2008 financial crisis explained: causes, timeline and amounts. Understand it with key concepts

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The 2008 financial crisis costed 1,500 billion USD. Here you can find key financial concepts to understand the crisis explaining the financial argot.

Table of Contents

It is difficult to synthesize the 2008 financial crisis in 1 paragraph without missing important information. But if I have to do it, I would focus on the main bad idea that triggered the crisis. That idea was to take loans given to people that are not good payers and sell them recombined to other groups assuming there will be never a consequence if this schema escalates. That crisis led to the Great Recession where house prices plunged more than during the Great Depression of 1929.

This article includes 51 reliable sources. Reputable sources include government sites like the Congressional Budget Office, through specialized institutions that protect people’s money like the Federal Deposit Insurance Corporation, regulators like the Securities and Exchange Commission, and even documentaries like one from HBO.

The Gist (“Too Long Didn’t Read” version of the article)

Every decade or so, something comes along that, at least in the short-term, devastates financial markets. That, based on recessions marked by the National Bureau of Economic Research (NBER) [50].

A financial crisis has consequences such as millions of people losing their homes, jobs and savings. The crisis was getting bigger and government intervened before many more serious effects appeared.

  • One serious impact is seen when banks stop giving credit. Many companies rely on credit given by banks for short-term payroll. So, without credit, many people would not get their salaries.
  • If there is no faith in the financial system and people get their money out of the bank, the bank cannot have the money needed to lend to small businesses.
  • Pension funds and retirements (401ks) were at risk due to the bad investments they held.

You can jump the the topic of most interest for you for easier navigation.

  1. Key numbers
  2. Infographic of money flow
  3. Crisis evolution through key concepts
  4. Causes of the crisis
  5. Timeline of the crisis (2008)
  6. Troubled Asset Relief Program (TARP)
  7. Timeline of crisis end and repercussions (2009-2017)
  8. How to avoid it next time?
  9. Which banks failed?

Here below the decomposition of topics to understand 2008 financial crisis.

1 Key numbers

  • $1.5 trillions
    • $831B for ARRA in 2009-2019 period [1]
      • (American Recovery and Reinvestment Act, ARRA – Tax Cuts and Spending)
    • $30B in Bear Stearns bailout [2]
    • $187B in Fannie and Freddie Bailout [2]
    • $700B for TARP Bailout (later reduced to $475B with Dodd-Frank Act) [3]
    • $182B for AIG bailout [4]
      • US Treasury later sold the shares for $22.7 billion in profit [4]
  • Unemployment remained higher than 9% from mid 2009 to end 2011 [5]
  • Housing prices fell 26% between 2007 and 2012 [6]
  • $172 billion moved from money markets to treasury bonds [7]
07 2008 Financial Crisis- YouTube Thumbnail
Key numbers of 2008 financial crisis

2 Infographic of money flow

Crisis evolution through key concepts
Infographic of money flow: Crisis evolution through key concepts

3 Crisis evolution through key concepts

3.1 Leverage

  • Borrowing money to amplify the outcome of a deal
  • Example:
    • One person has $10k
      • Buys 1 box
      • Sells it for $11k
      • Makes $1k profit =$11k – $10k
    • Another person using leverage borrows $1M with $10k
      • Has now $1M to buy 100k boxes.
      • Sells 100k boxes for $1.1M
      • Pays the $1M borrowed
      • Makes $90k profit =$1.1M – $1M -$10k (he initially had)
  • As person with leverage get more returns, banks apply the same principle.

3.2 Mortgage

A mortgage is a loan a person requests to a mortgage lender to be able to get the money needed to buy a house.

3.3 Mortgage broker

Contacted by want-to-be home-owners to get a mortgage and buy their house. Mortgage broker asks a mortgage lender for a mortgage.

  • Mortgage broker makes a commission and people become home owners.

3.4 Mortgage lender

Is contacted by a bank that wants to buy the mortgage.

  • Mortgage lender receives a fee on transaction

Mortgage lenders get money for lending mortgages from Fannie Mae and Freddie Mac. Fannie and Freddie give thousands of mortgages to investment banks.

3.5 Mortgage Backed Securities (MBS)

Investment banks created MBS.

  • Mortgage backed securities are the securitization of mortgages. It means it converts an illiquid asset into a liquid one: one that can be sold and bought [8].
  • Those MBS were hold by financial institutions around the world, hedge funds, mutual funds, corporate assets and pension funds
  • Home owners’ payments went directly to MBS owners
  • MBS owners were :
    • Hedge Funds
    • Investment Banks
    • Pension Funds
    • Insurance Companies
    • Sovereign Funds
    • Mutual Funds

3.6 Collateralized debt obligations (CDO)

  • Banks borrowed money to buy more mortgages and package into buckets (CDO). Their prices relied in sophisticated computing pricing models based on the assumption that house prices always go-up:
    • The tranches were sold to investors. With high risk on higher return MBS. As investors searched higher returns, they bought those higher-return-higher-risk MBS.
    • CDOs’ returns came from home owners paying their mortgages. That freed banks from collecting the mortgage of the loans they made. So they kept building mortgages and lending to people with low paying capabilities.
    • Tranches were classified by risk (e.g. safe, okay and risky). First money collected from mortgage payments went to “Safe”, then to “Okay” and what was left to “Risky”.
    • As less home owners pay, the risky tranche is the first impacted.
    • To compensate for higher risk, there is a higher rate of return in riskier tranches. For instance:
      • 10% for risky
      • 7% for Okay
      • 4 % for Safe
  • Traders started selling CDOs. Some of them were giving high rating. Lax lending requirements and low interest rates made home prices go higher. That made MBS and CDOs look like good investments.

3.7 Credit Default Swap (CDS)

  • To add even more “security”, banks sought insurance for the CDO’s Safe tranche using a Credit Default Swap.
  • Reliable insurance companies like American International Group sold insurance products in risky tranches. It was called Credit Default Swap. However, the company did not expect that all mortgages would be insolvent, and it did not have cash on hand to pay to everyone. Those CDSs were derivatives not regulated.
  • The Federal Reserve bailed out AIG to keep it from going bankrupt. Without it, all companies and pension funds owning CDS would have gone bankrupt.

3.8 Complex derivatives investments (CDIs)

More risked than MBS and CDOs. Complex derivatives investments included synthetic CDOs. Those were created to put even more money in their creators pocket.

3.9 Rating agencies

Qualify securities by their risk level.

  • Safe CDOs as AAA because before mortgages were only for good borrowers. So, mortgage debt was a good investment.
  • More than half of structured finance securities rated by Moody’s carried a AAA rating [9].
  • Okay tranche as BBB
  • Risky tranche as unrated

Banks can then sell the CDOs to investors groups according to their risk appetite. As CDOs are sold and homeowners paid, investors received the return they expected. So they asked banks to get more of them.

  • Banks asked mortgage lender for more mortgages
  • Mortgage lender asked mortgage brokers for more potential home owners
  • Mortgage brokers could not get more people to qualify for a mortgage.
  • Idea to solve that: subprime mortgages

3.10 Sub-prime mortgages

Investors wanted to buy more MBS because they were profitable. Then banks started to make subprime mortgages: loans granted to individuals with poor credit histories. This, to provide more investors the high returns alternatives investors were looking for.

  • Angelo Mozilo (Countrywide Financial) was the indisputable king of subprime lending. His company was then sold to Bank of America [10]. He encouraged the sales but admitted they were toxic. They were sold anyway to Wall Street firms.
  • If a home owner does not pay, the lender gets the house and typically houses go up in value. So, lenders started to add risk:
    • No down payment.
    • No proof of income.
    • Less restrictions to get a credit for a house.
  • At that moment, there was a shift from responsible home owners (prime mortgages) to less responsible owners (subprime mortgages).

3.11 Predatory lending practices

  • Subprime mortgages evolved into predatory lending practices. Financial institutions did not really verify the repaying capacity of individuals. Those mortgages included payments people could afford at first but not later as mortgage’s monthly payments ballooned above their means.
  • Maxime Waters (US. Congresswoman) confirmed teaser loans were announced at the beginning and later higher payments were due. The most complicated mortgages were given to people who did not understand them and were not able to pay for them [11].

3.12 Turning point (now with Subprime mortgages and predatory lending practices)

  • Mortgage broker still makes a commission.
    • when selling a mortgage to a mortgage lender.
  • Mortgage lender still makes a commission.
    • when selling the mortgage to an investment bank.
  • Investment bank turns it into CDO and sells them to investors.

3.13 Moral hazard

When one person takes more risk because someone else bears the burden of the risk.

  • Fees were added in every transaction with every participating enterprise: the broker, lender, securitizer, market maker. Every participating enterprise was sure the risk was transmitted to the next and had already received a commission.
  • Banks made the loans because they were expecting to sell the mortgages to somebody else.

3.14 Housing bubble:

When house prices raise to unsustainable levels mainly due to speculation and not real value.

3.15 Default payments:

Borrowers started not being able to pay the mortgages’ monthly payments (“defaulting” payments). That put homes again in the market. But there were no buyers and prices started to go down. In other words, offer of homes was high and demand that can pay for houses was low.

  • Once subprime lenders start defaulting:
    • Money from home owners started not going to CDOs anymore as now investment banks own a house and not the money from monthly payments.
    • As more and more home owners defaulted in their payments, the payments turned into houses.

3.16 Toxic asset

  • In August 2007 in Paris, BNP Paribas discovered the toxic securities (MBS, CDOs) and stop withdrawals from related funds. They raised the alarms [12].

3.17 Housing bubble burst

  • Many houses were in the market and nobody bought them. Then home prices started to go down.
    • That created problems to home owners still paying their mortgages. Because their house value started to decrease.
    • They did not want to pay mortgages on houses that were not anymore the value they agreed when taking the mortgage. Their houses were not anymore going up in value.
    • As home prices fell, borrowers saw their house value decrease and stop paying. Hence, pushing houses price low further.
    • As more and more payments on houses were not done, CDOs had not anymore money flowing from home owners to investors. Instead banks had many houses whose values were going down.
  • Banks tried to sell those CDOs to others but no one wanted them as most knew home owners were not paying.
    • Banks had already borrowed billions to create CDOs but were not able to sell them
    • Investors had already bought many of those CDOs not returning any profit and were trying to sell them. Nobody was buying them.
    • Mortgage lenders already had many sub prime mortgages they were willing to sell to banks. No bank was buying them.
    • Mortgage brokers were offering subprime lenders to mortgage lenders but no mortgage lender wanted to give money to sub prime mortgages.
  • There was no credit and banks and mortgage brokers start going bankrupt.

When bubble burst, big financial institutions stop buying subprime mortgages. Subprime lenders were stuck with bad loans.

3.18 Frozen credit markets

  • When housing prices started to fall in 2006, the pricing computing models were not anymore usable. No pricing nor value could be established on MBS and banks stopped lending each other. Which in turn froze credit market and the economy.
    • Even Warren Buffett said he would have needed to read 300k pages to understand a Mortgage Backed Security (MBS) [2, at 17:25].
  • In 2007 banks started to panic once they realized they would have to absorb the losses and stopped lending each other. They did not want worthless mortgages as collateral. So, inter-bank borrowing costs like Libor rose. Even when the FED pumped liquidity via the Term Auction Facility, it was not enough [13].
  • London, in September 2007, Northern Rock asked bank of England for emergency financial support. People were running on bank to get their money [14].
  • In October 2007, UBS was the first major bank to announce losses ($3.4 billion) from subprime related investments [15].

4 Causes of the crisis

4.1 Housing and mortgages

  • By 2004, home ownership peaked 69.2% in the US. Then, beginning of 2006, home prices started to decline [16].
  • When prices first fell, realtors first applauded arguing estate market would come back to a sustainable level. But many homeowners without good credit payment capacity got credits approved. Some even with more than 100% of home’s value.
  • US. home mortgage debt relative to GDP increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion [17].
  • As a consequence, Americans had homes worth less than what they paid for them. If they had adjustable-rate mortgages, the cost was going up as the home’s value was going down
  • The most vulnerable subprime borrowers were stuck with mortgages they couldn’t afford in the first place.
  • During 2007, subprime lenders where filing for bankruptcy. Like New Century Financial, who made almost $60 billion in loans in 2006 [18].
  • By October 2007, 3% of US homes were in the foreclosure process. Another 7% one month past due.
  • Amount of credit insured jump to $900B to $62T. It relies on real estate market going up
  • The decrease in housing prices due to subprime borrowers defaulting was the trigger that made dominoes start to fall.

4.2 Government role in crisis

Deregulation and too low interest rates for too long. Then favoring a monetary excess reflected in a too-long boom and a consequential bust [19].

4.2.1 Low interest rates

Alan Greenspan was chairman of the Federal Reserve (FED) for 20 years (from 1987 to 2006) and revered in Washington. He popularized the expression “Too big to fail”.

  • After 09/11 terrorist attack and dot-com bubble, FED lowered federal funds rate from 6.5% in May 2000 to 1% in June 2003 [20].
    • Hence discouraging investors from buying T-Bills from government due to too low return on investment.
    • Investors wanted more rewarding investments. Then banks connected investors to homeowners through mortgages to find high-returns investments.
    • The low interest rates encouraged banks to borrow more from FED
    • Other countries lend like Japan, China and Middle East. Then US banks take a lot of leverage as credit was cheap

Then, home prices went upwards as borrowers took advantage of low mortgage rates [21].

4.2.2 Deregulation of financial derivatives

Allowing banks to participate in derivatives investments linked to housing. Those complex financial products were so highly profitable and motivated banks to lend more. Even to riskier borrowers (those with high probability of not paying).

  • The 2 deregulating laws were:
    1. The Financial Services Modernization Act of 1999 (Gramm-Leach-Bliley Act) that let banks use deposits as a backup for investing in derivatives [22].
      • Bank lobbyists argued they needed it to compete with foreign firms. Banks promised to invest only in low-risk financial instruments to protect their customers [23]. They did not respected that agreement.
    2. The Commodity Futures Modernization Act of 2000 [24, 25].
      • Freed derivatives from regulatory supervision and state laws and regulations.
      • Almost only huge banks had the financial capacity to manage them.
  • Changes in US government in 2006 mostly related to crisis:
    • Henry Hank Paulson, former CEO of JP Morgan becomed Secretary of Treasury (July 2006-2009)
    • Ben Bernanke, former Princeton professor, becomed Chairman of the US Federal Reserve (2006-2014). He spent his career studying monetary policy and financial markets
    • Timothy Geithner, president of New York Federal Reserve (2003-2009). This role is FED’s eyes and ears in Wall Street
    • George Bush as president of the United States (2001-2009)
  • Government thought the increase in inter-bank loans interest rates was due to lack of liquidity. But in fact it was due to risk of counterparty.
    • Government provided $100 billion in the Economic Stimulus Act of 2008 [26] (passed in February). It did not triggered consumption as predicted by Milton Friedman’s permanent income theory. It states that temporary, as distinct from permanent increases in income do not lead to significant increases in consumption.

4.2.3 Perverse incentive

When a policy ends-up having a negative effect, opposite of what is intended.

  • Like mortgage brokers getting more money for selling riskier loans that made more profit to a company. Then leading to moral hazard.

Nevertheless, The Federal Reserve affirm that “the Community Reinvestment Act did not pushed banks to make investments in subprime areas” [27].

5 Timeline of the crisis (2008)

5.1 First half of 2008 – the fall of Bear Stearns ($30B)

  • In January 2008, FED cut its benchmark rate in 0.75%. The biggest cut in 25 years (only equaled by the one in March 2020 due to Covid-19 Crisis) as it sought to slow the economic slide [20].
  • In February, UK nationalized bank Northern Rock [28].
  • In March, Bear Stearns (created in 1923) was acquired by JP Morgan Chase.
    • Bailed out by JP Morgan [29] with a Fed backed $30B guarantee [13].
    • Around January 2008 , the richest CEO in Wall Street was Jimmy Cayne at the head of Bear Stearns. He was later forced by FED to get out as CEO and became an unpaid member of the board. It was more exposed to toxic assets than any other enterprise. He had charisma and ruthlessness to reach top but there were rumors he had the habit of smoking pod.
    • March 13 Thursday
      • On Wednesday, for Hank Paulson it was evident that Bear Stearns would disappear on Monday if there were no solution. Markets were fragile and people were doing a run on the money.
      • If they fail, the entire financial system was at risk. Ben Bernanke’s view of the Great Depression of 1929 and the will to avoid the economic contraction and shortage it generated made him create loans for financial institutions. Due to the Great Depression, a third of banks failed in US and it generated hardship and economic contractions. In the words of Ben Bernake: “It could have resulted in a 1930s style global financial and economic meltdown with catastrophic implications”[30].
    • March 14 Friday
      • Bush hesitates about bailouts as he is a free marketer [2].
      • A loan was not enough for a bank like Bear Stearns to avoid disintegration but JP Morgan Chase was fortunately a buyer (Hank Paulson) [2].
      • Then a deal was done with $30B to ease the buy of Bear Stearns by JP Morgan Chase
        • Marked the beginning of country debate of what should be done or not [2].
        • Bear Stearns 170$ stock price a year before went to $2 due to the acquisition by JP Morgan Chase where FED facilitated the transaction.

The message from Bear Stearns bailout was that government will not led a big bank fall.

Through the spring of 2008 (June-July) Paulson confirmed to everybody that US economy was fine. Lagarde warned him that a tsunami was coming and that they should be prepared.

5.2 July 2008 – Fannie and Freddie bailout ($187B)

Fannie Mae and Freddie Mac were US. 2 biggest lenders and were seized by US. government.

  • 2008 July 15 Tuesday
    • There was concern about Freddie Mac and Fanny Mae as they handled 90 percent of all mortgages. They were seen by all as backed by government in case of default. They had a government money printing machine in which governments implicitly says if anything goes wrong the government will pay the bill. There was no guarantee but the market assumed it was.
    • Ben Bernanke and Hank Paulson testimony go to Senate to ask for authorization to provide money needed to save markets [2].
  • 2008 September 4 Thursday
    • Congress authorized the Treasury Secretary to take control of Fannie Mae and Freddie Mac thanks to a bailout of $187B [2].

5.3 September 2008 – Fall of Lehman Brothers

  • September 9, Tuesday
    • Hank Paulson accepts to not bailout Lehman Brothers to spread the message that Fed will not be there to help all banks get out of financial distress.
    • Potential buyers for Lehman: Bank of America and Barclays (UK) [2].
  • September 11, Thursday
    • Lehman stock plummeted.
    • Richard (Dick) Fuld was CEO of Lehman Brothers and refused to sell his stocks. He did not recognized the situation’s gravity.
    • Lehman had existed since 1850 and recovered from 1929, 2001 terrorist attack that destroyed their offices.
    • Barclays wanted to buy Lehman but the decision maker would be UK chancellor and he said that buying Lehman would be importing US cancer. Hank Paulson’s call to Alistair Darling (UK’s chancellor) went to nowhere. No agreement on letting Barclays buy a part of Lehman’s assets [2].
    • Even the well known financial analyst Mohamed El-Erian asked his wife to cash out from banks [2].
  • September 12, Friday
    • Emergency meeting from government officials with banks CEO [2]:
      • Jamie Dimon from JP Morgan
      • Lloyd Blankfine from Goldman Sachs
      • John Thayne from Merrill Lynch
      • John Mack from Morgan Stanley
      • Purpose of the meeting: discuss that without their help, Lehman would be collapsed for Monday and what would that meant for the financial industry. Lehman’s CEO was not invited.
  • September 13, Saturday
    • Top CEOs meet again to know what Lehman collapse would mean [2].
  • September 15 Monday
    • Lehman had $630B in debt. And with $600B in assets, it filed for bankruptcy.
    • Bank inter lending dry-up. Then, a few days later ATMs would have stopped working. Crisis went from markets to mainstream.
    • One of largest McDonald’s franchises was relying on Bank of America for payroll and if banks were in trouble people were about to not being paid [2].
    • Lehman Brothers (founded in 1844) collapse was the largest bankruptcy in US. history. It was the fourth-largest investment bank with 25k employees worldwide [31].
  • September 16, Tuesday: FED loaned $85B to AIG as bailout.
    • AIG needed funds to stay afloat. It insured all others Wall Street banks.
    • FED gave $85B for AIG and fired the CEO.
  • September 17, Wednesday
    • The crisis created a desperate move to money market funds. Big enterprises used their available cash reserves to earn interest on them overnight. That freed banks to use that money to quickly lend only for the short term. Aggregating all the money moves, that accounts for $172B of previously money market accounts that were moved to even safer Treasury bonds [7]. Then Dow Jones Industrial Average losses 1/3 of its value.
    • If the US money market accounts had gone bankrupt, many daily business activities and the economy would have stopped. At that point, government action was immediately needed.
  • September 18 Thursday
    • Government needed to intervene in the banks. To not make it look like government is nationalizing banks, Hank Paulson thought about a buying troubled assets plan. Then Troubled Asset Recovery Plan (TARP) was born.
    • US was heading to Great Depression
    • Ben Bernanke and Hank Paulson went to congress and Ben said: “If you don’t give Hank what he needs, within 72 hours the US bank financial system will fail and then the world bank financial system will fail on top of that” [2].
    • Then, Congress worked on an expeditious solution instead of usual days analysis taken [2].
  • September 20, Saturday
    • Treasury Secretary Henry Paulson and Fed Chair Ben Bernanke proposed a $700 billion bailout for Congress approval [32]. The quick move was aimed to stop the huge money moves, but republicans were against any action to not bailout directly banks. A few days later, on October 2008, they finally approved it when stock markets were at a huge risk [33].
    • Hank Paulson on not saving Lehman but after doing bailouts. And what would have happened if he did not do that [34]:
      • 30 million Americans had deposits in money market accounts totaling $3.5 trillion. If there were a run on money market funds, the people owning that money would get hurt and also the major companies that use those funds for short-term operations. Big companies wouldn’t have the money for dividends and paying suppliers. Then small business also go down.
  • September 23, Tuesday
    • A bailout plan of $700B plan bailout was needed and Congress requested why that much and why only 72 hours limit to approve it [2]. Government does not want to approve bailouts. Even less in the middle of the election to be held on November 4.
  • September 24, Wednesday
    • John McCain calls for suspending the campaign but it was Obama’s call to him that proposed that [2].
    • Republicans and democrats came to Washington to deal with decisions being held. Hank Paulson feared politics intervene with current government and ended up forbidding bailouts. That would have triggered another Great Depression [2].
  • September 25, Thursday
    • Meeting at white house Bush with presidential candidates (with Obama and Mc Cain)
    • McCain did not have a plan but Obama did.
    • Paulson started having health issues. That accelerated the TARP approval by Nancy Pelosi (US government speaker).
  • September 29, Monday
    • Bailout is initially rejected and markets were falling at the same time. But Congress did not changed its mind [2].

5.4 October 2008 – TARP approval ($800B)

  • October 1, Wednesday
    • When Congress started to make the link to their 401 (k)s retirement account they reversed their attitude. A bailout of $800B is approved on October 2. But situation got worse in markets:
    • 2 of the biggest banks, Wachovia and WaMu, failed.
  • The only alternative was to give money directly to Wall Street and Bush approved it as there was no other option that could help [2].
  • 2008 October 13, Monday
    • Treasury officials (including Paulson) met with CEOs of main banks to give them money in exchange of preferred stocks [35]:
      • John Mack CEO Morgan Stanley
      • Jamie Dimon CEO of JP Morgan Chase, $25B
      • Lloyd Blankflein CEO of Goldman Sachs, $10B
      • John Thain CEO of Merrill Lynch
      • Vikram Pandit CEO of Citigroup, $25B
      • Bank of America, less than $15B
      • Wells Fargo, less than 25B
  • If a bank take the money publicly, it would mean they are in danger and their stocks price would be threatened. Then everybody was forced to take them [2].

5.5 November 2008 – AIG bailout ($182B)

In October and November Fed and Treasury restructured the bailout to $182B. In 2012, the government made a $22.7B profit when Treasury sold its last AIG shares [4].

  • AIG was the biggest insurance company. In business since 1919.
  • When AIG sold CDS to protect investors from risk. Its revenues quadruple to $3B per year (more than 17.% of company total revenues) [36].
    • AIG did not had the funds to pay people who bought CDS in case of default. It based the insurance on the probability of housing prices going down.
    • AIG realized that it could not pay for the insured products that failed.
    • FED gave $85B over 2 years to AIG in exchange of 80% equity stake at AIG. Then changing the CEO to Edward Liddy with a salary of $1.
      • AIG used $165M to pay executive bonuses for incentives to deal with crisis.
      • $182B given to AIG in total.
    • In March 2009 AIG reported $61B
    • In 2016 reduced its staff from 116k in 2008 to 56,400.
    • In 2012 FED sold AIG shares for $22.7B profit. In 2017 finally AIG was out of too big to fail list.

6 Troubled Asset Relief Program (TARP)

  • It was never $700 billion, as a few people might argue. The Treasury used almost $442 billion from the Troubled Asset Relief Program (TARP). Then, in 2018, it had returned $442.7 billion to the fund. The aftermatch is $900 million profit. That was achievable thanks to acquiring shares of bailed out enterprises when they were extremely low and conveniently selling them when prices were at all time highs.
  • The TARP funds contributed in five axes [7]:
    • $79.7 billion for bailing out automobile sector enterprises.
    • $245.1 billion for buying preferred stocks in exchange for cash.
    • $67.8 billion that changed to $182 billion for bailing out AIG.
      • On September 16, it was $85B and restructured in October to a $182 billion federal bailout for AIG.
    • $19.1 billion went to shore up credit markets. The banks repaid $23.6 billion, creating a $4.5 billion profit.
  • The Homeowner Affordability and Stability Plan spent $30.1 billion to update mortgages protecting people’s interests [37].

7 Timeline of crisis end and repercussions (2009-2017)

  • 2008 November 4
    • Obama elected (president 2009-2017).
  • 2009 January: Stimulus package
    • President Barack Obama refused to use the $700 billion still available for TARP to avoid bailing out more enterprises [38]. He proposed to Congress an economic stimulus.
    • On February 17, 2009, Obama signed the American Recovery and Reinvestment Act (ARRA). It included stimulus checks, tax cuts, and government spending in public works. By 2011, it was possible to send $831 billion to small businesses and consumers. That finally conducted to end the financial crisis in July 2009 [39].
  • 2009 January 5 Monday
    • Timothy Geithner is nominated by Obama as Secretary of Treasury. It was Obama’s best bet on someone without ideological burden [2].
    • $75B were given to help people avoid foreclosures [2].
  • 2009 February 19 Thursday
    • Financial institutions like AIG had contractual obligations to pay bonuses and top executives were spending that money while people were having trouble to pay bills.
    • The challenge was how to protect public interests without creating a bunch of private beneficiaries [2].
      • People were angry due to bailouts of huge financial enterprises that caused the issue and end up anyway in big financial enterprises.
  • 2011 September 17
    • CEOs take big compensations yearly [2]
      • 2006: total $106.2B
        • $939k salary
        • $6.3M cash bonus
        • $31.9M option exercises
        • $67.1M stock sales
      • 2007: total of $45.2M
        • $903k in salary
        • $4.3M in cash bonus
        • $40.3 option exercises
  • 2017 December 8 Friday
    • People thought there is a book rule for the elite and another for everybody else. And that increase populism, as people think “this economy is not working for me and system is rigged”.
    • Donald Trump elected.
    • People become more polarized. [2]

8 How to avoid it next time?

Banks cannot regulate themselves. They are now getting still bigger and if let, they would create another global crisis [40].

8.1 Dodd-Frank in 2010

  • Congress approved the Dodd-Frank Wall Street Reform Act. It restricted banks to not take too much risk. Also, it allowed the Fed to limit the bank size for those that were becoming too big to fail [41].
    • This is done through the Financial Stability Oversight Council. It looks-out for risks that affect the entire financial industry. It also oversees non-bank financial firms like hedge funds. If any of those gets too big, The council can suggests to FED the regulation of those firms. The FED then asks the firm to increase its reserve requirement. That requirement is the amount of cash or deposits financial institutions are required to keep with the Federal Reserve Banks.
    • Another part is the Volcker Rule. It limits the amount of risk banks can take. It prohibits banks from trading in stocks, commodities, or derivatives for their profit. They can only do so on behalf of their customers to offset business risk.
  • In other words, main advantages of Dodd-Frank law were:
    • Regulated more derivatives to be traded in all market exchanges.
    • Restricted riskier bank activities.
    • Increased government oversight of bank’s activities.
    • Forced bank to maintain larger cash reserves.
    • Reduce consumer predatory lending.
  • By 2018, some portions of the Act have been rolled-back by Trump administration. Like alterations of capital threshold requirements by certain banks. This was done under the Financial Choice Act [42], the Economic Growth, Regulatory Relief, and Consumer Protection Act [43, 44].

9 Which banks failed?

  • Between 2008 and 2015, more than 500. But no depositor lost money [45, 46, 47, 48].
  • In 2008, on January 25, Douglass National Bank of Missouri was the first bank to collapse [46]. On September 15, Lehman Brothers was acquired by bank of America. Later Indy Mac, became also one of the biggest bank failures. [49]

What is the next step?

The 2008 financial crisis affected more people who were not able to pay their monthly payments for the house they bought. They could have avoided the pain of later losing their homes if they had a budget in place and made a financial plan. Check our articles on How to make a budget and Financial Planning.

Sources

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