Analyze THREE ways in which the Great Depression and the economic downfall of 2008 altered the American social and economic fabric of society. Identify THREE New Deal measures that attempted to create a more stable economy. Discuss THREE measures used in 2008 to help revive the economy.
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How did the stock market crash in 2008?
The stock market crash of 2008 occurred on September 29, 2008. The Dow
Jones Industrial Average fell 777.68 points in intra-day trading. Until 2018, it
was the largest point drop in history. It plummeted because Congress rejected
the bank bailout bill.
Stock Market Crash of 2008
The stock market crash of 2008 occurred on September 29, 2008. The Dow Jones
Industrial Average fell 777.68 points in intra-day trading. Until 2018, it was the
largest point drop in history. It plummeted because Congress rejected the bank
bailout bill. But the crash had been building for a long time. The Dow hit its prerecession high on October 9, 2007, closing at 14,164.43. Less than 18 months
later, it had dropped more than 50 percent to 6,594.44 on March 5, 2009. That
wasn’t the greatest percentage decline in history. During the Great Depression,
the stock market dropped 90 percent. But that took three years. What caused this
crash? Follow the timeline below to understand exactly how it happened.
The Dow opened the year at 12,459.54. It rose despite growing concerns about a
housing market slowdown. On November 17, 2006, the Commerce
Department warned that October’s new home permits were 28 percent lower than
the year before. But government officials didn’t think the housing slowdown
would affect the rest of the economy. In fact, they were relieved that the
overheated real estate market appeared to be returning to normal.
But as home prices fell, they triggered subprime mortgage defaults. By August
2007, the Federal Reserve recognized that banks didn’t have enough liquidity to
function. The Fed began adding liquidity by buying banks’ subprime mortgages.
By October, some economists warned about the widespread use of collateralized
debt obligations and other derivatives. By late November, Treasury
Secretary Hank Paulson launched a bank-funded Superfund to purchase toxic
debt. As the year drew to a close, the Bureau of Economic Analysis revised its
growth estimate higher. It said that the nation’s gross domestic product had
increased 0.5 percent in the third-quarter. Its prior estimate said it had shrunk 0.5
percent. It seemed the U.S. economy could shrug off a housing downturn
and banks’ liquidity constraints. The Dow ended the year just slightly off its
October high, at 13,264.82.
At the end of January, the BEA revised its fourth-quarter GDP growth estimate
down. It said growth was only 0.6 percent. The economy lost 17,000 jobs, the first
time since 2004. The Dow shrugged off the news and hovered between 12,000 and
13,000 until March. On March 17, the Federal Reserve intervened to save the
failing investment bank Bear Stearns, the first casualty of the subprime mortgage
crisis. The Dow dropped to an intra-day low of 11,650.44 but seemed to recover.
In fact, many thought the Bear Stearns rescue would relieve investors. They
expected the intervention would avoid a bear market. By May, the Dow rose
above 13,000. It seemed the worst was over.
In July 2008, the subprime mortgage crisis threatened government-sponsored
agencies Fannie Mae and Freddie Mac. They required a government bailout. The
Treasury Department guaranteed $25 billion of their loans and bought shares of
Fannie’s and Freddie’s stock. The FHA guaranteed $300 billion in new loans. The
Dow fell, closing at 10,962.54 on July 15. It rebounded and remained above 11,000
for the rest of the summer.
The month started with chilling news. On Monday, September 15, 2008, Lehman
Brothers declared bankruptcy. The Dow dropped 504.48 points.On Tuesday,
September 16, the Fed announced it was bailing out insurance giant AIG. It
made an $85 billion “loan” in return for 79.9 percent equity, effectively taking
ownership. AIG had run out of cash. It was scrambling to pay off credit default
swaps it had issued against now-failing mortgage-backed securities.
On Wednesday, September 17, money market funds lost $144 billion. That’s
where most businesses park their overnight cash. Companies had panicked,
switching to even safer Treasury notes. They did this because Libor rates
were high. Banks had driven up rates because they were afraid to lend to each
other. The Dow fell 449.36 points.
On Thursday, September 18, markets rebounded 400 points. Investors learned
about a new bank bailout package. On Friday, September 19, the Dow ended the
week at 11,388.44. It was only slightly below its Monday open of 11,416.37. The
Fed established the Asset-Backed Commercial Paper Money Market Mutual Fund
Liquidity Facility. It loaned $122.8 billion to banks to buy commercial paper
from money market funds. The Fed’s announcement confirmed that credit
markets were partially frozen and in panic mode.
On Saturday, September 20, Secretary Paulson and Federal Reserve Chair Ben
Bernanke sent the bank bailout bill to Congress. The Dow bounced around 11,000
until September 29, when the Senate voted against the bailout bill. The Dow fell
777.68 points, the most in any single day in history. Global markets also
panicked, as well:
The MSCI World Index dropped 6 percent in one day, the
most since its creation in 1970.
Brazil’s Ibovespa was halted after dropping 10 percent.
The London FTSE dropped 15 percent.
Gold soared to over $900 an ounce.
Oil dropped to $95 a barrel.
To restore financial stability, the Fed doubled its currency swaps with foreign
central banks in Europe, England, and Japan to $620 billion. The governments of
the world were forced to provide all the liquidity for frozen credit markets.
Congress finally passed the bailout bill in early October, but the damage had
already been done. The Labor Department reported that the economy had lost a
whopping 159,000 jobs in the prior month. On Monday, October 6, the Dow
dropped 800 points, closing below 10,000 for the first time since 2004.
The Fed tried to prop up banks by lending $540 billion to money market funds.
The funds needed the cash to meet a continuing barrage of redemptions. Since
August, more than $500 billion had been withdrawn from money markets.
JPMorgan Chase managed the Fed’s Money Market Investor Funding Facility. It
purchased up to $600 billion of certificates of deposit, bank
notes, and commercial paper that would come due in 90 days. The remaining $60
billion came from the money markets themselves. But they were also purchasing
commercial paper from the MMIFF.
The Fed quickly lowered the fed funds rate to just 1 percent. But the Libor bank
lending rate rose to its high of 3.46 percent. The Fed also coordinated a global
central bank bailout.
The Dow responded by plummeting 13 percent throughout the month. By the end
of October, the BEA released more sobering news. The economy had contracted
0.3 percent in the third quarter. The nation was in recession.
The month began with more bad news. The Labor Department reported that the
economy had lost a staggering 240,000 jobs in October. The AIG bailout grew to
$150 billion. Treasury announced it was using part of the $700 billion bailouts to
buy preferred stocks in the nations’ banks. The Big Three automakers asked for a
federal bailout. By November 20, 2008, the Dow had plummeted to 7,552.29, a new
low. But the stock market crash of 2008 was not over yet.
The Fed dropped the fed funds rate to zero, its lowest level in history. The Dow
ended the year at a sickening 8,776.39, down almost 34 percent for the year.
In a burst of optimism, the Dow climbed to 9,034.69 on January 2, 2009. Investors
believed the new Obama administration could tackle the recession with his team
of economic advisers. But the bad economic news continued. The Dow
plummeted to its bottom of 6,594.44 on March 5, 2009. Soon afterward, Obama’s
economic stimulus plan instilled the confidence needed to stop the panic. On
July 24, 2009, the Dow reached a higher high. It closed at 9,093.24, beating its
January high. For most, the stock market crash of 2008 was over.
Investors bore the emotional scars from the crash for the next four years. On
June 1, 2012, they panicked over a poor May jobs report and the eurozone debt
crisis. The Dow dropped 275 points, and the 10-year benchmark Treasury
yield dropped to 1.443 during intraday trading. This was the lowest rate in more
than 200 years. It signaled that the confidence that evaporated during 2008 had
not quite returned to Wall Street.
In 2013, the stock market finally recovered. In the first six months, it gained more
points than in any year on record. Stock prices rose faster than earnings, creating
an asset bubble. The Dow set over 250 closing records until February 2018. Fears
of inflation and higher interest rates almost sent the Dow into a correction. Like
many other past stock market crashes, it did not lead to a recession.
Key Terms, Definitions and Explanations
The Glass-Steagall Act (1933)
The Glass-Steagall Act of 1933, passed during the Great Depression, prevented
commercial banks from trading securities with their clients’ deposits and created the FDIC as a
guard against bank runs. Passed in 1933 as the Banking Act, Glass-Steagall was chipped away
over the years and eventually repealed during the Clinton Administration with the GrammLeach-Bliley Act of 1999.
What is the Glass-Steagall Act?
The Banking Act, now known as Glass-Steagall, was sponsored by Senator Carter Glass
(D-VA) and Representative Henry Steagall (D-AL) with the intent of forestalling bank runs and
preventing future crises. The legislation had two main provisions:
1. Creation of the FDIC
The period from 1929 to 1933 saw a number of bank runs, which destabilized the
American (and world) economy. Fearful that their banks would fail, people pulled their deposits
out, which actually caused those banks to fail. To stop that self-perpetuating cycle, GlassSteagall created the Federal Deposit Insurance Corporation, which guaranteed bank deposits up
to a certain amount (initially $2,500, now $250,000).
2. Separation of Commercial and Investment Banking
As important as the FDIC’s creation was, the term Glass-Steagall usually refers to the set
of rules that kept a savings-and-loan type bank from engaging in speculative, risky trading with
customers’ deposits. If a bank took deposits, it could not trade in anything other than government
bonds; if it underwrote securities or engaged in market-making, it could not take deposits.
The motivation for this separation rested on alleged conflicts of interest. Glass and
Steagall, as well as others, accused banks of partnering with affiliates which later sold securities
to repay banks’ debts, or accepted loans from banks to buy securities. They also worried that
banks engaged in risk-taking speculation, rather than investing in corporations to promote
Five provisions of the Banking Act pertained to this separation:
1. Section 19: Federally chartered banks could not buy or sell securities, unless they were
investment securities, government bonds or trades made on behalf of a customer.
1. Section 5(c): Glass-Steagall would also apply to state-chartered banks.
2. Section 20: Banks could not be affiliated with firms whose primary purpose was trading
3. Section 21: If a bank did trade securities, it could not take deposits.
4. Section 32: Officers and directors of commercial banks (banks part of the Federal
Reserve System) were barred from holding advisory positions in companies whose
primary purpose was trading securities.
Gradual Weakening of the Glass-Steagall Act
Over the years, legislators and regulators chipped away at Glass-Steagall, culminating in
its repeal in 1999.
1935: Glass tries to repeal his own bill
Presumably, separating commercial and investment banking would prevent the conflicts
of interest that led banks to make risky loans or securities affiliates to make inefficient trades.
However, a 1934 study found that securities underwritten by bank affiliates fared no better and
no worse than those underwritten by non-affiliates.
In 1935, Glass introduced an amendment that would permit commercial banks to trade
securities again. President Roosevelt spoke out against the amendment, and though it passed the
Senate, it was tossed out during the House-Senate reconciliation process.
1963: OCC on the offensive
Following World War II, banks faced increasing competition from non-bank entities not
subject to Glass-Steagall. General Motors, Sears and others began offering consumer credit, thus
competing with banks for loans.
James Saxon, then the Comptroller of the Currency, feared that Glass-Steagall undermined
commercial banks’ competitiveness, putting them at a disadvantage to non-banks. Under his
guidance, the Office of the Comptroller of the Currency (OCC) issued regulations that would
have watered down Glass-Steagall, allowing banks to:
1. Offer commingled accounts, in which investors pool their funds to buy stocks and bonds
(similar to a mutual fund)
2. Buy and sell muni bonds
1966: Inflation exceeds interest rate cap on Reg. Q
Regulation Q, an often-forgotten provision of Glass-Steagall, capped interest rates paid
on savings and other deposit accounts. When the rate of inflation surpassed the maximum
interest yield, consumers pulled out their deposits in favor of bonds and other safe but betterpaying products.
More and more, consumers turned to non-bank entities for their loans. By 1972, in fact,
the nation’s three largest banks provided less credit than either the three largest retailers or the
three largest manufacturers. Prime customers bypassed commercial banks, going straight to
capital markets for their borrowing needs or to get a higher yield on their savings. Banks were
left with the sub-prime customers that capital markets wouldn’t lend to.
1966: Interest Rate Adjustment Act passes
In the same year, the Federal Reserve allowed savings and loan associations (S&L’s, or
thrifts) to pay higher savings account interest rates than commercial banks. They could also offer
negotiable order of withdrawal (NOW) accounts, which function like checking accounts but are
not subject to interest rate caps. S&L’s were not covered by Glass-Steagall.
1971: Investment Company Institute v. Camp
After 1963, the OCC’s relaxed rules wound their way through the justice system. Finally,
in 1971, the Supreme Court ruled that the OCC had overreached. They argued that the new rules
violated the spirit of Glass-Steagall, and struck them down.
1977: Merrill Lynch introduces the cash management account
Capping nearly a decade of deposit-account innovation, Merrill Lynch launched a “cash
management account,” which allowed customers to write checks against funds held in a money
management account. Cash management accounts were functionally similar to checking or
savings accounts, but Merrill could use those deposits to trade securities, while banks couldn’t.
Increasingly, investment banks offered products typically seen in commercial banks, and
at better rates. The FDIC and OCC declined to regulate these bank-like entities, however, so
Glass-Steagall began to lose relevance.
1978: The birth of the mortgage backed security
Bank of America issued the first mortgage-backed security, in which it pooled mortgages
and sold them to investors.
1980’s: Commercial acquires investment, and vice versa
In the 1980’s and 1990’s, commercial banks increasingly traded in over-the-counter
derivatives, such as interest rate swaps. Moreover, during the Reagan and Bush administrations,
the FDIC and OCC approved a number of mergers between commercial banks and securities
1982: The OCC allowed Citibank to offer a collective investment trust, essentially reissuing Saxon’s directive.
1982: The FDIC issued a policy statement allowing state-chartered, non-Federal Reserve
banks to affiliate with securities firms, even if they had FDIC insurance.
1983: The Federal Reserve authorized Bank of America to buy Charles Schwab, then the
nation’s largest brokerage firm.
1987: The Federal Reserve allowed Bankers Trust, Citigroup and JPMorgan to trade
mortgage-backed securities, muni bonds and commercial paper.
1999: Repeal of Glass-Steagall and the Gramm-Leach-Bliley Act
Signed into law by President Clinton, the Gramm-Leach-Bliley Act repeals the provisions
preventing banks from affiliating with securities. Therefore allowing commercial and
investment banks to come together.
Gramm-Leach-Bliley Act (1999)
What is the GLB Act?
After numerous attempts to repeal Glass-Steagall spanning the Bush and Clinton
administrations, President Clinton signed the Gramm-Leach-Bliley Act that repealed the
provisions preventing banks from affiliating with security firms. Though the line between
commercial and investment banking was already blurring, the passage of Gramm-Leach-Bliley
accelerated the pace.
Commercial banks traded in increasingly risky and complex securities, continuing to buy and sell
mortgages, collateralized debt obligations and other derivatives. Because of the instruments’
complexity and institutions’ vulnerable positions, many banks faced stark losses during the 2008
financial crisis. Commercial institutions received emergency loans from the Federal Reserve, and
investment banks Goldman Sachs and Morgan Stanley were actually designated as bank entities
so they could take advantage of those loans. The vulnerability of commercial banks, revealed by
the crisis, has resurrected the debate over Glass-Steagall.
The Gramm–Leach–Bliley Act (GLB), also known as the Financial Services
Modernization Act of 1999, enacted November 12, 1999, is an act that repealed part of
the Glass–Steagall Act, removing barriers in the market among banking companies,
securities companies and insurance companies that prohibited any one institution from
acting as any combination of an investment bank, a commercial bank, and an insurance
company. With the passage of the Gramm–Leach–Bliley Act, commercial banks,
investment banks, securities firms, and insurance companies were allowed to consolidate.
The legislation was signed into law by President Bill Clinton.
A year before the law was passed, Citicorp, a commercial bank holding company, merged
with the insurance company Travelers Group in 1998 to form the conglomerate
Citigroup, a corporation combining banking, securities and insurance services under a
house of brands that included Citibank, Smith Barney, Primerica, and Travelers. Because
this merger was a violation of the Glass–Steagall Act and the Bank Holding Company
Act of 1956, the Federal Reserve gave Citigroup a temporary waiver in September 1998.
Less than a year later, GLB was passed to legalize these types of mergers on a permanent
basis. The law also repealed Glass–Steagall’s conflict of interest prohibitions “against
simultaneous service by any officer, director, or employee of a securities firm as an
officer, director, or employee of any member bank”.
Many of the largest banks, brokerages, and insurance companies desired the GLB at the
time. The justification was that individuals usually put more money into investments
when the economy is doing well, but they put most of their money into savings accounts
when the economy turns bad. With the new Act, they would be able to do both ‘savings’
and ‘investment’ at the same financial institution, which would be able to do well in both
good and bad economic times.
Subprime Mortgage Crisis
What is Subprime Mortgage?
First of all, we need to understand what subprime means. By dictionary, “Subprime” is an
adjective relating to or for people with a poor credit rating. Simply says, if you never clear your
credit card balance monthly, you have a poor credit rating. A poor credit rating people are
disqualified to apply for conventional mortgage or loan application. They’re disqualified because
they have higher risks that they are no …
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