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Chapter 1
To Rescue, Rebalance, and Rebuild
Recession begins December 2007
Financial Crisis Begins September 2008
Jan 2009 12 million unemployed, GDP falls precipitously
American Recovery and Reinvestment Act of 2009 (signed January 2009)
2000s were an Age of high Consumption and Government Spending
(need to rebalance – higher investment, saving, and exports)
Major US problems: --- health care
--- stagnating middle incomes
--- continued use of fossil fuels
--- need to revitalize innovation and R&D
--- improve K-12 education, community colleges
--- expand clean energy economy
Housing Prices Doubled 1997 – 2006
--- this led to complex financing and expansion of credit derivatives
--- housing prices begin falling in early 2007
--- start of financial strain
--- early 2008 economy begins to show downturn
First 8 months of 2008 employment fell by 137,000 people/month
September 2008 Lehman Brothers fails due to CDS exposure
AIG threatened due to CDS exposure
Credit spreads increase, stock market falls 24% in Sept and Oct 2008
January 2009 loses in employment reaches 544,000 people/month
Real GDP growth -2.7% QII 2008,
-5.4% QIV 2008,
-6.4% QI of 2009
Basic Outline of the ERP 2010
Chapter 2 Actions Taken to Rescue the Economy
Chapter 3 Worldwide Actions Taken in Response to the Recession
Chapter 4 Transition from High C and G to High I and Net Exports
Chapter 5 US Fiscal Deficit and Debt and Health Care Reform
Chapter 6 Financial Reform
Chapter 7 Health Care Reform
Chapter 8 Strengthening the Labor Force
Chapter 9 Energy Usage Reforms
Chapter 10 Boosting Productivity
Chapter 2
Rescuing the Economy from the Great
Recession
Recession Begins December 2007 due to the fall in housing prices
Bubble housing prices fall from 200 (index) to 125 (index) 2007 - 2010
S&P stocks also had a bubble but not as important as housing
Subprime Market, Alt-A Market are threatened with meltdown
Housing prices ----- 3.5% fall in Jan-June 2007
6.0% fall in June –Dec 2007
Tax cut in early 2008 successful (consumption constant even though real
wealth falling)
During IIIQ 2008 economy and financial markets fall heavily
Risk Spreads increase dramatically
S&P falls 29% and housing falls 11% during the fall of 2008
20% fall in net worth of household wealth from Dec 2007 to Dec 2008
CP market froze in fall 2008, transactions cut in half
Securitization loans reduced
-- auto loans
-- credit cards
-- student loans
-- commercial loans
GM and Chrysler needed loans in Dec 2008 and Jan 2009
to avoid bankruptcy
Job loss got worse through January 2009
Commercial Paper (CPs) used to finance payrolls and suppliers.
-- short term credit very important for doing business
-- changes in the supply of short term credit affects long term investment
Obama Administration seeks to make financial firms more
responsible and less risky
Policies Used to Rescue the Economy
--- Monetary Policy
--- Financial Policy
--- Fiscal Policy
--- Housing Policy
Monetary Policy
Federal Funds Rate was Reduced from 2007 to 2009
March 2008 Special Lending Facility to Banks and Financial Institutions
CP Lending Facility Created in Oct 2008
March 2009 -- QEI $300b of long term debt purchased by the Fed
Fed buys Fannie Mae and Freddie Mac Debt
Fed Assets tripled between Jan 2008 – Dec 2008.
Dramatic move away from short term securities.
Dramatic Increase in Reserves in the Banking System
Some claim that inflation could rise in the future
This fear is not credible because –
(1)Fed Funds rate should be 5% lower than it is (but it cannot be negative)
(2)Fed can easily retire the reserves through open market sales, also rate paid on
reserves can be raised
Financial Policy
Sept 7 2008
Fannie Mae and Freddie Mac placed under conservatorship
When referring to government control of private corporations such as Freddie
Mac or Fannie Mae, conservatorship implies a more temporary control than
does nationalisation.
Sept 16 2008 AIG given $85b in credit line
Sept 19 2008 Money Market Mutual Funds given guarantees by US Treasury
Oct 03 2008 Emergency Economic Stabilization Act of 2008 ($700b)
-- $350b used to buy preferred equity shares in financial institutions
-- $350b requires Presidential notification of Congress
Jan 12 2009 President Bush released second half of TARP funds (Obama
agrees)
Feb 10 2009 Treasury Secretary Geithner establishes Financial Stability
Plan
--- creates stress tests for 19 largest banks
--- Treasury adds $100b to Fed to increase credit to firms
--- reduce troubled (toxic) assets from balance sheets of financial
institutions
--- actions taken to reduce mortgage rates and reduce foreclosures
--- auto industry financing $20b GMAC, Chrysler financing, etc.
Chrysler bankrupt April 30, 2009
GM bankrupt June 01 2009
As of Sept 20, 2009 US government gave $80b for restructuring of car
companies
Fiscal Policy
American Recovery and Reinvestment Act 2009 (ARRA) signed Feb 17, 2009
Cost is $787b and involves tax cuts and spending increases = 2% of GDP
Design: --- spread over 2 years
--- well diversified
--- directed at long term needs (enduring capital investments)
Individual Tax Cuts – 1/3 of ARRA was tax cuts
-- typical family $800 per couple
-- $250 to seniors, veterans, disabled (total of $14b)
Business Tax Cuts – tax cuts on investment (tax deductions)
-- carry back of losses
An accounting technique with which a company retroactively
applies net operating losses to a preceding year's income in order
to reduce tax liabilities present in that previous year
-- 75% exclusion from capital gains on small business
-- better and expanded lending through SBA
Fiscal Relief to State and Local Governments -- $140b to states and localities
Direct Support to Individuals -- $90b
--extension of unemployment benefits,
subsidies to health insurance, increased food stamps
-- reduced taxes on unemployment benefits
Direct Government Investment Spending
-- investment in transport and basic scientific research
-- greater spending in health technology
-- expansion of smart electric grid
-- tax credits for energy related investment and spending
Additional Programs – “Cash for Clunkers”
-- old car + $4500 when buying new car
originally $1b for program but $3b added after exhaustion
November 2009 Worker, Homeownership and Business Assistance Act 2009
--- cut taxes on business
--- provided additional 20 weeks unemployment
--- COBRA program expanded to help unemployed keep health insurance
Congress passed the landmark Consolidated Omnibus Budget Reconciliation Act (COBRA) health benefit provisions in
1986. The law amends the Employee Retirement Income Security Act, the Internal Revenue Code and the Public
Health Service Act to provide continuation of group health coverage that otherwise might be terminated .
Housing Policy
Make Home Affordable Program March 2009
-----------
Fed buys GSE debt, MBS
Refinancing simplified
Loan modifications $75b
$8000 tax credit helps to move purchases forward
aid to states and local housing finance
Have the Policies Been Effective?
Interest Rate Spreads Have Come Down
S&P Stock Index Has Risen
Small Business Loans Have Increased
Mortgage Rates Have Come Down
House Prices Are Turning Around
Real GDP Growth is Positive and Rising
Investment Remains Weak
Stimulus Saved Jobs
Employment Growth in Health and Federal Government
Challenges Ahead
--- Employment
--- Housing
--- Deficits and Debt