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

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)

Chapter 2 Rescuing the Economy from the Great Recession

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, 2009GM 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