An Overview of Recent Bank Bailouts in the U.S.

An Overview of Recent Bank Bailouts in the U.S.

Government bailouts are not new, but interest has increased because of large and far reaching bank bailouts in the wake of the 2008-2009 economic crisis. A bailout constitutes government intervention in an economic situation that is considered too drastic to wait for the market to self-correct. The economic crisis that began in 2007 and took hold in 2008-2009 is believed to be a direct result of risky investments, reckless decision making, and investors taking on greater risk in the hopes of greater returns. The government’s concern about the failure of banks is tied to the role banks play in the larger economy—as sources of credit or lenders to businesses. Banks also work on the demand side, by extending credit to consumers. When businesses are unable to get financing, they experience difficulties in purchasing parts for manufacture, participating in research and development efforts, expanding product lines, hiring staff, and expanding their markets. When consumers can’t get credit or lose their jobs, they don’t spend money and purchase goods. It is a cyclical problem, where the loss of credit on both the business and consumer sides begins to have a direct impact on one another.

Most prominent in this discussion is the subprime mortgage crisis of the early twenty-first century. Early in the twenty-first century, the real estate market grew and housing prices rose dramatically. Many lenders found creative ways to give mortgages to buyers who might otherwise not qualify for a loan. As a result, the housing market grew and houses increased in price—some beyond their value. When the housing market collapsed and as prices plunged, interest rates on adjustable rate mortgages (ARMs) increased and the economy began to weaken; thus, borrowers could not afford the loans they had been given, with many holding mortgages that exceeded the value of their homes. Foreclosures resulted, and many hedge funds, which specialized or had their basis in the resale of mortgage-backed securities, failed. Business sectors related to the housing market also felt the collapse, including construction, finance, and real estate.

The government has stepped in several times since the beginning of 2008 to assist failing financial institutions. In September 2008, the federal government extended $85 billion to the American International Group (AIG), the country’s largest insurer and one of the world’s largest companies. In the same month, the federal government took two government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, into receivership in order to stabilize the financial positions of those organizations. Since the failure of large financial institutions, coupled with decreased consumer spending, could result in a significant decline in economic growth and possibly economic collapse, the government saw a need for a larger plan. The Emergency Economic Stabilization Act of 2008 was passed in early October of 2008. The legislation was the result of weeks of wrangling between Republican and Democratic legislators and the White House. The legislation targeted the purchase of mortgage backed securities and an infusion of capital into failing banks.

Debate over the efficacy and the execution of these bailouts continued into 2009, with some believing that government intervention is not the answer, and that it rewards poor decision making on the part of companies and mortgage borrowers. Others fear greater government control, possible mismanagement, and poor oversight. In spite of the criticism, economists and others argued that something needed to be done to ensure confidence in US markets, as well as prevent an economic crisis.

American Recovery & Reinvestment Act of 2009 (ARRA): A government stimulus program designed to stimulate the economy by investing in US infrastructure, job creation and preservation, energy efficiency, science, and social programs.

Bailout program: A bailout is when a government, business or individual infuses money into a struggling entity to prevent complete failure or collapse.

Emergency Economic Stabilization Act of 2008 (EESA): An act authorizing the US Treasury Department to take action to restore liquidity and stability to the US financial system. The program not only bailed out the financial industry by purchasing so-called toxic assets, but also provided tax relief and incentives for energy conservation.

Subprime mortgage: Loans made to borrowers who have poor credit and are a greater risk to the lender. Subprime mortgages often include a higher interest rate (above the prime interest rate) or other undesirable terms that would not be offered to conventional borrowers with good credit. Adjustable rate mortgages (ARMs) are one example.

Subprime mortgage crisis: An economic and financial crisis created by large numbers of defaults on subprime loans.

Troubled Assets Relief Program (TARP): A provision of the EESA, authorizing the secretary of the treasury to make funds available to purchase troubled assets from financial institutions.

 

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