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2008 FINANCIAL CRISIS TIMELINE and
IMPACT ON THE FEDERAL BUDGET
In order to fully understand the impact of the credit crisis on the U.S. economy and the federal budget, it’s important to
understand the U.S. fiscal position immediately prior to the crisis.
Between 2001 and 2008—before the credit crisis—the Federal Debt had nearly doubled:
--Debt Held by the Public had increased from $3.3 trillion in FY 2000 to $6 trillion by early 2008; and
--Total Federal Debt (which includes amounts owed to the Social Security and other Trust funds) had nearly doubled
from $5.7 trillion to $10 trillion.
Moreover, the annual budget deficit had grown to more than $450 billion, and the long-term fiscal outlook projected
unsustainable budget shortfalls due to rapid growth in Medicare, Medicaid, and Social Security.
As a result of the pre-existing budget crisis, the steps described below to stabilize the financial, housing, and auto
sectors have required massive new borrowing by the Treasury. The measures are not funded with current taxpayer
dollars because the Treasury is already operating in the red. Rather, the costs will be borne by subsequent
generations of taxpayers who will bear the increasing burden of massive annual interest payments to finance the
current generation’s swollen debt.
Seeds of the Financial Crisis:
--Banks were issuing “subprime mortgage loans” (which are risky loans that start with low “variable” interest rates
that increase dramatically after an initial period).
--As long as home prices were rising – largely as a consequence of a speculation bubble – residential mortgage
borrowers who found that they couldn’t afford the higher monthly payments could sell their houses at a profit and pay
off the loan.
--But when the “housing bubble” burst and home prices fell, homeowners unable to meet monthly payments lost
their homes in foreclosures, while banks and other mortgage-lenders lost money (unable to recover the amount of the
mortgage loan).
--The financial impact of the foreclosures was magnified throughout the economy due to the widespread marketing of
“mortgage-backed securities” (MBSs), which bundled 1000 or more individual mortgages. The government
sponsored entities – Fannie Mae and Freddie Mac – which exist to increase housing credit, were hit especially hard
because of their heavy investment in subprime mortgages and MBSs based on subprime mortgages.
--Investment banks also invested heavily in MBSs and in many cases borrowed money to buy them (known as
“leveraging”) – which magnified their financial risk.
--In a regulatory move that further magnified the scope of the crisis, investment banks in 2004 had successfully
lobbied the SEC for a weakening of regulations that allowed them to use cash reserves to buy MBSs.
--When the housing bubble burst and subprime mortgages went bad in early 2008, a highly leveraged (deeply indebted)
investment bank – Bear Stearns – collapsed and, as the crisis unfolded, Lehman Brothers went bankrupt and other
investment banks were sold.
--The crisis was further exacerbated by the widespread existence of “credit default swaps (CDSs),” where speculators
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essentially bet on MBSs or other financial instruments defaulting.
--Amidst a cascade of fear about the solvency of financial and other institutions heavily invested in MBSs and
CDSs, lenders stopped offering loans and entering into other financial transactions—fearing the borrowers would be
unable to repay the loans.
--Without sufficient credit, businesses slowed spending significantly and laid off workers, which in turn reduced
consumer spending, causing a vicious circle of declining economic activity.
--Declining economic activity and the credit crisis, hit the U.S. auto industry especially hard as consumers put off the
purchase of new cars.
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2008 Financial Crisis Time Line
Federal Budget Impact
March 2008: Bear Stearns, one of the largest global
investment banks, was sold for a fraction of its previous
value due in large part to the subprime mortgage crisis.
No direct budget impact, but the collapse of Bear Stearns
ignited a crisis of confidence in the financial markets.
July 2008: Fannie Mae and Freddie Mac share values
plunged in July 2008 due to concern about the value of
their mortgage-backed securities and their ability to borrow
from credit markets.
No direct budget impact, but the plunge in Fannie and
Freddie stocks led to enactment of the housing rescue
bill and the subsequent Federal takeover of Fannie and
Freddie on September 7, 2008. (see below).
Background:
--Fannie and Freddie are shareholder-owned corporations,
originally chartered by the government, that play a central
role in mortgage finance. The two GSEs (governmentsponsored enterprises) buy home mortgages from the
original lenders, repackage them as mortgage-backed
securities and either sell them or hold them in their own
portfolios. This allows the original lenders to make
additional mortgages.
--However, when the housing bubble burst and mortgagebacked securities lost value, Fannie and Freddie shares
plunged.
July 13, 2008: Treasury announced an effort to backstop
Fannie and Freddie—in coordination with the Fed—by
increasing the GSE’s line of credit with the Treasury and
announcing Treasury’s right to purchase equity in the
GSEs.
Giving Fannie and Freddie an increased line of credit
would increase Treasury Debt, as would Treasury
purchasing equity in the GSEs. However, this was never
calculated since by early September, Fannie and Freddie
were seized (see below).
July 30, 2008: President signed into law the Housing and
Economic Recovery Act of 2008 which:
--Increased the Treasury line of credit to Fannie and
Freddie;
--Provided authority to purchase stock in Fannie and
Freddie;
--Created the Federal Housing Finance Agency (FHFA)
to regulate Fannie and Freddie;
--Increased to $625,000 the size of mortgages Fannie and
Freddie can purchase;
--Authorized $300 billion in FHA loan guarantees to assist
in restructuring mortgage loans;
--Provided a $7500 refundable tax credit for first-time
homebuyers; and
--Increased the Federal Debt Ceiling from $9.8 trillion
to $10.6 trillion in anticipation of the need for Treasury to
support Fannie and Freddie.
CBO said there was a more than 50% probability that the
Fannie and Freddie provisions would not need to be
used, but said if they were used the costs to the Treasury
could be as high as $100 billion. Due to the
uncertainties, CBO estimated a cost of $25 billion.
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Sept. 7, 2008: Fannie Mae and Freddie Mac seized by
Government. The newly-created Federal Housing
Finance Agency (FHFA) assumed full authority over the
assets and operations of Fannie and Freddie – an action
that had been viewed in July as unlikely.
Specifically, Treasury committed to invest as much as
$200 billion in preferred stock to guarantee solvency and
protect current holders of Fannie and Freddie debt.
However, the commitment to stand behind all Fannie and
Freddie debt obligations exposes the government to about
$5 trillion of debt.
CBO Director Orszag said on Sept. 9 that CBO intended
to incorporate the assets and liabilities of Freddie and
Fannie into the Federal budget baseline. Whether the
new CBO Director will follow this course, and how this
would translate into annual deficit calculations remains
unclear. One thing we know for sure is that if Treasury
spends $200 billion for preferred stock in the GSEs, that
amount will add to total Federal Debt.
OMB, on the other hand, said on Sept. 12 that they
would keep Fannie and Freddie’s operations off-budget
despite the Federal takeover. (Whether Peter Orszag as
OMB Director-designate will alter this stance remains
unclear.) One item for certain is that if Treasury spends
$200 billion for preferred stock in the GSEs, that
amount will add to total Federal Debt.
Sept. 14, 2008: Bank of America buys Merrill Lynch.
No direct impact on Federal Budget.
Sept. 15, 2008: Lehman Brothers files for bankruptcy.
No direct impact on Federal Budget.
Sept. 16, 2008: Federal Reserve gives insurance giant AIG
(American International Group) an $85 billion bridge
loan; in addition, a $38 billion line of credit with the Fed,
as well as a $21billion debt purchasing arrangement with
the Fed. (But see Nov. 10, below, for modification of
assistance.)
Initially, this will add up to $85 billion to the total
Federal Debt, although the long-term budgetary impact
will depend on the financial health of AIG.
Sept. 19, 2008: Treasury announces it will provide
guarantees for the nation’s money market mutual funds.
Could add dramatically to Federal debt, depending on
how often and how much the Treasury is called upon to
backstop money market funds.
Sept. 20, 2008: Bush Administration proposes $700
billion financial rescue plan to buy mortgage-related
“troubled assets” from financial institutions over a twoyear period.
(see October 1 legislation below)
Sept. 29, 2008: House rejects $700 billion financial rescue
bill by a vote of 228-205. Dow falls 777 points, the largest
ever one-day drop.
(see October 1 legislation below)
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Oct. 1, 2008: Senate passes revised financial rescue bill
(HR 1424) including:
--creation of Troubled Assets Relief Program (TARP)
that allows Treasury to borrow up to $700 billion to
purchase, insure, hold, and sell financial instruments
related to residential or commercial mortgages issued prior
to 3/14/08
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According to CBO, the TARP would “entail some net
budget cost—which would, however, be substantially
smaller than $700 billion” (depending on eventual
income from selling the assets). Annual budget deficits
would reflect projected net costs. Nevertheless, the
initial purchase of assets would require Treasury
borrowing up to $700 billion—directly adding to the
accumulated Federal debt. (Also, CBO estimates a “few
billion dollars per year” for administrative costs.)
$250 b available immediately
$100 b additional released upon notification to
Congress
$350 b if President submits detailed plan, subject
to 15-day congressional review
--temporary increase in FDIC insurance to $250K through
2009; borrowing authority authorized to back up the
increases
The increase to $250K per account could result in
significant new debt, depending on the number and size
of bank failures.
--renewable energy and conservation tax incentives
The energy provisions, costing a net $1 billion in FY
’09, were largely offset by revenue raisers.
--AMT patch
The AMT patch is projected to cost $79 billion in FY
’09, adding to the debt.
--individual and business “tax extenders”
The tax extenders are projected to cost $24 billion in FY
’09, adding to the debt.
--increased debt ceiling to $11.3 trillion
Expectations of potential new debt are reflected in the
increase of the debt ceiling to $11.3 trillion.
Oct. 3, 2008: House approves revised bailout bill (HR
1424) by a vote of 263-171; President Bush signs into law
the same day (PL 110-343).
See above.
Oct. 8, 2008: Federal Reserve loans another $37.8 billion
to AIG, on top of the $85 billion loaned in Sept.
Initially, this will add another $37.8 billion to the total
Federal Debt, although the long-term budgetary impact
will depend on the financial health of AIG. The single
year deficit impact will depend on projections of future
returns.
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Oct. 14, 2008: Treasury announced that it will use $250
billion of the previously authorized $700 billion to
purchase “preferred” stock in major banks in order to
inject money directly into the credit markets.
Established as the “capital purchase program” (CPP).
The $250 billion for CPP is to be taken from the TARP,
which is deficit-financed. In a December 2 report, the
GAO found that “Treasury has yet to address a number
of critical issues, including determining how it will
ensure that CPP is achieving its intended goals....”
Under the plan, $125 billion went to 9 banks; Citigroup,
Bank of America, Wells Fargo, and JPMorgan Chase each
received $25 billion in return for preferred stock. Five
banks split another $25 billion. Another $100 billion was
made available for smaller regional banks.
The government would also guarantee new debt issued by
banks for 3 years in exchange for limits on executive pay
and golden parachutes.
The FDIC will also now provide unlimited insurance to
back all business accounts (non-interest-bearing checking
accounts) in the U.S.
The guarantee on new bank debt would result in Federal
outlays and increased debt if defaults occur.
[Background: Preferred stock usually carries no voting
rights, but may carry superior priority over common stock
in payment of dividends and upon liquidation.]
The FDIC could incur costs associated with backing
business checking accounts at all banks.
Nov. 10, 2008: Fed restructures AIG (American
International Group) loan and adds additional relief to
the rescue plan, increasing the total package to more
than $150 billion:
The $40 billion stock purchase is to be taken from the
TARP, which is deficit-financed.
--reduce original $85 billion bridge loan to $60 billion, cut
the interest rate, and extend the loan to 5 years
--Treasury will purchase $40 billion in preferred stock
--Fed will purchase up to $22.5 billion of AIG’s mortgagebacked securities
--Fed will also lend $30 billion to backstop AIG’s credit
default swaps
Nov. 12, 2008: Treasury Secretary Henry M. Paulson Jr.
said that the $700 billion financial bailout program
would not be used to buy troubled mortgage-backed
securities, as originally intended.
Instead, capital would be provided directly to nonbank
companies as well as banks and financial institutions, and
that more would be done to prevent home foreclosures. At
the time, he also ruled out use of TARP funds for the auto
industry. (But see Dec. 19 below.)
Fed’s purchase of MBS’s and the backstop for credit
default swaps could require a Treasury loan to the Fed
(requiring more Treasury borrowing , adding to debt held
by the public)
Requires near-term increases in the Federal debt,
although the long-term cost depends upon the health of
the banks Treasury invests in.
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Nov. 18, 2008: Treasury Sec. Paulson, testifying at House
Financial Services Committee, says Administration will
not commit any of the remaining $350 billion in TARP,
and is firmly opposed to using any of the TARP funds to
provide a bridge loan to the auto industry. (But see Dec.
19 below.)
Nov. 23, 2008: In an effort to shore up Citigroup Inc.
(which had seen stocks plummet 60% the prior week),
Treasury pledges to purchase another $20 billion in
preferred stock (beyond the $25 billion infusion in
October). In addition, govt agencies (Treasury, FED,
FDIC) pledge to back up to $306 billion of “troubled
asset” losses (after Citi absorbs the first $29 billion).
The $20 billion stock purchase is to be taken from the
TARP, which is deficit-financed.
Additionally, there is potentially major exposure for
Federal Government as a backstop on Citi’s troubled
assets.
Nov. 25, 2008: Treasury and Fed announce a new $800
billion plan to ease the credit crunch. The Fed will
purchase up to $500 billion of Fannie and Freddie
mortgage-backed securities plus $100 billion of the GSEs'
debt. In addition, the Fed will lend up to $200 billion to
holders of asset backed securities to boost consumer and
small-business loans (to be called the Term Asset-Backed
Securities Loan Facility), while Treasury will provide $20
billion of TARP funds to provide credit protection.
Dec. 19, 2008: Treasury announces it will make $17.4
billion in loans to GM and Chrysler. ($13.4b for GM; $4b
for Chrysler) Funds could be “called back” if automakers
cannot prove viability by March 31.
As with all TARP funding, the $17 billion is deficitfinanced.
Dec. 29, 2008: Treasury announces $6 billion in aid to
auto-finance company GMAC
As with all TARP funding, the $6 billion is deficitfinanced.
Jan. 9, 2009: Congressional oversight panel releases a
report questioning the effectiveness and transparency of
TARP disbursements. The report is available at
http://cop.senate.gov/documents/cop-010909-report.pdf
Jan. 12: President Bush--acting on behalf of Presidentelect Obama--informed Congress of the Treasury's
intention to utilize the remaining $350 billion authorized
by the TARP program.
Jan. 15: The Senate voted down a measure that would
have blocked release of the remaining $350 billion
authorized by the TARP program.
As with all TARP funding, these funds are borrowed by
the Treasury and add directly to the public debt.
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Jan. 15: Treasury announces infusion of another $20
billion into Bank of America, and will limit the
company’s losses on $118 billion of troubled assets to 10%
of that amount.
As with all TARP funding, these funds are borrowed by
the Treasury and add directly to the public debt.
Commitment of the $700 billion TARP
(troubled asset relief program) funds
(enacted October 3, 2008)
Additional $350 billion
subject to 15-day
congressional review
$20 b to Bank of America
Additional $100 billion
at President’s discretion
$40 billion to purchase
AIG stock and $25 billion
for Citigroup stock;
another $20 billion for a
Fed lending program to
support consumer and
small business loans; and
$23.4 billion for auto
industry.*
Initial $250 billion
Originally intended for
“purchase of troubled
assets”; now intended to
purchase stocks in major
banks and other financial
institutions (including
AIG).
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