The sudden shutdown of much of the economy of the U.S. and of the world starting in February and March of 2020 led to deep concern, if not panic, in world financial markets. Millions of people were suddenly unemployed or furloughed, millions of small businesses faced bankruptcy, and stocks plunged some 30% in the fastest fall of global markets in history. Demand collapsed, and prices for nearly all financial assets fell. Trillions of dollars of financial transactions were in danger of unravelling.
The Federal Reserve immediately rode to the rescue, slashing interest rates and buying up all kinds of financial assets. These purchases of bonds and similar products injected cash into the markets to provide much-needed liquidity, and kept the system on track. In late March, the U.S. federal government authorized trillions of dollars of payments to individuals and businesses to stave off bankruptcy, and forbade foreclosures on mortgages, to keep people from losing their homes (at least in the near term). Banks and governments in other nations took similar measures. By May, it was clear that the worst scenarios had been averted, even though there will be significant lingering consequences of the Covid shutdowns.
The speed and scale of the Fed and government responses in March, 2020, may be attributed in part to learnings from the 2008-2009 Global Financial Crisis (GFC). In that crisis, the severity of the problem was not understood at first. There was naturally reluctance to take unprecedented actions to do what was perceived as bailing out of irresponsible banks and other companies. Over a period of many months, various measures were implemented to address some immediate needs, but then more and more problems kept cropping up. It was a macroeconomic game of whack-a-mole.
As a bit of a history lesson, here is a timeline of the main financial events of January-September, 2008. These descriptions are taken, with only minor editing, from an article by Kimberly Amadeo in The Balance.
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January 2008: Fed Tries to Stop Housing Bust
Easy credit and expectations of always-increasing home prices led to a speculative run-up in housing in 2002-2006. Mortgages were given to people who really could not afford them, and billions of dollars of those unsound sub-prime mortgages were repackaged and sold into the broad financial system. That all began to unravel in 2006-2007. In response to a struggling housing market, the Federal Market Open Committee began lowering the fed funds rate. It dropped the rate to 3.5% on January 22, 2008, then to 3.0% a week later. Economic analysts thought lower rates would be enough to restore demand for homes.
It didn’t help the millions of homeowners who had adjustable-rate mortgages.
February 2008: Bush Signs Tax Rebate as Home Sales Continue to Plummet
President Bush signed a tax rebate bill to help the struggling housing market. The bill increased limits for Federal Housing Administration loans and allowed Freddie Mac to repurchase jumbo loans.
February’s homes sales fell 24% year-over-year. It reached 5.03 million according to the National Association of Realtors. The median resale home price was $195,900, down 8.2% year-over-year. Foreclosures were up.
March 2008: Fed Begins Bailouts
The Fed Chair realized the Fed needed to take aggressive action. It had to prevent a more serious recession. Falling oil prices meant the Fed was not concerned about inflation. When inflation isn’t a concern, the Fed can use expansionary monetary policy. The Fed’s goal was to lower the LIBOR benchmark interest rate, and keep adjustable-rate mortgages affordable. In its role of “bank of last resort,” it became the only bank willing to lend.
It increased its Term Auction Facility program to $50 billion. It also initiated a series of term repurchase transactions. These were 28-day term repurchase agreements with primary dealers. The Fed’s goal was to pump $100 billion into the economy.
March 11: The Fed announced it would lend $200 billion in Treasury notes to bail out bond dealers. They were stuck with mortgage-backed securities and other collateralized debt obligations. They couldn’t resell them on the secondary market. The subprime mortgage crisis dried up the secondary market for these debt products.
No one knew who had the bad debt or how much was out there. All buyers of debt instruments became afraid to buy and sell from each other. No one wanted to get caught with bad debt on their books. The Fed was trying to keep liquidity in the financial markets.
But the problem was not just one of liquidity, but also of solvency. Banks were playing a huge game of musical chairs, hoping that no one would get caught with more bad debt. The Fed tried to buy time by temporarily taking on the bad debt itself. It protected itself by only holding the debt for 28 days and only accepting AAA-rated debt.
March 14: The Federal Reserve held its first emergency weekend meeting in 30 years. On March 17, it announced it would guarantee Bear Stearns‘ bad loans. It wanted JP Morgan to purchase Bear and prevent bankruptcy. Bear Stearns’ had about $10 trillion in securities on its books. If it had gone under, these securities would have become worthless. That would have jeopardized the global financial system.
March 18: The Federal Open Market Committee (FOMC) lowered the fed funds rate by 0.75% to 2.25%. It had halved the interest rate in six months. That put downward pressure on the dollar, which increased oil prices.
That same day, federal regulators agreed to let Fannie Mae and Freddie Mac take on another $200 billion in subprime mortgage debt. The two government-sponsored enterprises would buy mortgages from banks. This process is known as buying on the secondary market. They then package these into mortgage-backed securities and resell them on Wall Street. All goes well if the mortgages are good, but if they turn south, then the two GSEs would be liable for the debt.
The Federal Housing Finance Board also took action. It authorized the regional Federal Home Loan Banks to take an extra $100 billion in subprime mortgage debt. The loans had to be guaranteed by Fannie and Freddie Mac.
Fed Chair Ben Bernanke and U.S. Treasury Secretary Hank Paulson thought this would take care of the problem. They underestimated how extensive the crisis had become. These bailouts only further destabilized the two mortgage giants.
April – June: Fed Lowers Rate and Buys More Toxic Bank Debt
April 30: The FOMC lowered the fed funds rate to 2%.
April 7 and April 21: The Fed added another $50 billion each through its Term Auction Facility.
May 20: The Fed auctioned another $150 billion through the Term Auction Facility.
By June 2, the Fed auctions totaled $1.2 trillion. In June, the Federal Reserve lent $225 billion through its Term Auction Facility. This temporary stop-gap measure of adding liquidity had become a permanent fixture.
July 11, 2008: IndyMac Bank Fails
July 11: The Office of Thrift Supervision closed IndyMac Bank. Los Angeles police warned angry IndyMac depositors to remain calm while they waited in line to withdraw funds from the failed bank. About 100 people worried they would lose their deposit. The Federal Deposit Insurance Corporation (FDIC) only insured amounts up to $100,000. This was later raised to $250,000.
July 23: Treasury Secretary Paulson made the Sunday talk show rounds. He explained the need for a bailout of Fannie Mae and Freddie Mac. The two agencies themselves held or guaranteed almost half of the $12 trillion of the nation’s mortgages.
Wall Street’s fears that these loans would default caused Fannie’s and Freddie’s shares to tumble. This made it more difficult for private companies to raise capital themselves. Paulson reassured talk show listeners that the banking system was solid, even though other banks might fail like IndyMac.
July 30: Congress passed the Housing and Economic Recovery Act. It gave the Treasury Department authority to guarantee as much as $25 billion in loans held by Fannie Mae and Freddie Mac.
September 7: Treasury Nationalizes Fannie and Freddie
The FHFA placed Fannie and Freddie under conservatorship. It allowed the government to run the two until they were strong enough to return to independent management.
The FHFA allowed Treasury to purchase preferred stock of the two to keep them afloat. They could also borrow from the Treasury. Last but not least, Treasury was allowed to purchase their mortgage-backed securities.
The Fannie and Freddie bailout initially cost taxpayers $187 billion. But over time, they two paid back all costs plus added $58 billion in profit to the general fund.
September 15, 2008: Lehman Brothers Bankruptcy Triggered Global Panic
Paulson urged Lehman Brothers to find a buyer. Only two banks were interested: Bank of America and British Barclays.
Bank of America didn’t want a loan. It wanted the government to cover $65 billion to $70 billion in anticipated losses. Paulson said no. The U.S. Treasury had no legal authority to invest capital in Lehman Brothers, as Congress hadn’t yet authorized the Troubled Asset Relief Program. Barclays announced its British regulators would not approve a Lehman Brothers deal.
Since Lehman Brothers was an investment bank, the government could not nationalize it like it did government enterprises Fannie Mae and Freddie Mac. For that same reason, no federal regulator, like the FDIC, could take it over. Moreover, the Fed couldn’t guarantee a loan as it did with Bear Stearns. Lehman Brothers didn’t have enough assets to secure one.
When Lehman’s declared bankruptcy, financial markets reeled. The Dow fell 504 points, its worst decline in seven years. U.S. Treasury bond prices rose as investors fled to their relative safety. Oil prices tanked.
Later that day, Bank of America announced it would purchase struggling Merrill Lynch for $50 billion.
September 16, 2008: Fed Buys AIG for $85 Billion
The American International Group Inc. turned to the Federal Reserve for emergency funding. The company had insured trillions of dollars of mortgages throughout the world. If it had fallen, so would the global banking system. Bernanke said that this bailout made him angrier than anything else. AIG took risks with cash from supposedly ultra-safe insurance policies. It used it to boost profits by offering unregulated credit default swaps.
October 8, 2008: The Federal lent another $37.8 billion to AIG subsidiaries in exchange for fixed-income securities.
November 10, 2008: The Fed restructured its aid package. It reduced its $85 billion loan to $60 billion. The $37.8 billion loan was repaid and terminated.The Treasury Department purchased $40 billion in AIG preferred shares. The funds allowed AIG to retire its credit default swaps rationally, stave off bankruptcy, and protect the government’s original investment.
September 17, 2008: Economy Almost Collapsed
Due to losses from Lehman’s bankruptcy, investors fled money market mutual funds. That’s where companies obtain their short-term cash.
September 16: The Reserve Primary Fund “broke the buck.” It didn’t have enough cash on hand to pay out all the redemptions that were occurring.
September 17: The attack spread. Investors withdrew a record $172 billion from their money market accounts. During a typical week, only about $7 billion is withdrawn. If it had continued, companies couldn’t get money to fund their day-to-day operations. In just a few weeks, shippers wouldn’t have had the cash to deliver food to grocery stores. We were that close to a complete collapse.
September 19, 2008: Paulson and Bernanke Meet with Congress
U.S. Treasury Secretary Henry Paulson (L) speaks as Federal Reserve Board Chairman Ben Bernanke (R) listens during a hearing before the House Financial Services Committee on Capitol Hill September 24, 2008 in Washington, DC. Photo: Alex Wong/Getty Images
September 19: Paulson and Bernanke met with Congressional leaders to explain the crisis. Republicans and Democrats alike were stunned by the somber warnings. They realized that credit markets were only a few days away from a meltdown.
The leaders were prepared to work together in a bipartisan fashion to craft a solution. But many rank-and-file members of Congress were not on board.
Bernanke announced the Fed would lend the money needed by banks and businesses to operate so they wouldn’t have to pull out the cash in money market funds. This, along with the announcement of the bailout package, calmed the markets enough keep the economy functioning.
September 20, 2008: Treasury Submits Legislation to Congress
On September 20, Paulson submitted a three-page document that asked Congress to approve a $700 billion bailout. Treasury would use the funds to buy up mortgage-backed securities that were in danger of defaulting. By doing so, Paulson wanted to take these debts off the books of banks, hedge funds, and pension funds that held them.
When asked what would happen if Congress didn’t approve the bailout, Paulson replied, “If it doesn’t pass, then heaven help us all.”
September 21, 2008: The End of the “Greed Is Good” Era
Goldman Sachs and Morgan Stanley, two of the most successful investment banks on Wall Street, applied to become regular commercial banks. They wanted the Fed’s protection.
September 26, 2008: WaMu Goes Bankrupt
Washington Mutual Bank went bankrupt when its panicked depositors withdrew $16.7 billion in 10 days. It had insufficient capital to run its business. The FDIC then took over. The bank was sold to J.P. Morgan for $1.9 billion.
September 29, 2008: Stock Market Crashes as Bailout Rejected
A trader gestures as he works on the floor of the New York Stock Exchange September 29, 2008 in New York City. U.S. stocks took a nosedive in reaction to the global credit crisis and as the U.S. House of Representatives rejected the $700 billion rescue package, 228-205. Photo by Spencer Platt/Getty Images
The stock market collapsed when the U.S. House of Representatives rejected the bailout bill. Opponents were rightly concerned that their constituents saw the bill as bailing out Wall Street at the expense of taxpayers. But they didn’t realize that the future of the global economy was at stake.
Stock investors did, sending the Dow Jones Industrial Average down 770 points. It was the most in any single day in history. It didn’t stop there. Global markets panicked: The Morgan Stanley Capital International World Index dropped 6% in one day, the most since its creation in 1970.
To restore financial stability, the Federal Reserve doubled its currency swaps with foreign central banks in Europe, England, and Japan to $620 billion. The governments of the world were forced to provide all the liquidity for frozen credit markets.
[Again, these descriptions are taken nearly verbatim from 2008 Financial Crisis Timeline, by Kimberly Amadeo. See her article for coverage of the rest of 2008, and the ending of the recession in 2009.]