The Bank Bailout Plan of 2008

Since the creation of the Federal Reserve System in 1913, the U.S. government has played a significant role in regulating banks and promoting the stability of the financial sector. Besides overseeing the activities of banks, the government created the FEDERAL DEPOSIT INSURANCE CORPORATION, which insures the money of depositors. However, the credit squeeze of 2008 and the accompanying collapse of major banks and other financial instructions led to what has been called ''the bank bailout plan.''      
Congress enacted and President GEORGE W. BUSH signed the Emergency Economic Stabilization Act of 2008 (EESA), Pub. L. 110-334. EESA established a program called the Troubled Asset Relief Program (TARP), which gave the TREASURY DEPARTMENT the authority to purchase or insure up to $700 billion of troubled assets. By the end of 2009, many of the affected banks had regained their financial footing and were paying back the TARPP funds to the Treasury. Despite this apparent success, critics of TARP argued that it had overpaid for the troubled assets. Moreover, the Obama administration had failed to make meaningful reforms of the financial industry.       
The source of the 2008 financial meltdown, which government officials claimed almost brought the U.S. and world economies to collapse, was the decision by the FEDERAL RESERVE BOARD following September 11, 2001, to lower interest rates on the money it lends major banks. The U.S. economy had slipped into a mild recession following the terrorist attacks, and the Fed hoped to stimulate it by making money more available. The Fed's hopes came true when the cheap money led to low home-mortgage rates. Low interest rates, combined with sub-prime, adjustable mortgages, allowed individuals who could never qualify for financing to own a home. Many individuals bought houses with little or no down payments and bought houses that were more than they could truly afford. The subprime mortgages in turn were packaged and ''securitized'' by investment banks; mortgage-backed SECURITIES became lucrative financial instruments, though the worth of them was tied to the ability of homeowners to make their payments.      
The dramatic growth in the value of homes suggested to some economists that the United States was experiencing a REAL ESTATE bubble rather than a period of solid, sustained expansion. They feared that any type of economic contraction would lead to higher interest rates for subprime adjustable MORTGAGE holders and a high number of home foreclosures.       
As the economy started to tighten in 2006, the fears of these economists began to be realized. Many new homeowners could not pay skyrocketing monthly payments and foreclosures increased. Even longtime homeowners were affected because they had refinanced their homes for the low interest rates but took adjustable rate rather than fixed rate mortgages. Despite these signs, banks continued to sell these risky mortgages and financial products.       
When investment bank Bear Stearns moved towards BANKRUPTCY in early 2008 because of the shrinking value of the mortgage-backed securities, the Federal Reserve stepped in, assumed $30 billion of its debts and forced a sale of the bank to JPMorgan Chase for a price that was less than the value of the Bear Stearns' Manhattan skyscraper. In August the federally sponsored entities Freddie Mac and Fannie Mae raced towards insolvency.       
Freddie and Fannie were central to the U.S housing market, holding mortgages that diminished in value every day. On September 7, the Treasury Department took control of both entities. The long-respected investment bank Lehman Brothers was next. Unlike Bear Stearns, the government refused to step in, forcing it into bankruptcy on September 12. On September 16, the American International Group (AIG), one of the world's largest insurance companies, revealed it was teetering on financial ruin.       
AIG had insured risky securities that were tied to securitized mortgages. The federal government feared that if AIG collapsed, it would produce a domino effect as banks that had insured its securitized mortgages would be left with toxic assets that had little value. The government essentially bought AIG for $85 billion. As these events unfolded, the STOCK MARKET dropped almost 500 points and individuals withdrew about $140 billion from their money-market funds, sparking fears that there would be a run on the banks.       
On September 18, Treasury Secretary Henry Paulson, a former Wall Street investment banker, announced a three page, $700 billion proposal to bail out the banks. He proposed that the government buy the toxic assets from the largest banks, which could stabilize their financial position. Members of Congress were skeptical, in part because the three-page proposal was scant on details and gave Paulson total, unreviewable control over how he spent the $700 billion. Because these events occurred during the 2008 presidential campaign, politics also factored into the debate on the proposal.       
On September 29, the House of Representatives voted down a modified version of Paulson's plan. The stock market lost nearly 9 percent of its value after the vote was taken, the worst decline since 1987. Congress took note of Wall Street's reaction and reached a compromise. The House passed the bill on October 3 and sent EESA to President Bush for signing. As the United States began to confront its problems, the banks of Europe and Asia were forced to deal with the crisis as it played out around the world.       
The TARP program was set up to handle the disbursement of the $700 billion. The law defined ''troubled assets'' to include residential or commercial mortgages and any ''securities, obligations, or other instruments that are based on or related to such mortgages'' originated or issued before March 14, 2008. The securitized mortgages clearly were the prime ''toxic assets'' that burdened the balance sheets of the major banks. EESA released $250 billion to the Treasury immediately, with the president authorized to release $100 billion more. For the remaining $350 billion, the Treasury had to notify Congress of its intent to use the money.        
Congress had 15 days to pass a resolution denying the Treasury the authority to do so. Paulson originally intended to hold AUCTIONS for the trouble assets but finally decided it would be better for the government to loan the money. TARP mandated that the Treasury receive non-voting stock from the banks in return for the TARP funds. Congress also was outraged at the enormous bonuses paid to bank executives for acquiring these toxic assets. The TARP contained language that banned banks that accepted TARP money from offering incentives that encouraged ''unnecessary and excessive risks'' to its top executives. For senior executives hired in the future, the banks were banned from offering lucrative SEVERANCE packages.       
TARP also was intended to help homeowners avoid FORECLOSURE. The Treasury was required to set up a program to achieve this objective but details were sketchy. Secretary Paulson had no interest in implementing this provision, telling Congress that TARP ''was not intended to be an economic stimulus or an economic recovery package.'' Congress was concerned with how the Treasury would run TARP, so it established the Financial Stability Oversight Board and a Congressional Oversight Panel. A February 2009 report from the panel claimed that the government had greatly overpaid for the toxic assets. It had paid $254 billion for assets valued at $176 billon.       
As TARP got off the ground, the U.S economy had taken a drubbing. It is estimated that $8 trillion of wealth was wiped out in the stock when measured from its highest point in the decade. Though TARP did stabilize the problem banks (nine banks took TARP money in return for stock), it was rumored that the incoming Obama administration might nationalize some of the troubled banks. That was not the case. Instead, Treasury secretary Timothy Geithner, who as head of the Federal Reserve Bank of New York played a key role in the fall 2008 with the bailout program, announced that it would perform ''stress tests'' on the 19 largest U.S. banks. The government wanted to know whether the banks were sufficiently capitalized to weather more declines in the economy. The results of the tests were promising. Ten of the 19 banks needed additional capital totaling $75 billion.       
Starting in March 2009, some of the banks returned to profitability. Then in June, 10 banks were allowed to return their portion of the $700 billon TARP funds. They paid back to the government a total of $68 billion. The zeal with which the banks returned the money was primarily based on extricating them from government oversight and restrictions on executive pay. By September, Geithner reported to Congress that the TARP program was winding down and that more banks would likely repay their bailout funds. Though the bank bailout appeared to be successful in stabilizing the largest banks, financial reform regulation legislation was having a slow and difficult journey through Congress.      
Moreover, though the public came to the rescue of these private banks, credit remained tight in late 2009 for businesses and individuals alike.

Gasparino, Charles. 2009. The Sellout: How Three Decades of Wall Street Greed and Government Mismanagement Destroyed the Global Financial System. New York: HarperBusiness.
Goodman, Peter. 2008. ''Taking Hard New Look at a Greenspan Legacy.'' New York Times. October 8.
Morris, Charles. 2009. The Two Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash. New York: Public Affairs.
Phillips, Kevin. 2008. Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism. New York: Viking.
Sorkin, Andrew Ross. 2009. Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System and Themselves. New York: Viking.
Varchaver, Nicholas, and Katie Benner. 2008. ''The $55 Trillion Question.'' Fortune. September 30.

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