The Federal government is spending hundreds of billions of dollars to add liquidity to the financial markets to avoid a complete collapse. Here's a chronology of the how the crisis evolved, what caused it and steps the government has been taking along the way.
November - Paulson, Bernanke to Revive Credit Card Lending
The Treasury will partner with the Federal Reserve to use part of the $700 billion bailout to address a freeze in the consumer credit market. The $1 trillion secondary market for credit card, auto and student debt had come to a standstill.
AIG Bailout Revised to $150 Billion
The Federal Reserve's $85 billion bail-out of insurance giant AIG has been revised. The Treasury Department will purchase $40 billion in preferred shares as part of its Capital Repurchase Plan. The Federal Reserve will purchase $52.5 billion in mortgage-backed securities. The funds will allow AIG to retire many credit default swaps, freeing it up to lend more.
Fed Loans $540 Billion to Bail Out Money Market Funds
The Federal Reserve announced it will lend $540 billion to allow money market funds to have enough cash to meet a continuing barrage of redemptions. Since August, over $500 billion has been withdrawn from money markets, which is where most businesses park their overnight cash. Businesses have been hoarding cash because LIBOR rates have been high, since banks have been reluctant to make loans.
World Governments Bail Out Banks
On October 14, 2008, the governments of Europe, Japan and the U.S. took unprecedented coordinated action to try and stem the ongoing global credit crisis.
Bank Bailout Bill Alternatives
Many of these alternatives are being implemented, including coordinated central bank rate cuts, the Federal Reserve acting as a commercial lender, and a clearinghouse for credit default swaps.
Did Fannie and Freddie Cause the Mortgage Crisis?
Many have blamed the mortgage funding practices of Fannie Mae and Freddie Mac for creating the subprime mortgage crisis. Although they played a large role, they cannot be held 100% responsible. Instead, they are a prime example of the larger economic forces that really caused the banking credit crisis and bailout.
Bailout Bill is Passed
The bill establishes the Troubled Assets Recovery Program (TARP) which will give troubled banks the right to submit a bid price to sell their assets to TARP as part of a reverse auction.
Could the Mortgage Crisis and Bailout Have Been Prevented?
Signs of the current mortgage crisis first appeared in November 2006, when new home permits dropped 28% from the year before. At that time, most economists thought that, as long as the Federal Reserve dropped the interest rates by summer, the housing decline would reverse itself. However, what they didn't realize was the sheer magnitude of the subprime mortgage market, which had created a "perfect storm" of bad events.
How the Bailout Affects You
The bill should stop the current credit panic, allowing LIBOR rates to return to normal, and making it easier for everyone to get loans. Without credit market functioning, businesses are not able to get the capital they need to run their day-to-day business. Already it is difficult for people to get credit applications approved for home mortgages and even car loans. If the crisis were to continue, it would lead to a shut-down of small businesses, who can't afford the high interest costs. Also, those whose mortgage rates reset would see their loan payments jump. This would cause more foreclosures, which would add more houses to the market, further depressing home prices.
September - WaMu Goes Bankrupt
WaMu bank was taken over by the FDCI and sold to J.P. Morgan for $1.9 billion after its panicked depositors withdrew $16.7 billion in 10 days, leaving it with insufficient capital to run its business.
