Government intervention during the subprime mortgage crisis

Government intervention during the subprime mortgage crisis

Due to the subprime mortgage crisis, a variety of government bailouts were implemented to stabilize the financial system during late 2007 and early 2008. Governments intervened in the United States and several Western European countries, such as Belgium, France, Germany, Ireland, Luxembourg, the Netherlands and the UK.

United Kingdom

Northern Rock

Northern Rock had difficulty finding finance to keep the business going and approached the Bank of England as lender of the last resort on the 12 September 2007. This caused mass concern about the bank's future. The Bank of England and the UK Government both insisted that the bank was secure and would not collapse. However this failed to stop thousands of customers withdrawing around £1billion from their savings. Northern Rock's share price plummeted and intense pressure from the media, political opposition parties and customers of Northern Rock, forced the Government to nationalize Northern Rock on 17 February 2008.

Bank rescue package

Banks that are short of capital can ask to be rescued. The government will use money from tax payers to buy shares in the banks, making them part nationalised. Banks who take the rescue packages will have restrictions on executive pay and dividends to existing shareholders.

United States

Bear Stearns

On March 16th 2008, J.P. Morgan Chase announced that it would buy Bear Stearns for $500 million or $2 a share [http://www.nytimes.com/2008/03/16/business/16cnd-bear.html] , those same shares a year earlier were trading at around $150. [http://www.businessweek.com/bwdaily/dnflash/content/mar2008/db20080314_993131_page_2.htm] Later, on March 24th 2008 J.P. Morgan Chase increased the offer to $1.2 billion or $10 a share [http://www.nytimes.com/2008/03/25/business/25bear.html] and five days later the acquisition was approved. [http://www.ft.com/cms/s/d42c01d2-2d8d-11dd-b92a-000077b07658,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2Fd42c01d2-2d8d-11dd-b92a-000077b07658.html%3Fnclick_check%3D1&_i_referer=http%3A%2F%2Fen.wikipedia.org%2Fwiki%2FBear_Stearns&nclick_check=1] In order for deal to go through J.P. Morgan Chase required [http://www.usatoday.com/money/industries/banking/2008-03-17-bear-stearns-bailout_N.htm] the Fed to issue a nonrecourse loan of $29 billion to Bear Stearns. [http://www.federalreserve.gov/newsevents/press/other/other20080627a2.pdf] [http://www.jpmorgan.com/cm/Satellite?c=JPM_Content_C&cid=1159339104093&pagename=JPM_redesign%2FJPM_Content_C%2FGeneric_Detail_Page_Template] This means that the loan is collateralized by mortgage debt [http://seekingalpha.com/article/70098-bear-stearns-bondholders-win-big] and that the government can't go after J.P. Morgan Chase's assets if the mortgage debt collateral becomes insufficient to repay the loan. [http://seekingalpha.com/article/70098-bear-stearns-bondholders-win-big] [http://hussmanfunds.com/wmc/wmc080324.htm]

The bailout was taken in part to avoid a potential fire sale of nearly U.S. $210 billion of Bear Stearns' MBS and other assets, which could have caused further devaluation in similar securities across the banking system. [ [http://www.msnbc.msn.com/id/23662433/ JPMorgan to buy Bear Stearns for $2 a share - U.S. business - MSNBC.com ] ] [ [http://www.msnbc.msn.com/id/23638138/ After Bear Stearns, others could be at risk - U.S. business - MSNBC.com ] ] Chairman of the Fed, Ben Bernanke, defended the bailout by stating that a Bear Stearns' bankruptcy would have affected the real economy [http://www.cbsnews.com/stories/2008/04/03/business/main3991713.shtml?source=RSSattr=HOME_3991713] and could have caused a "chaotic unwinding" of investments across the US markets. [http://www.bloomberg.com/apps/news?pid=20601087&refer=worldwide&sid=a7coicThgaEE]

Independent National Mortgage Corporation (IndyMac)

Before its failure , the Independent National Mortgage Corporation (Indymac) was the largest savings and loan association in the Los Angeles area and the seventh largest mortgage originator in the United States. [] The failure of IndyMac Bank on July 11, 2008, was the fourth largest bank failure in United States history [cite news |first=Andrea |last=Shalal-Esa |title=FACTBOX: Top ten U.S. bank failures |url=http://www.reuters.com/article/ousivMolt/idUSTRE48P0YC20080926 |work=Reuters |publisher=Thomson Reuters |date=2008-09-25 |accessdate=2008-09-26 ] , and the second largest failure of a regulated thrift.cite news
url= http://www.newsday.com/business/nationworld/wire/sns-ap-indymac,0,5354918.story
title=Government shuts down mortgage lender IndyMac
first=Alex
last=Veiga
publisher=Associated Press (Newsday)
date=2008-07-12
accessdate=2008-07-12
] IndyMac Bank's parent corporation was IndyMac Bancorp until the FDIC seized IndyMac Bank cite web
url= http://www.thestreet.com/story/10431578/1/indymac-bancorp-to-liquidate.html
title= IndyMac Bancorp to Liquidate
accessdate= 2008-08-01
last= LaCapra
first= Lauren Tara
date= 2008-08-01
work= TheStreet.com
] .

Fannie Mae and Freddie Mac

The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), two large government-sponsored enterprises, are the two largest single mortgage backing entities in the United States. Between the two corporations, they back nearly half of the $12 trillion mortgages outstanding as of 2008.cite news | first = Charles | last = Duhigg | title = Loan-Agency Woes Swell From a Trickle to a Torrent | url = http://www.nytimes.com/2008/07/11/business/11ripple.html?ex=1373515200&en=8ad220403fcfdf6e&ei=5124&partner=permalink&exprod=permalink | work = The New York Times | location = New York, New York | date = 2008-07-11 | accessdate = 2008-09-17 ] During the mortgage crises, some in the investment community feared the corporations would run out of capital. Both corporations insisted that they were financially solid, with sufficient capital to continue their businesses, but stock prices in both corporations dropped steadily nonetheless.

Due to their size and key role in the US housing market, it had long been speculated that the US Government would take action to bolster both companies in such a situation. On 30 July 2008, this speculation became reality when President Bush signed the Housing and Economic Recovery Act of 2008. While analysts disagreed on the financial need for such a bailout, the investor confidence provided by an explicit government show of support was likely needed in any case.

On 5 September 2008, the Treasury Department confirmed that both Fannie Mae and Freddie Mac would be placed into conservatorshipcite news | first = John | last = Poirier | coauthors = Patrick Rucker | title = Government plan for Fannie, Freddie to hit shareholders | url = http://biz.yahoo.com/rb/080906/fannie_freddie.html?.v=4 | work = Reuters | publisher = Yahoo! Finance | date = 2008-09-06 | accessdate = 2008-09-17 ] with the government taking over management of the pair.

Lehman Brothers, Merrill Lynch & Co. and AIG

Lehman Brothers and Merrill Lynch

On September 15th 2008, a day which has been dubbed Meltdown Monday by some News outlets,] ] the 94 year-old Merrill Lynch agreed to be acquired by Bank of America for $50 billion. Also on that day Lehman Brothers, facing a refusal by the federal government to bail it out, filed for Chapter 11 bankruptcy protectioncite news | first = | last = | title = Lehman Brothers: Bankruptcy filing won’t impact Tampa unit | url = http://www.bizjournals.com/tampabay/stories/2008/09/15/daily2.html | work = Tampa Bay Business Journal | publisher = American City Business Journals, Inc. | location = Tampa Bay, Florida | date = 2008-09-15 | accessdate = 2008-09-17 ] . Treasury Secretary Hank Paulson cited moral hazard as a reason for not bailing out Lehman Brothers.]

American International Group

Meanwhile Goldman Sachs and JP Morgan Chase tried but failed to raise $70 billion to lend AIG.cite news | first = Justin | last = Fox | title = Why the Government Wouldn't Let AIG Fail | url = http://www.time.com/time/business/article/0,8599,1841699,00.html | work = TIME | publisher = Time Inc. | date = 2008-09-16 | accessdate = 2008-09-17 ] One day later, The Fed found itself forced to bail out insurance giant AIG by providing an emergency credit liquidity facility of up to $85 billion,] which will be repaid by selling off assets of the company. After concluding that a disorderly failure of AIG could worsen the current financial and economic crisis, [] and at the request of AIG, the Fed intervened, after AIG had demonstrated that it could not obtain financing from any source. The Federal Reserve required a 79.9 percent equity stake as a fee for service and to compensate for the risk of the loan to AIG.

Washington Mutual

The Seattle based bank holding company Washington Mutual declared bankruptcy on September 26, 2008. The 120 year old company, one of the largest banking institutions in the US West, was driven into bankruptcy by the subprime crises. On the previous day, September 25, 2008, the United States Office of Thrift Supervision (OTS) announced that it closed the holding company's primary operating subsidiary, Washington Mutual Savings Bank, and had placed it into the receivership of the Federal Deposit Insurance Corporation (FDIC). The FDIC sold the assets, all deposit accounts, and secured liabilities to JPMorgan Chase, but not unsecured debt or equity obligations. [ [http://online.wsj.com/article/SB122238415586576687.html" J.P. Morgan to Take Over Faltering WaMu"] ] Washington Mutual Savings Bank's closure and receivership is the largest U.S. bank failure in history. [Levy, Ari; Hester, Elizabeth. [http://www.bloomberg.com/apps/news?pid=20601087&sid=aWxliUXHsOoA&refer=home "JPMorgan Buys WaMu Deposits; Regulators Seize Thrift"] . "Bloomberg L.P.". September 26, 2008. Retrieved September 26, 2008.] Kerry Killinger, the CEO from 1988 to August 2008, had been fired by the board of directors. Virtually all savings and checking account holders were not affected as the accounts were insured by the FDIC during the collapse, and subsequently transferred in whole to JPMorgan Chase. The holding company, Washington Mutual Inc was left without its major asset and equity investment, its former subsidiary Washington Mutual Savings Bank, and filed for bankrupcty the following day, the 26th.

WaMu's collapse is the largest U.S. bank failure in history. [Levy, Ari; Hester, Elizabeth. [http://www.bloomberg.com/apps/news?pid=20601087&sid=aWxliUXHsOoA&refer=home "JPMorgan Buys WaMu Deposits; Regulators Seize Thrift"] . "Bloomberg L.P.". September 26, 2008. Retrieved September 26, 2008.]

Wachovia

Wachovia Corp., the fourth biggest US bank by assets, agreed on September 29, 2008 to divest all of its banking subsidiaries to CitiGroup in an all-stock transaction, scheduled to be consummated by December 31, 2008. The transaction "open bank" was facilitated by the FDIC and with the concurrence of the United States Department of the Treasury, and the Board of Governors of the Federal Reserve Bank. The FDIC guaranteed to Citigroup to cover any losses on the Wachovia banking portfolio greater than $42 billion, in exchange for $10 billion in preferred stock.

Emerging plan to bail out financial institutions

On 19 September 2008, the U.S. government announced a plan to purchase large amounts of illiquid, risky mortgage backed securities from financial institutions [ [http://www.ustreas.gov/press/releases/hp1149.htm Treasury - Paulson News Release] ] , which is estimated to involve at minimum, $700 billion of additional commitments. [http://www.nytimes.com/2008/09/21/business/21cong.html?hp] This plan also included a ban on short-selling of financial stocks. [ [http://money.cnn.com/2008/09/19/news/economy/paulson/index.htm?postversion=2008091910] ] The mortgage market is estimated at $12 trillion [ [http://www.nytimes.com/2008/07/11/business/11ripple.html?ex=1373515200&en=8ad220403fcfdf6e&ei=5124&partner=permalink&exprod=permalink NY Times] ] with approximately 9.2% of loans either seriously delinquent or in foreclosure through August 2008. [ [http://www.mbaa.org/NewsandMedia/PressCenter/64769.htm MBA Survey] ]

References


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