This page is one part of the Finance Repo and a supporting document for the longer essay When Magic Unravels: The 2008-2009 Crisis.

Untitled – The 2008-2009 Crisis: General Facts & Chronology

• General Facts
  • What are the facts of a Credit Crisis? What about the Debt Crisis?
    • What do Crises look like?
  • This is one of the top 6 government bailouts.
  • The U.S. economy is the world’s largest, with a gross domestic product (GDP) of approximately $14.5 trillion as of the end of 2008. This economy supports a massive governmental bureaucracy with a budget of $2.9 trillion for 2008. In 2008, the federal budget deficit exceeded $450 billion – an all-time high at the time. In 2009, the budget deficit is expected to exceed $700 billion.
  • Wall Street’s poorest performance since the Great Depression of the 1930s saw stock market wealth worth $6.9 trillion wiped out during 2008.
  • As of October 2008, the national debt exceeded $10 trillion for the first time.
  • 2001 til 2009, the total cost of the war on terror has exceeded $2 trillion.
  • In 2008, the federal budget deficit exceeded $450 billion – an all-time high at the time. In 2009, the budget deficit is expected to exceed $700 billion.
  • Over one million jobs were eliminated in the U.S. in 2008, which contributed to the unemployment rate approaching 8%. With U.S. per capita earnings of $48,000, one million layoffs translate to approximately $48 billion in eliminated payroll and earnings for working families. These statistics do not include under-employment figures in the country – it is estimated that one out of nine Americans are underemployed. As of 2007, approximately 12.5% of Americans lived below the poverty line.
  • As the U.S. approaches the end of the 2000s, some economists and government accountants estimate that Social Security and Medicare unfunded liabilities would exceed $80 trillion.
  • The U.S. residential mortgage market is an $11 trillion market (source)
  • Fannie Mae and Freddie Mac own (or back) more than $5 trillion of U.S. mortgages in 2009. The two companies account for almost half of the $12 trillion U.S. mortgage market.
  • People in short positions may not be any more right on the crisis than those in long (source)
  • “A housing boom mostly concentrated in a single, nearly contiguous blob reaching from Sacramento to the environs of Las Vegas and Phoenix was transmuted into a global financial disaster.” (source)
  • “All these home loans are packaged into mortgage-backed securities. You have your different tranches…Triple-A, all the way down. And there are these pooling and servicing agreements, which tell the services who collect your loan payments how you’re supposed to interact with the borrower. So, if a borrower falls behind, here’s what you’re supposed to do to try to maximize cash flow. Now, the servicers are trying to maximize cash flow for the investors in the aggregate. They’re not supposed to be picking and choosing which tranche of investors to be favoring. They’re supposed to be acting on behalf of all of them.” (source)
  • “1.8 million sub-prime mortgages almost brought the banking structure to its knees, and we’ve got 8.1 million alt-As starting to reset at the end of this year.” (source)
  • “The bank should cut your principal, because maybe they’re only going to get 60 cents on the dollar in foreclosure.” (source)
  • The Government National Mortgage Association (Ginnie Mae) had been bundling and selling securitized mortgages as ABSs for years; their ‘AAA’ ratings had always had the guarantee that Ginnie Mae’s government backing had afforded . Investors gained a higher yield than on Treasuries, and Ginnie Mae was able to use the funding to offer new mortgages.
  • Amid this flight to quality, three-month Treasury bills became the new “must-have” fixed-income product and yields fell a shocking 1.5% in a matter of days. Even more notable than the buying of government-backed bonds (and short-term ones at that) was the spread between similar-term corporate bonds and T-bills, which widened from about 35 basis points to more than 120 basis points in less than a week.
• Chronology
  • 2001-2003
    • To keep recession away, the Federal Reserve lowered the Federal funds rate 11 times - from 6.5% in May 2000 to 1.75% in December 2001 - creating a flood of liquidity in the economy. The Fed continued slashing interest rates, emboldened, perhaps, by continued low inflation despite lower interest rates. In June 2003, the Fed lowered interest rates to 1%, the lowest rate in 45 years.
    • the number of homes sold – and the prices they sold for – increased dramatically beginning in 2002. At the time, the rate on a 30-year fixed-rate mortgage was at the lowest levels seen in nearly 40 years
    • Over a four-year period — from February 2002 to February 2006 — the Case-Shiller index increased … about 50 percent in constant dollars. Certainly, those price increases cannot be explained by increases in average income. Income growth was quite modest from 2002 to 2006. Nor can the boom be explained by a dearth of new housing supply. Construction rose dramatically during the boom. (source)
    • To get a 50 percent real increase in housing prices, real interest rates would have had to decline by more than …10 percentage points…, which is not what happened. … Real rates actually rose slightly between 2002 and 2006.(source)
  • 2004
    • in October 2004, the Securities Exchange Commission (SEC) relaxed the net capital requirement for five investment banks – Goldman Sachs (NYSE:GS), Merrill Lynch (NYSE:MER), Lehman Brothers, Bear Stearns and Morgan Stanley (NYSE:MS) - which freed them to leverage up to 30-times or even 40-times their initial investment
    • From June 30, 2004, onward, the Fed started raising rates so much that by June 2006, the Federal funds rate had reached 5.25% (which remained unchanged until August 2007).
    • by 2004, U.S. homeownership had peaked at 70%; no one was interested in buying or eating more candy. Then, during the last quarter of 2005, home prices started to fall, which led to a 40% decline in the U.S. Home Construction Index during 2006.
    • But in 2004, the U.S. Department of Housing and Urban Development (HUD) directed Fannie Mae and Freddie Mac to purchase more loans made to subprime borrowers. This would expand the market for subprime loans and also enable the two GSEs to fulfill their affordable housing mandate in the U.S. From 2004-2006, Fannie Mae and Freddie Mac purchased $434 billion in securities backed by subprime loans, further fueling the boom in subprime lending. In 2004 alone, the two GSEs purchased $175 billion in subprime securities, accounting for 44% of the market and an increase of 116% from 2003, when they bought $81 billion in these securities.
  • 2005
    • In 2005, Fannie Mae and Freddie Mac purchased $169 billion of subprime securities, accounting for 33% of the market.
      
  • 2006
    • in 2006, Fannie Mae and Freddie Mac scaled their subprime purchases back to $90 billion.
    • The CDO market (secured mainly with subprime debt) ballooned to more than $600 billion in issuance during 2006 alone – more than 10-times the amount issued just a decade earlier.
    • by the middle of 2006, cracks began to appear. New homes sales stalled, and median sale prices halted their climb.
  • 2007
    • During February and March 2007, more than 25 subprime lenders filed for bankruptcy, which was enough to start the tide. In April, well-known New Century Financial also filed for bankruptcy.
    • Dow Jones Industrial Average to all-time highs in July of 2007.
    • According to 2007 news reports, financial firms and hedge funds owned more than $1 trillion in securities backed by these now-failing subprime mortgages – enough to start a global financial tsunami if more subprime borrowers started defaulting. By June, Bear Stearns stopped redemptions in two of its hedge funds and Merrill Lynch seized $800 million in assets from two Bear Stearns hedge funds.
    • Aug 2007 – Northern Rock collapse (UK)
    • December of 2007, when the United States Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank (ECB) and the Swiss National Bank took coordinated action to address the developing credit crisis.
    • TAF: The Term Auction Facility was launched on December 12, 2007. It permitted banks to use securities as collateral to take short-term loans from the federal government for periods of either 28 or 84 days. In the Fed’s words, TAF is a “credit facility that allows a depository institution to place a bid for an advance from its local Federal Reserve Bank at an interest rate that is determined as the result of an auction.” The first auction took place on December 17.
    • Fannie Mae and Freddie Mac recorded $14.9 billion in combined net losses in 2007, depleting their capital and undermining their financial strength. With Fannie Mae already down 83% for the year and Freddie Mac down 88% on concerns about their solvency, Treasury Secretary Henry Paulson said federal regulators would back the two GSEs and asked Congress for the authority to inject unlimited amounts of capital into the two companies. These measures served to improve investor sentiment only briefly. By the last week of July, the stocks had resumed their slide amid escalating concerns about their survival. Under the conservatorship agreement, the U.S. Treasury would make a capital infusion of (up to) $100 billion into each GSE. In exchange, each GSE would issue $1 billion of senior preferred stock with a 10% coupon to the U.S. Treasury. Other conditions of the agreement were that each GSE’s retained mortgage and mortgage-backed securities portfolio should not exceed $850 billion as of December 31, 2009, to be reduced by 10% per year until it reached $250 billion.
  • 2008
    
    • Iceland’s Near-Collapse
    • FNMA and FDMC’s role
      
  • 2008 Jan-August
    • The Fall of the Market
    • TSLF: The Term Securities Lending Facility was launched on March 11, 2008. Like TAF, which made credit available to “depository institutions,” TSFL made $200 billion in credit available to other financial institutions (brokerage firms and other entities such as Fannie Mae, Freddie Mac, Citigroup, Countrywide Financial) for 28-day periods as opposed to the traditional overnight loans. These entities use securities as collateral to borrow money. Weekly auctions began on March 27, 2008.
    • PDCF: On March 17, 2008, the Federal Reserve announced the creation of the Primary Dealer Credit Facility. Unlike TAF and TSLF, which were designed to address long-term funding needs, PDCF provides daily access to cash to the same entities that borrow from TAF and TSLF. The institutions pay an interest rate equal to the Fed’s primary credit rate for short-term (overnight) loans
    • In March 2008 – Bear Stearns acquired by JPM.
    • Merrill Sale to BOA.
    • In July – IndyMac.
  • 2008 September
    • On September 7, 2008, amid mounting concerns about the solvency of the two GSEs, the Federal Housing Finance Agency (FHFA) - the regulator of Fannie Mae and Freddie Mac - determined that the two GSEs could not continue to operate safely and fulfill their public mission. This was deemed to pose an “unacceptable risk to the broader financial system” and the U.S. economy. Therefore, FHFA announced that it would place the companies under conservatorship, which is essentially the equivalent of a Chapter 11 bankruptcy, and appoint new leadership.
    • the rescue of AIG,  (source)
    • AMLF: In September, 2008, the Federal Reserve Board announced the creation of the Asset-Backed Commercial Paper Money Market Fund Liquidity Facility, which loans money to banks and bank holding companies to help them meet redemptions in money market funds. They do this by lending funds to borrowers to purchase eligible ABCP’s from the money market fund. Because the market for commercial paper dried up, the government feared that investors would be unable to redeem their assets from money-market funds.
      
    • The commercial paper market shut down, 3-month Treasuries dipped below zero, and a money market mutual fund “broke the buck” for only the second time in history. (source)
    • September 1, 2008 one month LIBOR-OIS spread was 47 basis points. (source)
    • Sept 15 Lehman Bros goes bankrupt. See Case Study. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide. With $639 billion in assets and $619 billion in debt, Lehman’s bankruptcy filing was the largest in history. (source)
      
    • September 18th, when we first went to Congress, the LIBOR-OIS spread had climbed to 135 basis points. (source)
    • September 21, 2008: Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), the last two of the major investment banks still standing, convert from investment banks to bank holding companies in order to gain more flexibility for obtaining bailout funding.
    • September 25, 2008: After a 10-day bank run, the Federal Deposit Insurance Corporation (FDIC) seizes Washington Mutual, then the nation’s largest savings and loan, which had been heavily exposed to subprime mortgage debt. Its assets are transferred to JPMorgan Chase (NYSE:JPM).
    • September 28, 2008: The TARP bailout plan stalls in Congress.
    • September 29, 2008: The Dow declines 774 points (6.98%), the largest point drop in history. Also, Citigroup (NYSE:C) acquires Wachovia, then the fourth-largest U.S. bank.
  • 2008 October
    • October 3, 2008: A reworked $700 billion TARP plan, renamed the Emergency Economic Stabilization Act of 2008, passes a bipartisan vote in Congress. (U.S. bailouts date all the way back to 1792. Learn how the biggest ones affected the economy in Top 6 U.S. Government Financial Bailouts.)
    • Assess TARP
    • October 6, 2008: The Dow closes below 10,000 for the first time since 2004.
    • October 22, 2008: President Bush announces that he will host an international conference of financial leaders on November 15, 2008.
    • By October 2008, the Federal funds rate and the discount rate were reduced to 1% and 1.75%, respectively. Central banks in England, China, Canada, Sweden, Switzerland and the European Central Bank (ECB) also resorted to rate cuts to aid the world economy.
    • When TARP bill passed on October 3, LIBOR-OIS spread had nearly doubled to 263 basis points. (source)
    • Oct 3 – TARP or “National Economic Stabilization Act of 2008″ or “Emergency Economic Stabilization Act of 2008″ becomes law. $700 billion to purchase distressed assets, especially mortgage-backed securities.
    • Oct 10, LIBOR-OIS spread had spiked to 338 basis points. (source)
    • The CEOs of 9 largest banks meet Treasury on Monday, October 13, 2008 and agreed to participate in the Capital Purchase Program. (source)
      
    • CPFF: The Commercial Paper Funding Facility came along in October of 2008, as commercial paper fell victim to illiquid credit markets. It was designed to provide a market for commercial paper by purchasing commercial paper from eligible  issuers. The facility would use a special purpose vehicle (SPV) to buy and hold these commercial paper to maturity and use the proceeds at maturity to repay the funds they borrowed from the Fed.
    • In October of 2008, revisions to the TARP program were announced by Treasury Secretary Paulson and President Bush; allowing for the first $250 billion to be used to buy equity stakes in nine major U.S. banks, and many smaller banks. This program demands that companies involved lose some tax benefits, and in many cases incur limits on executive compensation.
  • 2008 November, December
    
  • 2009
    • In January, Treasury began collecting data from the twenty largest recipients of capital under the CPP, representing almost 90% of CPP capital investments. (source)
    • “How does AIG figure into that? Weren’t there $400 million worth of bonuses paid out there?” (reply)
      • “For these large global institutions like AIG, or like Citigroup, that are these big global bank holding companies, there’s no receivership authority (to repudiate contractual bonuses)… creditors could then put the company into bankruptcy.” (source)
  • 2009 March
    • TALF came next. In March of 2009, the Term Asset-Backed Securities Lending Facility, or bailout number two, tossed $200 billion more into the bailout pool by printing new money. The government launched TALF after the asset-backed securities (ABS) market froze over in October, causing consumers and small business owners to be unable to access credit. TALF was supposed to “help market participants meet the credit needs of households and small businesses by supporting the issuance of ABS collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA).” This effort also wasn’t enough.
    • TALF helped “securitization markets begin to show some thawing. (May 2009) they did $10 billion of transactions. (April 2009) we’d done $3 billion.” But this is new securitization, not legacy. TALF may expend to legacy CMBS and RMBS. (source)
    • PPIP: The Public-Private Investment Program, rolled out in March 2009, was created to buy bad assets in order to get them off of banks’ books. It was funded with a combination of TARP money and money from private investors. The program’s main purpose was to provide price discovery in the market for toxic assets and to remove these assets from the balance sheets of financial institutions.
  • 2009 April
    • FSP: Bailout number three, the Financial Stabilization Plan, grew TALF to a trillion dollars. It also permits commercial-mortgage backed securities (CMBS) to be used as collateral.
    • The FSP promised to create a new “public-private” governmental fund to absorb toxic assets and leverage private capital to stimulate the financial markets. It also aimed to further standardize the banking system and provide capital to unstable lending institutions. A consumer-business lending initiative was also included to restore consumer credit for stable borrowers.
    • TARP legislation created something called the Office of Financial Stability (source)
  • 2009 May
    • In the 7 months since Congress passed the TARP, Treasury has now invested approximately $200 billion in 579 healthy, viable banks in 48 states, Puerto Rico, and Washington D.C., with new investments each week. The investments have ranged from as high as $25 billion to as small as $300,000. The median investment is around $15 million.” (source)
    • “Some 30% of the TARP funds that have been deployed (til May 2009) have been invested in Citi and Bank of America, if I’m correct. About $90 billion” (source)
    • “loans that originated before March of ‘08, right? That’s — we’re buying with TARP funds”. (source)
    • “Until 17 January (2009), you’ve got a lender like Bank of America lending without any income documentation”. (source)
  • 2009 June
    • Jun 17 Obama releases draft of proposal (doc) that involves
      • I. Promote Robust Supervision and Regulation of Financial Firms #
      • II. Establish Comprehensive Regulation of Financial Markets #
      • III. Protect Consumers and Investors from Financial Abuse #
      • IV. Provide the Government with the Tools it Needs to Manage Financial Crises #
      • V. Raise International Regulatory Standards and Improve Interrlational Cooperation #
  • 2010