haven't recovered yet.

In hindsight, we can now see how it happened, and wonder how we could have been so blind. Understanding how it happened does not allow us to yet see how we will get out of it. However, a review will give us perspective, which allows hope.

1. Fed Innovates to Replace Failed Banking System:

In 2008, Federal Reserve Chairman Ben Bernanke used innovations to allow the Fed to shore up the failed financial system. In March, the Fed launched the Term Auction Facility, which makes short-term loans available to cash-strapped banks who won't lend to each other. In October, the Fed made $540 billion in loans to bail out money market funds. In November, the Fed agreed to buy $800 billion in mortgage-backed securities in an attempt to lower interest rates. In its role as bank of last resort, the Fed became the only bank that was still lending.

2. Bear Stearns Bailout:

In March, the Federal Reserve held the first emergency weekend meeting in 30 years to try and save investment bank Bear Stearns, which was in danger of going bankrupt thanks to bad mortgage-backed securities and other collateralized debt obligations. The Feds were afraid, and rightly so, that the failure of Bear Stearns would have spread to other overleveraged investment banks, including Merrill Lynch, Lehman and Citigroup. In fact, that is exactly what later happened with Lehman's bankruptcy. By the end of the year, Citigroup also needed a bail-out, even though it was a supposedly less-risky commercial bank.

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3. Freddie Mac and Fannie Mae Bailout:

In September 2008, mortgage companies Fannie Mae and Freddie Mac, who hold or guarantee more than $5 trillion, or half, of the nation's mortgages, became government agencies again. The U.S. Treasury Department bought $100 billion in preferred stock and mortgage-backed securities (MBS). The action came after Wall Street's panicked selling caused Fannie's and Freddie's shares to tumble, making it impossible for these private companies to raise additional capital themselves. For more, read Costs of Fannie and Freddie Bailout

4. Lehman Brothers Bankruptcy Triggers Global Recession:

If Treasury Secretary Paulson had only known that his action would lead to a global recession. In September, he said no to government protection for Lehman's $60 billion in uncertain mortgage assets in a weekend negotiation with potential buyers Barclay's and Bank of America. At the time, he thought the amount was too much, and he was being pressured to keep the government off the hook. Now, it seems like small potatoes. Lehman's Brothers bankruptcy panicked global bankers, which led to the recession we are in now.

5. Fed Nationalizes AIG:

In September, the Federal Reserve bought shares in insurance giant AIG. Why was AIG worth saving? Because it insured credit default swaps, which basically insures loans and mortgages against default. If AIG went under, so would all of these loans, which are owned by financial institutions around the world, including money market funds, pension funds and retirement accounts. In November, the Fed increased the bailout from $85 billion to $150 billion.

6. Credit Markets Freeze:

In September, banks withdrew $160 billion from ultra-safe money market accounts. Banks were hoarding cash for write-downs on bad mortgages and withdrawals in bank runs. By the end of the week, banks held $190 billion in cash, as opposed to a normal $2 billion
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reserve. Hoarding led to an increase in LIBOR, which affects $360 trillion in loans and credit card assets. The credit freeze led to a cash shortage for many businesses, such as Circuit City and the Big 3 auto companies. In response, the Federal Reserve lowered interest rates to zero, reducing LIBOR. However, banks continue to hoard cash into 2009.

7. End of Investment Banking:

In November, Goldman Sachs and Morgan Stanley, two of the most successful investment banks on Wall Street, became regular commercial banks, ending an era of deregulation and high risk.

8. Stock Market Crash: By the end of 2008, the Dow was down 34%, closing at 8,816.62. Other indices did worse: the S&P 500 ended at 907.22, a 38% decline, the MSCI Europe Index was down 45% and the MSCI Asia Pacific Index dropped 43%. The Dow dropped 25% in October alone, from 10,831 on October 1 to 8,175 on October 27. It reached its low of 7,552 on November 20, a 46% decline from its October 2007 high of 14,164.

9. $700 Billion Bailout (Oct 3):

On October 3, the Senate passed the $700 billion bailout bill, now known as the TARP program. The program was initially designed to purchase toxic mortgages from banks, freeing up cash for more loans. However, it was taking too long to implement, so on October 14, the Treasury used $350 billion for the Capital Repurchase Program, which purchased preferred stock in major banks. By November, the funds were also used to keep credit card companies in business. By the end of November, Citigroup also joined the bailout list. However, the auto industry only received part of what they asked for.

10. Obama Wins Presidency (Nov 3):

Barack Obama won the Presidency in November, promising to provide sorely-needed hope to jumpstart the stalled economy. His proposals to streamline regulatory agencies, improve transparency for financial disclosure, and crack down on manipulative trading activities would help restore confidence in financial markets. However, his first priority is
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to pump as much as $800 billion into the economy through tax relief and jobs programs. Once the crisis is resolved, Obama would implement the rest of his 10 point program, which includes more labor and environmental controls on free trade agreements, and health care reform.

Obama has surrounded himself with top-notch, respected and experienced economic staff. He put together an Economic Advisory Board, led by former Federal Reserve Chairman Paul Volcker. He named hard-hitting Mary Schapiro as head of the SEC. As Treasury Secretary, Tim Geithner brings experience from both the New York Fed and the IMF. Even Obama's Vice-President, Joe Biden brings a great deal of fiscal policy experience to the team.

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