The Pros And Cons Of The Sub-Prime Mortgage Crisis

Submitted By TyTucci8
Words: 3904
Pages: 16

I. Intro
During October 2008 it appeared as if the U.S financial system was going to implode under the pressure of a Sub-Prime Mortgage Crisis that lead to a subsequent, systematic banking failure. The phrase depression came to the forefront of conversation as financial indicators like the Dow Jones Industrial Average made unprecedented declines. The Dow fell from 10325.38 on October 3, 2008 and did not hit bottom until it had almost halved at 6626.94 on March 6,2009. With the confidence of the American consumer at an all-time low and no way out, the Federal Reserve was forced to join forces with the U.S Government in a desperate attempt to keep the entire American financial system from buckling. As a credit crisis stemming from overleveraging ran rampant from subprime homeowners into Wall Street firms who had overextended their books, the Federal Reserve and the United States Government led by Chairman of the Federal Reserve Ben Bernanke and Secretary of the Treasury Hank Paulson Jr, would unveil a series of monetary and fiscal policies unprecedented in size.
The initial domino in the 2008 banking crisis was the near illiquidity of mortgage giants Fannie Mae and Freddy Mac, the U.S Government immediately took over operations of both Fannie and Freddy and pledged a 200 billion dollar cash injection to keep both afloat. A week after this initial action the Government then created Maiden Lane LLC in order to broker the purchase of Bear Stearns by JP Morgan and to save insurance giant AIG from bankruptcy. Specifically, Maiden Lane I purchased 30 billion dollars’ worth of mortgage backed securities in order to ease the financial burden to JP Morgan. Maiden Lane II purchased 20 billion dollars in mortgage backed securities and Maiden Lane III purchased 19.5 billion in credit default swaps and transferred these toxic assets from the books of AIG onto the shoulders of the government.
On September 15, 2008 investment bank Lehman Brothers, the fourth largest investment bank in the U.S, filed for Chapter 11 bankruptcy protection following the massive exodus of most of its lenders, creating drastic losses in its stock, and devaluation of its assets by credit rating agencies. The filing marked the largest bankruptcy in U.S. history. “The filing set off a chain reaction of panic as The Dow Jones closed down just over 500 points (−4.4%) on September 15, 2008, at the time the largest drop by points in a single day since the days following the attacks on September 11, 2001.” (Michael Grynbaum (2008-09-15). "Wall St.’s Turmoil Sends Stocks Reeling". The New York Times. Retrieved 2008-09-15.) In the following week as the mortgage backed security crisis unraveled, so too did other large financial institutions like Goldman Sachs and Bank of America. These investment banks experienced a systemic credit freeze as all liquidity left the mortgage backed security market. In order to prevent a systematic collapse of the American banking structure the U.S Government teamed with the Federal Reserve to begin negotiations for an unprecedented economic capital infusion to unfreeze the credit market. On September 29th just two weeks after the failure of Lehman Brothers the first attempt at a 700 billion dollar economic stimulus package was rejected sending The Dow Jones into a 7% down turn, making the largest drop in market history. On a second attempt the legislation was passed and on October 3rd 2008, George W. Bush signed the revised version of a 700 billion dollar troubled asset relief program to remove assets from the books of Wall Street giants like Goldman Sachs, State Street, and Bank of America and other investment banks. The purpose of this bailout, as it came to be called, was to provide liquidity to banks who could in turn lend money to borrowers. This piece of legislation brought the Dow Jones to a temporary bottom at 8451.19, down approximately 2750 points from just five weeks earlier.
The swift actions of the Federal Reserve and