the current economic "situation"
When cJ first penned this page we were worried about sounding too doomsday-y, lest our alarmism add to the fear cycle that leads to economic collapse. No point in worrying about that anymore. There's little doubt the global financial world is in seriously bad shape these days - and there are few economists who think we aren't in a deep recession - but how deep is still an open question.
The Treasury, the Federal Reserve (the US's lending arm which tries to keep the economy on an even keel) and Congress got an early start in intervening in the economy in ways they hoped will cushion the crash - although critics say many of their interventions were too little, too late, and too confused. Through interest rate tweaks, stimulus plans, heavy lending, new regs and bail-outs big and bigger they're hoping to give the economy enough bounce to keep the crisis from turning to catastrophe.
How'd this happen?
CitizenJoe wouldn't dare sum up the causes of the current financial mess in a few phrases, but the G20 "communique" world leaders produced in a November '08 meeting does dare: "weak underwriting standards, unsound risk-management practices, increasingly complex and opaque financial products and consequent excessive leverage." (WP)
What does that mean? Let us oversimplify: a few years back brokers and banks started offering more and more high-risk mortgages to people that had slim chance of making their payments; brokers could do so because they were able to chop up those mortgages and sell them off in bits (called "tranches" that then got packaged into "mortgage backed securities") and so pass along the risk to Wall Streeters (and pension funds and 401ks); those tranches became part of the web of securities traded on Wall Street that were increasingly complex and so hard to value; but because everyone kept making money, financial firms kept borrowing more (leveraging) so they could invest even more in the seemingly endless boom.
It all worked fine while housing prices kept soaring, allowing homeowners to refinance their homes whenever they needed more cash. But when a small spike of homeowners started defaulting on their mortgages, a downward spiral set in of real-estate prices crashing and yet more foreclosures, as defaulting homeowners had a harder time refinancing their homes in a sinking market. At the same time, everyone holding on to mortgage backed securities started to realize they may be holding to, well, junk. Financial firms started to fall, making banks nervous about whether all their investments and loans were similarly locked up in bum securities. That made banks want to lend less, drying up credit all around. As few things clam up an economy more than dried up credit, recession was just around the corner. (Also see cJ's housing crisis overview and this explainer from David Leonhardt at the NYTimes.)
What's a government to do?
When an economy slumps, there are a couple of things a national government can - and usually will - do to perk it up: lower interest rates and inject money into the economy (via "stimulus" packages). Because of the character of this particular slump, DC is also taking steps to grease the lending wheels of Wall Street and to stave off massive home foreclosures. Below is a running record of DC's plans and actions: (also see this NYTimes graphic of all the money the Treasury and Fed have spent, promised, loaned and guaranteed during the crisis - as of November 26, 2008.)
Bailouts big and bigger. The government's fastest - and perhaps most far-reaching - intervention has been its bailouts of "too big to fail" financial firms, starting with Bear Stearns and capping off with a $700 billion bailout fund approved by Congress in 2008. The auto industry also cashed in, after convincing lawmakers that, if they completely collapsed, they could bring down the US economy with them.
The massive Wall Street bailouts were seen as necessary by many economists, but many would have preferred to see irresponsible financial firms take a permanent fall. Either way, the bailouts are supposed to be temporary measures, keeping the finance industry from going into lending perma-freeze just long enough to get the economy going.
Pumping up the economy: Congress passed a $168 billion "stimulus" plan in early '08, doling out $600 checks to most working Americans (low income taxpayers got $300). With checks starting to arrive in May, economists hoped consumers would hit the mall (and not the savings bank) to shoot some energy into the economy.
Another bigger boost arrived in early '09 with Congress okaying a $787 billion "economic recovery" to pump money into infrastructure projects, state aid for health care, middle class tax breaks and new energy projects.
Stealth help from the Fed: Even though the financial industry bailout and stimulus bills suck up most media attention, the Federal Reserve has been playing a quiet - but possibly more massiveat - role in propping up the economy.
The first played its usual economy-boosting game of lowering interest rates (which makes it more attractive to borrow and invest in the economy) to avoid a recession; but then started funneling money to investment houses (as loans) to prop up confidence among investors and keep credit humming. The Washington Post estimates the Fed has loaned about about $900 billion in response to the crisis as of November 24, 2008. A June 2009 disclosure from the Fed said they had $448 billion out in short term loans (WP).
Add on to that another $800 billion the Fed announced on November 26 it would be pumping out - $600b for Fannie and Freddie and $180b to funnel money toward consumer credit. (WP, WP, NYT) That effort saw quick results with mortgage rates dropping to historic lows, even though only credit-worthy homeowners seem to be benefiting. (USAT, WP)
Propping up mortgages: Congress and DC regulators are also churning out ways to save homeowners from defaulting mortgages - by easing up and creating new federally backed loans - while protecting families from future risky loans. See our Housing Jitters page.
Regulating Wall Street: At least part of the current headache on Wall Street is blamed on newer, higher-risk and under-regulated ways of investing. Banks have the FDIC hanging over them to make sure they aren't going too far out on a limb (or at least making their work more transparent); many on the Hill would like to see DC also take a larger role in regulating all financial institutions.
Obama's economics team proposed a new regulatory regime on June 17 to rein in the risky practices of the financial industry and hopefully avoid future bubble-inducing behavior in the markets. Parts of the plan include: setting stricter liquidity requirements for financial firms (so they have more of their own - rather than borrowed - cash in investments and have more cash on hand); requiring that front-line lenders keep some of the risk of their loans (rather than repackaging risk off to investors); creating a new consumer protection agency to oversee financial products (WP), and giving the Fed oversight of all financial firms (not just banks) and more power to step in when large firms go skating on thin ice.
A lot of the administration's recommendations will require an okay from Congress. With lawmakers lining up on both sides of the debate - some wanting even stricter rules and others saying Obama is going to far - it remains to be seen how far and fast they'll be able to push new regs. Another, previously announced, proposal - that would put derivatives, credit-default-swaps and other "exotic" securities under regulatory control, is also waiting on congressional action. At the same time, federal financial oversight bodies are moving to set tighter regulations on their own; the SEC for example is proposing stricter cash reserves for money market funds (NYT). (NYT, NYT, WP, WP, WP, NYT, WP, WP, NYT, WP, WP, WP, WP, WP)
How the US decides to regulate its markets may also depend on what the rest of the world does. In November, hopes were high that the G20 (made up of the world's wealthiest nations and major emerging powers) would begin to create global oversight of the financial markets, but when the group re-met in April global financial rules and enforcement largely fell by the wayside. (WP, NYT)
Easing student loans: With the credit crunch putting the squeeze on student loans, Congress voted to open up federal lending, HR 5715, to make sure students can still pay their tuition without paying skyrocketing rates. (WP)
Updated June 17, 2009
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