Wednesday, January 7, 2009

Financial Crisis of 2008--A Summary

... The Calendar

1980s--Reagonomics lays a groundwork of deregulation and trickle-down economic policies; U.S. borrowing spree (personal and federal) and poor international balance of payments swell

1990s--fiscal belt-tightening and poor oversight let the embers grow

2000-2007--Federal ignorance and complicity let the housing bubble swell adding non-regulated, non-transparent, sub-prime mortgage derivatives; credit default swaps grow to trillions of dollars; and short-term Wall Street profits are linked to excessive management pay incentives

late 2007 into 2008--sub-prime mortgages begin to reset to higher interest rates; housing-loan defaults rise

April-May 2008--Bear Stearns, one of the largest global investment banks and securities trading firms, fails; bought by J. P. Morgan, a huge financial services firm with $2.3 trillion capitalization and deposit base, with Fed guarantee of shakiest assets

July, August 2008--bonds ratings lowered, raising margin requirements; credit default swaps overhang financial markets; credit markets tighten

Sept. 7, 2008--Fannie Mae and Freddie Mac collapse and are nationalized; they were formed in 1968 and 1970 respectively as privately owned GSEs (Government Sponsored Enterprises) to purchase and securitize mortgages to assure availability of home-buyer loans

Sept. 15, 2008--Lehman Brothers, a huge global financial services firm, files chapter 11--largest bankruptcy in U.S. history; disorderly process allowed by Fed frightens Wall Street regarding future willingness of U.S. to protect major institutions

mid-Sept. 2008--credit markets seize up; large and small would-be borrowers face liquidity crises

Sept. 16, 2008--American International Group (AIG), an enormous global insurance company with considerable long-term assets, threatens to fail due to illiquidity from raised capital requirements due to downgrade of AA bond ratings; receives $85 billion government credit for 80% of equity

Sept. 25, 2008--Washington Mutual (WaMu), the largest U.S. savings and loan association, goes into receivership after 10-day run-on-the-bank withdrawals total $16.4 billion

Sept./Oct. 2008--Wachovia, the 4th largest bank-holding company in the U.S., looks weak; potential sale to Citigroup falls through

Sept./Oct. 2008--Congress passes TARP bailout; TARP is a $700-billion "Troubled Assets Relief Program" to purchase "poison" bank assets (mostly securitized, sub-prime and alt-A mortgage defaults); Congress is under tremendous public scrutiny and condemnation

Nov. 2008--TARP funds are diverted by Treasury into purchase of big banks' equity but these funds go into bank reserves, not lending; biggest recipients are:
...Citigroup ($45 billion in bailout funds)
...J.P. Morgan Chase ($25 billion)
...Bank of America ($25 billion)
...Wells Fargo ($25 billion)
...Goldman Sachs ($10 billion)
...Morgan Stanley ($10 billion)
...PNC Financial Services ($7.6 billion)
...U.S. Bancorp ($6.6 billion)
...SunTrust ($4.9 billion)

Nov. & Dec. 2008--international reductions of interest rates

Dec. 31, 2008--Wachovia, continuing weak, is purchased by Wells Fargo; a few days later Moody's downgrades Wells Fargo because of Wachovia acquisition

... The Remedies

(1) let big corporations fail if they must, but in an orderly way--
...nationalize them (to limit the spreading and protect the guts of the systems),
...replace the management,
...sell off valuable assets, and
...hold weak assets for calmer times
...(shareholders lose money; creditors do not)

(2) break up (early) any corporations that are "too big to be allowed to fail"

(3) regulate rating agencies--and forbid bond-issuers from paying for ratings (these should be paid for by the borrowers or the government)

(4) regulate Wall Street more carefully and knowledgeably--
...regulate (and limit) obscure derivative securities and credit default swaps
...impose new capital requirements for banks
...forbid SEC regulators from revolving-door into Wall Street (require delay)
...require SEC to have experienced, Wall-Street-savvy regulators
...require mark-to-market accounting and transparent financial records