The events that began 10 years ago this month provided early signs of an impending stress in the financial system, but were either missed, or dismissed, by the regulators and various stakeholders across the board. However, dominos kept falling one after the other, culminating into the eventual fall of the United States’ fourth largest investment bank Lehman Brothers one year later. While the regulators and authorities were scrambling to keep the financial system from falling apart before it, Lehman Brothers’ bankruptcy was a wake up call for those at the highest levels of the government. Earlier this week, in the first part of this 2-part series, we explored the key events in the run up to that fateful day of 15 September 2008. This second part looks at the hectic events that followed.
The pessimism and panic hammered the global financial markets after the bankruptcy of Lehman Brothers. The US benchmark index Dow Jones Industrial Average plunged as much as 20% in a month to 8,758.84 points on 1 October 2008 from 11,069.73 points on 1 September 2008. It was one of the biggest monthly falls ever witnessed in the American stock markets. Indian equity markets too reacted very badly as the sentiment all across the globe turned miserable. The 30-share barometer Sensex tumbled 27% in the same period to 9,748.08 points from 13,417.91 points.
Market madness after Lehman bankruptcy: September 2008
The credit cycle started freezing as everybody in the market begin to pile up. Within days of Lehman bankruptcy, US banks Washington Mutual and Wachovia went down, and even giant organisations JPMorgan and Goldman Sachs came under threat. The net asset value of shares in the Reserve Primary Money Fund fell below $1, primarily due to losses on Lehman Brothers commercial paper and medium-term notes. The FOMC repeatedly expanded the existing swap lines and authorised new swap lines with the Bank of Japan, Bank of England, and Bank of Canada.
TARP: October 2008
JPMorgan Chase acquired the banking operations of Washington Mutual, while Wells Fargo announced a competing proposal to purchase Wachovia Corp. Congress passed and President George Bush signed into law the Emergency Economic Stabilization Act of 2008, which established a $700 billion Troubled Asset Relief Program (TARP) for buying up banks’ bad assets. This facility allowed banking organisations to apply for a preferred stock investment by the US Treasury. Nine large financial organisations announced their intention to subscribe to the facility in an aggregate amount of $125 billion. The FOMC voted to reduce its target for the US Federal Reserve rate 50 basis points to 1.5 percent. The government bailed out several banks, including the Royal Bank of Scotland, Lloyds TSB, and HBOS, to avoid hammering the collapse of the banking industry.
AIG loan swap: November 2008
The Federal Reserve Board approved American Express and American Express Travel Related Services to become bank holding companies. This was followed by the Treasury announcing that it will purchase $40 billion of AIG preferred shares under the TARP program, a portion of which will be used to reduce the Federal Reserve’s loan to AIG from $85 billion to $60 billion. US Treasury Secretary Hank Paulson formally announced that the Treasury has decided not to use TARP funds to purchase illiquid mortgage-related assets from financial institutions.
Automobile companies queue up
Chief Executives of Ford, General Motors, and Chrysler testified before Congress, requesting an access to the TARP for federal loans. The Federal Reserve Board announced the creation of the Term Asset-Backed Securities Lending Facility (TALF), under which the Federal Reserve Bank of New York would lend up to $200 billion spread between Treasury securities, mortgage-backed securities, and agency bonds. During this period, the Federal Reserve announced the first round of quantitative easing on 25 November 2008, which continued until 2013.
Between 2007 and 2009, millions of people lost their jobs. (Image: Reuters)
Recession: December 2008
Ireland was one of the first countries which officially entered recession in September. In December, the US government statisticians of the National Bureau of Economic Research announced that the world’s largest economy is slowing down and since 2007 it has been in a recession. The FOMC voted to establish a target range for the US Federal Reserve’s effective policy rate of 0 to 0.25 percent — lowest in the history.
Meanwhile, the new US President Barack Obama was elected on a message of hope that first he has to deal with the financial crisis. Later in February 2008, he signed a $787 billion stimulus package. The US Treasury Department authorised loans of up to $13.4 billion for General Motors and $4 billion for Chrysler from the TARP.
The US Securities and Exchange Commission (SEC) released a report that recommended against the suspension of fair value accounting standards. The report was mandated by the Emergency Economic Stabilization Act of 2008 (EESA).