United States; see also European Union
Global credit crisis sparks financial bailout plan in the United States; credit woes spread in Europe, forcing EU to convene meeting to deal with crisis
Summary:
The current financial farrago, rooted in the credit crisis, became a global phenomenon by the start of October 2008. In the United States, after failure of the passage of a controversial bailout plan in the lower chamber of Congress, an amended piece of legislation finally passed through both houses of Congress. There were hopes that its passage would calm jitters on Wall Street and restore confidence in the country's financial regime. Meanwhile, across the Atlantic in Europe, with banks also in jeopardy of failing, and with no coordinated efforts to stem the tide by varying countries of the European Union, there were rising anxieties not only about the resolving the financial crisis, but also about the viability of the European bloc. Following is an exploration, first, of the situation in the United States, and, second, of the situation unfolding in Europe.
Focus 1: United States:
In September 2008, the realized and mark-to-market losses in mortgage backed securities (MBSs) among investment banks resulted in insufficient operating capital and, more importantly, led to a loss of confidence of creditors in extending credit to those companies known to be heavily exposed to MBSs. This dynamic claimed a total of three victims in recent months (Bear Stearns in March 2008, followed later by Lehman Brothers and Merrill Lynch, with the latter pursuing a buyout from Bank of America in order to stave off insolvency).
The credit crunch gathered force when this refusal to extend credit to counterparties expanded to one of the world's largest insurers, AIG, as the market was fearful of default, given the exposure to credit-related financial derivatives, which AIG had on its books (in light of the aforementioned credit crunch). This situation prompted fears of a credit rating downgrade of AIG, which effectively would have made the company insolvent. The Federal Reserve and the Treasury Dept injected $85 billion into AIG to prevent a collapse, taking an 80 percent ownership interest and effectively nationalizing the company (as it did with Fannie Mae & Freddie Mac, the world's largest mortgage guarantors).
Despite these actions, the aggregate loss of confidence in counterparty solvency led to an acute escalation in the credit crisis, as both traders and investors reacted, and as witnessed by intense volatility in global stock markets. In response, there was coordinated central bank action in the United States, the European Union, Japan, China and Russia, manifested by short-term liquidity to the banking system to provide credit to needy parties.
Still, with financial markets ensconced in what could well become a systemic crisis, the United States was poised to take strong measures to deal with the situation. United States Treasury Secretary Henry Paulson argued that the "toxic debts," which were reverberating throughout the financial system, required strong measures to deal with the situation. Paulson asserted that the credit crisis was compromising the larger economic situation with jobs, pensions, companies, leaving the entire financial regime at risk.
In response to the chaos raging in the financial markets, the Bush administration said it would have to spend billions in taxpayers' money to purchase bad debts. Other measures would involve a temporary ban by the Securities and Exchange Commission on short-selling and the establishment of guarantees on money market deposits in order to restore confidence.
The central focus, however, was the proposal to purchase and manage the orderly liquidation of these toxic mortgage backed securities. With this plan in the offing, there was some restoration of confidence that the private sector's credit crisis was going to be absorbed by the government, ultimately leading to a massive two-day rally in global equity markets.
President George W. Bush said that quick bipartisan support would be needed to pass necessary legislation on the proposal. But such action was not immediate as Republicans and Democrats in Congress reacted with dismay to the $700 billion price tag attached to the three-page financial rescue or "bailout" plan proposed by Treasury Secretary Paulson.
While Treasury Secretary Paulson emphasized the imperative to act quickly, Democrats in Congress said they would not easily comply by spending taxpayers' money to bail out the excesses of Wall Street. They indicated that several changes would have to be made to the existing proposal, including greater oversight, assistance for people at risk of losing their homes to foreclosure, assurances that taxpayer money not be used for extravagant executive packages, and also some equity upside for the taxpayers. Meanwhile, Congressional Republicans, particularly in the House of Representatives, appeared to rail at the idea of both the original proposal, as well as the new amendments. Urging from Vice President Cheney that the House Republicans fall into line with the Bush administration did not appear to exact positive results. Nevertheless, the Democratic-led Congress was attempting to work in a bipartisan fashion to forge an agreement.
Meanwhile, the proposals were met with differing feedback from the two presidential contenders looking to succeed Bush. Republican presidential nominee John McCain was on the record saying repeatedly that the "fundamentals of the economy" were solid. He eventually said that the Federal Reserve should concentrate on managing the money supply and inflation.
Democratic presidential nominee Barack Obama appeared to acknowledge the potential global financial implications. He, like Congressional Democrats, placed the blame for the credit crisis squarely on Republicans, the Bush administration and the lack of regulation, but he also issued cautious support for the crafting of a compromise solution. Obama demanded that any rescue package would have to contain specific amendments, ensuring transparency, accountability, greater oversight, taxpayer equity upside, as well as relief for homeowners in trouble.
The political situation took a turn toward the bizarre when on Sept. 24, 2008, McCain was expressing alarm that the country could plunge into a depression within days without immediate action. To that end, he announced he was "suspending" his campaign and going to Washington D.C., to try to help resolve the situation. McCain also said he would not attend the scheduled presidential debate unless there was an agreement on the rescue package. The situation resulted in sharp criticism from leading Democrats, such as Senate Majority Leader Harry Reid, who noted that all the relevant players on finance and banking committees in both congressional chambers were already working long hours to reach an agreement. Obama echoed a similar note, expressing reticence about injecting presidential politics into what was becoming a national -- even international -- crisis.
Still, President Bush, who issued a sobering address to the nation on the financial crisis, invited both presidential contenders, along with the leaders of both parties, to the White House to discuss the crisis and the rescue package proposals. Media reports suggested that the meeting reversed much of the progress that had been forged all week long, and resulted in an angry revolt from House Republicans, who did not believe that their grievances or counter-proposals were being heard. At issue for House Republicans was their insistence of the establishment of an insurance program to protect against the losses of mortgage-backed securities. Media reports noted that with the negotiations process breaking down, Treasury Secretary Paulson implored the congressional leadership not to allow their efforts to end in failure.
The situation took a grim turn when Washington Mutual gained notoriety as the largest bank failure in United States history, It was thusly taken over by regulators and sold to J.P. Morgan Chase.
Despite these obstacles and negative developments, by Sept. 28, 2008, after a week of intense negotiations, House Speaker Nancy Pelosi announced concurrence on the rescue package.* Pelosi was quick to point out that the package was not a Democratic proposal, but simply a good faith effort to work cooperatively to solve the crisis in a way that was fair to American taxpayers. Pelosi touted the fact that her party's demands (described above) had been met. She emphasized that the agreement was not a "bailout" for Wall Street so much as it was a bipartisan agreement to ensure that Americans' pensions, savings and jobs would be safe. Senate Majority Leader Reid acknowledged that Americans' concerns and furor over the "greed on Wall Street" and "un-enforced regulations" were well-justified. But he also said, "Every American has an interest in fixing this crisis - inaction would paralyze the economy."
Both houses of Congress were, therefore, set to vote on the compromise plan, which essentially constitutes the largest government intervention into the markets since the depression of the 1930s. Factions of both parties were quickly shoring up support to block its passage.
For his part, President Bush expressed support for the draft of the compromise legislation saying, "This bill provides the necessary tools and funding to help protect our economy against a system-wide breakdown," he said in a statement.
The deal* addresses several of the key concerns raised by both Democrat and Republican critics of the original plan proposed by the Bush administration.
*Elements of the Emergency Economic Stabilization Act of 2008: --
-Treasury will get the money in phases - $250 billion immediately, $100 billion at the request of the White House; the remaining $350 billion subject to possible veto by Congress
- Banks accepting rescue funds would have to hand over equity in return, paving the way for taxpayers to benefit from the banks' recovery
- If funds cannot be recovered, then the banking industry would have to finance the rescue plan expenses
- Limited payment or "golden parachutes" for banking executives
- Oversight in the form of monitoring agencies, an independent Inspector General, and a bipartisan oversight board
- Banks would be expected to join insurance programs to protect against the losses of mortgage-backed securities
On Sept.29, 2008, the bill went down to defeat in the lower chamber of the United States Congress. Indeed, the United States House of Representatives rejected the bailout plan for the United States financial institutions, sending the stock market into a state of shock. The Dow Jones dropped seven percent -- 770 points -- marking a record one-day fall.
Attention focused on Republicans in the lower chamber, since only a small number of legislators from that political party voted in favor of the plan. While some Democrats joined Republicans in rejecting the bill, two-thirds of House Democrats voted in its favor. The repercussions included not only the aforementioned stock market volatility, but also questions about how banks would deal with their exposure to bad loans and how credit markets could regain their footing. Moreover, the situation evoked grave anxieties about a potential second Depression if no plan was agreed upon to deal the credit crisis.
By Oct. 1, 2008, the upper Chamber of the United States Congress -- the Senate -- had overwhelmingly passed an amended version of the Emergency Economic Stabilization Act of 2008. Indeed, about three-quarters of the Senate voted in its favor. The amended bill, quite controversially, included a number of tax cut incentives for pet projects, as well as additional protections for people with savings in the bank. The latter addition involved an increase in the amount insured by the United States government in bank accounts from $100,000 to $250,000.
Passage of Emergency Economic Stabilization Act of 2008 in the Senate, along with recriminations for causing the drop in the stock market by rejecting the bill in the first vote, placed pressure on the House of Representatives to successfully pass the amended legislation. To that end, on Oct. 3, 2008, the United States House of Representatives voted in favor of the bailout package. As before, significantly more Democrats voted to pass the bill than Republicans in the lower chamber. President George W. Bush quickly signed the bill into law.
Focus 2: Europe
On Sept. 28, 2008, as the United States was reeling from the unfolding credit crisis, Europe's banking sector was also hit by its own woes when the Dutch operations of the European banking and insurance entity, Fortis, was partly nationalized in an effort to prevent its ultimate demise. Radical action was spurred by anxieties that Fortis was too much of a banking and financial giant to be allowed to fail. The Netherlands, Belgium and Luxembourg forged an agreement to contribute more than 11 billion euros (approximately US$16 billion) to shore up Fortis, whose share price fell precipitously due to worries about its bad debts.
A day later, the mortgage lender -- Bradford and Bingley -- in the United Kingdom was nationalized when the British government took control of the bank's mortgages and loans. Left out of the nationalization scheme were the savings and branch operations, which were sold off to Santander of Spain. Earlier, the struggling mortgage lender, Northern Rock, had itself been nationalized. The head of the British Treasury, Alistair Darling, indicated that "big steps" that would not normally be taken were in the offing, given the unprecedented nature of the credit crisis.
On the same day, financial woes came to a head in Iceland when the government was compelled to seize control of the country's third-largest bank , Glitnir, due to financial problems and fears that it would go insolvent. Iceland was said to be in serious financial trouble, given the fact that its liabilities were in gross excess of the country's GDP. Further action was anticipated in Iceland, as a result.
On Sept 30, 2008, another European bank -- Dexia -- was the victim of the intensifying global banking and financial crisis. In order to keep Dexia afloat, the governments of France, Belgium, and Luxembourg convened talks and agreed to contribute close to 6.5 billion euros (approximately US$9 billion) to keep Dexia from suffering a demise.
Only days later, the aforementioned Fortis bank returned to the forefront of the discussion in Europe. Belgian Prime Minister Yves Leterme said he was hoping to locate a new owner with the aim of restoring confidence in Fortis, and thusly, preventing a further downturn in the markets. Leterme said that the authorities were considering takeover bids for the Belgian operations of the company (the Dutch operations were nationalized as noted above.)
By Sept. 5, 2008, one of Germany's biggest banks, Hypo Real Estate, was at risk of failing. In response, German Chancellor Angela Merkel said she would exhaust all efforts to save the bank. A rescue plan by the government and banking institutions was eventually agreed upon at a cost of 50 billion euros (approximately US$70 billion). This agreement involved a higher cost than was previously discussed.
Meanwhile, as intimated above, Iceland was enduring further financial shocks to its entire banking system. As such, the government of Iceland was involved in intense discussions aimed at saving the country's financial regime, which were now at severe risk of collapse due to insolvency of the country's commercial banks.
Meanwhile, on Sept. 4, 2008, the leaders of key European states -- United Kingdom, France, Germany, and Italy -- met in the French capital city of Paris to discuss the financial farrago and to consider possible action. The talks, which were hosted by French President Nicolas Sarkozy, ended without consensus on what should be done to deal with the credit crisis, which was rapidly becoming a global phenomenon. The only thing that the four European countries agreed upon was that there would not be a grand rescue plan, akin to the type that was initiated in the United States. As well, they jointly called for more greater regulation and a coordinated response. To that latter end, President Nicolas Sarkozy said, "Each government will operate with its own methods and means, but in a coordinated manner."
This call came after Ireland took independent action to deal with the burgeoning financial crisis. Notably, the Irish government decided days earlier to fully guarantee all deposits in the country's major banks for a period of two years. The Greek government soon followed suit with a similar action. These actions by Ireland and Greece raised the ire of other European countries, and evoked questions of whether Ireland and Greece had violated any European Union charters. An investigation by the European Union was pending into whether or not Ireland's guarantee of all savings deposits was anti-competitive in nature.
Nevertheless, as anxieties about the safety of bank deposits rose across Europe, Ireland and Greece saw an influx of new banking customers from across the continent, presumably seeking the security of knowing their money would be safe amidst a financial meltdown. And even with questions rising about the decisions of the Irish and Greek government, the government of Germany decided to go down a similar path by guaranteeing all private bank accounts. For his part, British Prime Minister Gordon Brown said that his government would increase the limit on guaranteed bank deposits from £35,000 to £50,000.
In these various ways, it was clear that there was no concurrence among some of Europe's most important economies. In fact, despite the meeting in France, which called for coordination among the countries of the European bloc, there was no unified response to the global financial crisis. Instead, that meeting laid bare the divisions within the countries of the European Union, and called into question the very viability of the European bloc. Perhaps that question of viability would be answered at a forthcoming G8 summit, as recommended by those participating in the Paris talks.
-- Denise Youngblood Coleman Ph.D.
Houston, Texas
October 5, 2008
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