bank that was going bankrupt because of its exposure to mortgage-backed
securities. Over the next six months, “Fannie Mae” and “Freddie Mac,” which
fund most of the home loans in the nation; investment bank Merrill Lynch; and the
world’s largest insurance company, American International Group (AIG), had to
be bailed out by the federal government. When investment bank Lehman Brothers
went bankrupt and Washington Mutual, the nation’s sixth-largest bank, failed, the
markets panicked.
This series of disasters and near disasters led to around-the-clock meetings of
Fed and Treasury leaders, who produced a plan for the government to buy mortgage-
related assets from banks and other financial institutions. In a stunning rebuke to
party leaders and President Bush, the Senate initially rejected the proposed plan and
took the lead on retooling the bill. The Senate passed the bill by a bipartisan 75–24 vote.^32
Two days later the House passed the bill by a 263–171 vote, with strong support from
both parties.^33 President Bush signed the Emergency Economic Stabilization Act into
law on October 3, 2008. The Troubled Asset Relief Program (TARP) was established
under the act to buy up to $700 billion in bad assets to help stabilize the banks.
Despite this significant rescue plan, the crisis spiraled out of control in the following
weeks. Stock markets plunged worldwide, with the U.S. stock market shedding 35
percent of its value in the two months after the crisis began. Credit markets remained
frozen, and it became clear that an alternative approach was needed. European
leaders swiftly agreed to an approach in which governments would directly invest in
banks, providing them with desperately needed capital in return for equity stakes in
the banks. The United States followed suit with an initial allocation of $250 billion
to directly invest in banks, followed by an announcement that the Treasury would
abandon its plan to buy toxic debt created by the subprime mortgage mess and use all
the funds to directly invest in banks. By mid-November, the economic panic had eased,
but the situation remained fragile.
When President Obama took office in 2009, things were still very grim. Stocks
finally bottomed in March 2009 (down 56 percent from their October 2007 high),
shortly after Treasury Secretary Timothy Geithner announced the administration’s
Financial Stability Plan. The plan focused on four problems: frozen credit markets,
weakened bank capital, a backlog of troubled mortgage assets on bank balance
sheets, and falling home prices. Working with the Fed to stabilize the financial
markets, the Treasury had largely resolved three of those four problems one year
later. Credit markets were operating, and banks were in much better shape, having
raised more than $140 billion in capital and $60 billion in unsecured debt. Banks
used these funds to repay the Treasury, which as of March 2018 has earned a 10.3
percent profit for the government. The Treasury expects to eventually recover all of
the TARP expenditures (with 96.6 percent recovered as of June 2018).^34 The housing
market has also stabilized, with sales up and prices slowly rising in most markets.
Troubled mortgage assets remain on the balance sheets of many banks, but
with their stronger base of capital and the strengthened housing
market, these securities were not as great a concern as they had
been.^35 In September 2012, the Fed announced a new policy to
inject money into the economy, promising to buy $40 billion a
month of mortgage-backed securities. Three months later
this policy was increased to $85 billion a month. This was
an open-ended commitment and was seen as the boldest
move yet by the Fed to revive the economy. Overall, the Fed
increased its balance sheet from just over $900 billion when
the crisis began to just over $4.5 trillion when the balance sheet
peaked in October 2015 (see Figure 15.3). Thus, the Fed injectedProtesters at a rally against
government bailouts for Wall Street
called for the resignation of the
chief executive of Goldman Sachs
and cancellation of bonuses for all
Goldman employees. Huge profits and
bonuses on Wall Street in 2009–2010
were very controversial, as the national
unemployment rate held at nearly
10 percent.Full_16_APT_64431_ch15_530-571.indd 549 15/11/18 2:34 PM