How Did We Get Here?

Who is to blame for the Great Recession?

I remember being told in high school how, when the United States entered World War II and incurred the nations first long-standing domestic and international debt, the US Government being in debt was a positive for the economy. But, in the decades since, as the country had faced its cyclic recessions and the taxpayers had to constantly makeup the difference to keep that debt under control, the desire for tax relief had changed the psyche of the American public to demand a balanced federal budget. And, to everybodys joy, President Clinton was able to achieve just that in the late 1990s. And the world was setup for failure from that point on. So, is Bill Clinton the one to blame for this current recession almost 20 years after he balanced the budget? Or, is it President Bush, who was unable to anticipate the coming crisis despite a Bull Economy for most of his tenure? Or, is it President Obama, who, through his bailout programs and his inability to create sufficient jobs, has allowed the national debt to balloon to over $16 trillion? What if none of them are to blame? What if their policies and actions are a result of something else? What if their decisions were driven by public and economic sentiment? To fully understand the current situation we must travel back in time. In fact, we must travel back a full century, to 1913, to get an idea of how economics and politics have become inextricably linked.

The Progressive Movement Following the United States Civil War, the economy of the nation began to flourish. Big Business came to the forefront of the booming American economy and Americans began making money hand-over-foot. With no government involvement at the time in the economy, businesses were self-regulated, meaning that they were not regulated at all. And that led to the many monopolies seen in those days. Many people in the small Middle Class began to see what was happening, large businesses could corner a certain market and self-regulate the entire market; this included product prices, employee wages, and workplace environment. The workers had no choice, they must work to earn a living; so it didnt matter what workplace conditions were like or how little they got paid, if you quit your job there was no other place to get hired. Sure, the Interstate Commerce Act and the Antitrust Act were ratified law, but they werent enforced. The Middle Class saw a lack of protection from the business owners and demanded government involvement. It was realized that, if the government had to spend money to provide consumer protection, then it needed a way to make money as well. And if it was the consumer receiving the benefits of the governments money, then it should be the consumers responsibility to pa y for it. The first of three major economic moves by then president Woodrow Wilson was the Sixteenth Amendment to the Bill of Rights, ratified in February of 1913. This is the ever unpopular federal income tax; it was not the first time in Americas short history that an income tax was enacted, but, this time, it was permanent. An additional protection was passed the very next year, and that was the creation of the Federal Trade Commission; the Commissions charge was to maintain good business practices throughout the United States and enforce, to a greater degree than ever before, the Sherman Antitrust Act of 1890. The most crucial of his economic changes came in December of 1913, however. This was the passing into law of the Federal Reserve Act and the establishment of a privately-owned, government-operated, self-regulating federal bank. Its three part mission upon its establishment was the maintenance of maximum employment, stable prices, and moderate long-term interest rates. And the way it goes about achieving these objectives is the precise reason why private banking and the economic health of the US Government are forever entwined. Why and Who? Why do we need a central national bank system? The answer lies in the bank panics suffered during the Free Bank Era, which survived only a few years longer after the passing of the Federal Reserve Act. The term we must focus on here is called a bank run. Banks are businesses, and, like any other business, they must make money. In order to make money, they take the greater percentage of currency that their customers deposit, whether from bank accounts, loan repayments, or mortgages, and reinvest that money into other businesses, additional loan agreements, or government bills and bonds. This leaves them open to two major issues. First, if

not enough people become customers of the institution, then they have too little to reinvest and cannot expand their business, most notably to buy equity. Second, and more seriously, in the case of consumer panic leading to a major liquidation of assets, the bank will not have enough currency to cover the withdrawals. In that case, prior to the establishing of the Federal Reserve, a banks only option was to borrow from another bank , which could set its own interest rate on the loan. Plus, if the lender bank put itself at risk, then it too may borrow from yet another bank. And so, a bank run occurs; and economic stability was put at risk. Any bank that wanted the protection of the Federal Reserve Act had to guarantee to provide their District Federal Reserve Bank (of which there are 12 throughout the country) no less than 3% of the value of their total capital and surplus in receipt of stock. In return, the member bank would receive a dividend from the FRBs profits equivalent to 6% of the members stock value. Additionally, as a member, the bank had voting rights to six of the nine members of the board of directors in control of the regional FRB. The other three members of the board were voted on by the Federal Reserve Board of Governors, who also approved the FRBs nomination for president and CEO (a five year term with no limit on reappointments). The nine members of the FRBs board of directors are separated into three groups. Group A are the member-voted representatives in charge of the member banks interests. Group B are the member-voted representatives in charge of the publics interests. Group C are Board of Governors representatives also in charge of the publics interests. The next step above a FRBs board of directors is the Board of Governors, which is a separate federal agency whose members are appointed by the POTUS and approved by congress for a 14 year term, one every two years, without reappointment. From among the Governors, the POTUS also appoints the Chairman and the Vice Chairman of the Board. Both serve four year terms without limit of reappointment. The loophole to be found here is that, although a Governor cannot be reappointed, he/she is only replaced upon the approval of a replacement. Hence, if no suitable replacement is found, a Governor may serve for as long as the situation dictates. The board is charged with setting monetary policy for the nation, regulating and supervising the overall banking system, and overseeing the 12 District Federal Reserve Banks. While the Board of Governors is the overall policy setter for the Federal Reserve System, the Governors, along with the New York District Federal Reserve Bank president and four other Reserve Bank presidents (chosen on a rotational basis), form the Federal Open Market Committee. The Committee sets its own internal structure, but, historically, the Chairman of the Board of Governors and the President of the Federal Reserve Bank of New York serve as the Committees Chairman and Vice Chairman, respect ively. The purpose the FOMC is to oversee open market operations, or, in other words, it controls the buying and selling of US government bonds on the open market to affect the total money supply and enforce the national monetary policy.

How? While trying to explain the operations of the Federal Reserve System is long and somewhat complicated, the bases behind those operations are rather intuitive. The setting up of the Federal Reserve Banks accomplished two purposes right away. First, it established a central bank with which the US Department of the Treasury could obtain an account so that it could conduct its own business. Second, it provided a surge volume of money for member banks to borrow from, as a last resort, to prevent the bank runs that the Free Bank Era was susceptible to. In addition to that, all bank to bank loans use the Federal Reserve as the middle man, which allows the FOMC to set minimum loan rates. This minimum loan rate is also the reference used to establish the prime lending rate, the reference rate that banking institutions use to set credit rates. By operating in this manner, it also allows for the nations money supply to be elastic; meaning, the total money supply in the nation can be expanded or contracted based the current market. For example, a seasonal market downturn causes a scare within the public. The banks customers begin withdrawing their funds from the banks in large numbers. In anticipation of this, and as member banks between regions borrow from one another, the actual money supply in the whole of the Federal Reserve decreases. Based on the law of supply and demand, in this situation, we have a lowering money supply with an unchanged or increasing demand; as a result, the value of the dollar goes up. If it increases too much, then it will cause the overall market to deflate (products will get too cheap), thereby reducing profit margins and stifling the economy. In this case, the Federal Reserve will buy currency from the government (paper currency at manufacturing cost and coins at face value) via the Department of the Treasury. As the market recovers, the opposite will happen, and the Federal Reserve will sell the currency back to the government to prevent inflation in the market. In this way the government can also recycle the money supply, replacing worn bills and coins with new ones. So, we now have an institution for the government to conduct its banking operations through, an in place system for providing banks and consumers protection from market fluctuations and severe changes, a method for setting lending rates for personal consumers, businesses, banks, and international interests, and a mechanism for controlling the nations money supply to counteract inflation and deflation of the economy. However, the system is not perfect, and its imperfections have been called out many times in the century following its inception. A Time to Roar The second half of the 1910s saw the years of World War I, and by 1917 the United States had joined the fight. In order to get the war machine turning, business and consumer income taxes were raised, while import tariffs for raw materials needed for the war were lowered. By 1920, Republican Warren Harding had taken the reins as POTUS and the League of

Nations was set up in Europe. The war had kick-started the automobile industry, the electric utilities industry, and the communications industry. Residual benefits were huge in the oil, glass, and road infrastructure industries. The post-war United States was on its way to an economic boom, and since the war machine was no longer needed, President Harding decided to raise import and export tariffs and lower income taxes in a big way. He also appointed Herbert Hoover as Secretary of Commerce and charged him with increasing economic efficiency by regulating business practices. The national debt was cut by one-third during the decade, and, as a result of land prices not reducing to pre-war levels, many rural residents moved to the urban centers. The boom of the automobile industry allowed suburban residents and commercial distributors larger travel radii. This allowed for urban tourism to skyrocket and businesses to expand into the suburbs. Commercial offices and city residents needed more room in the urban centers, and so the steel industry flourished as the first of the city high-rises were built. It was a time of profit and a time of excess. The Roaring Twenties were in full swing. Speculation and Crash By September of 1929, the stock market had increased tenfold as, despite President Hardings raising of tariffs early in the decade, international trade started linking US markets to European markets. The prosperity, thought by many to be perpetual at the time, was not to last. For trade goods the process of speculation became commonplace in the 1920s, and the dangers were not fully understood. But there were some who understood the dangers; however, the market still took a heavy hit on the 18th of the month. Then, in London two days later, a prominent British investor was arrested for fraud, and their market officially crashed amid the fears. Coupled with the fears generated by the London crash, the Smoot-Hawley Tariff Act that was being discussed in congress drove further fear into the minds of investors, and for the next month stocks would fluctuate rapidly. Then, on October 24th, investor fears began to be realized and the market lost 11% at the opening bell. Richard Whitney, vice president of the NY Stock Exchange, gained the backing of the large banks, and throughout the day began buying large blocks of blue chip stock (in reference to the valuable blue poker chip and indicating corporations with a national reputation for high quality, reliability, and profitability) in an effort to stave off further market fears. The market indeed did recover slightly, to a loss of 6.38 points. However, over the weekend the newspapers ran the stories relating investor fears in the market, generating more public fear, and, on Monday the 28th, the market again plunged another 13%. Finally, on Black Tuesday, the 29th, the market fell another 12% on trading volume that would not be seen for another 40 years. The American market had crashed, and recovery would not be realized for twelve years. The speculation used in the late twenties caused investors to buy up their stock with money lent to them by brokers; so much so, that there was more money lent

out in stock purchasing than there was currency circulating through the US. Add in to that a wheat surplus and a good wheat harvest overseas, causing wheat prices to reach historical lows, and it was no surprise that once fear was struck into the heart of the investors that a big sell-off occurred. The Great Depression One of the key questions asked by economists when they study the Great Depression is this, where was the Federal Reserve when the bank runs began in 1929? It seemed that the fear of unreliable lending was also driven into the hearts of the FOMC. But, was the crash the true cause of the depression? Some have speculated that it was only a driver to accelerate a process that was already started by unsecured investor lending. Regardless of the cause, the result was catastrophic. Bank runs continued, business borrowing took a huge downturn, unemployment skyrocketed, and consumer spending plummeted. What looked like an immediate recovery in the first half of 1930 was short-lived. Although the market recovered to nearly pre-crash levels, consumer investment and borrowing were still depressed. Adding to the difficulty was the passing into law of the Smoot-Hawley Tariff Act, which raised import and export tariffs significantly, causing like retaliation by our major trading partners. Mother Nature also played a role, as a severe drought struck the Midwest, lowering commodity outputs for trading on the market and further lowering the incomes of the agrarian community. As stock markets began to feel the depression worldwide, a worldwide buying of the US gold deposits began in an effort prevent further devaluing of the dollar, forcing the Federal Reserve to raise interest rates on the banks and resulting in the failure of some 4,000 banks nationwide. The Federal Reserve also contracted the money supply by one-third in an effort stave off inflation, to no avail. By 1933, the US faced 25% unemployment, with upwards of 50% of the nations workpower going unused (due to full-time workers delegated to part-time). Banks that had failed left many with a significant loss of savings due to no deposit insurance. Tens of thousands were poor and homeless, and with charity lines running thin, the nation was on the verge of revolt. Lets Make a Deal In 1932, Democrat Franklin D. Roosevelt accepted a presidential nomination and won the office on the promise of a new deal for the American public. And he didnt fail them. His New Deal policies enacted from 1933 to 1938 set the stage for the modern American economy and began the true bipartisanship of US politics. The list of acts and laws coming out of the first and second New Deals is long, and none of them will be discussed at length here, but the more important ones will be briefly discussed. The subsequent political bipartisanship was a result of the Republican Partys dissension from the increased level of government invasion into the economy. But, as will be seen, the American public took to the New Deal quickly and with zeal as the economy started to grow and their money was secured.

In terms of banking, the Emergency Banking Act allowed for Roosevelt to close all banks and reopen them in an orderly manner with any necessary government backing such that the public would put its money back into the system. In addition to that, the Glass-Steagall Act of 1933 limited the affiliations allowed between commercial banks and investment banks to regulate market speculation and investor loan availability. Roosevelt also ended the gold standard of US currency; instead it would now be a floating value dependent on domestic and foreign markets. This freed the dependency of the money supply on the value of gold and allowed the Federal Reserve to increase the money supply with minimal effect on the economy. The Securities Act of 1933 and the establishment of the Securities & Exchange Commission in 1934 required corporations to now disclose balance sheets and statements to provide investors with more truthful reports on the status of those corporations and provided for regulation of the stock market to prevent corporate abuse. Additional policies with regards to public works projects and agricultural recovery seemingly created a government bank out of the national budget, as the government pledged loans to businesses for the building of numerous buildings and dams, and enacted forced regulation of agricultural output. The aims of these policies were to reduce unemployment and raise income to the devastated farming communities. In 1939 the Food Stamp Plan was also enacted and survives as a successful policy to this day. Industry received its own reforms in the establishment of the National Recovery Administration, in which major industries agreed to terms of minimum wage, work week rules, and the abolishment of child labor. This was seen by many as an end to true competition in business, but the recovery of industry through these policies was tremendous. Only two years after its inception, the NRA was dissolved due to being found unconstitutional by the US Supreme Court, but industry held itself to the ideals in the face of recovery. Another important act for industry was the passing of the Hot Oil Act of 1935, preventing the sale of illegal oil in the United States. The housing sector saw the establishment of the Home Owners Loan Corporation and the Federal Housing Authority, both of which set standards on housing appraisals, housing construction requirements, and a more efficient mortgage process. The final piece of the first set of new deals was the Reciprocal Tariff Act, which gave the president authority to perform bilateral negotiations with any nation wishing to trade with the US, thereby restoring international trade to good-standing. The second set of new deals saw the rise of Social Security (which covered retirement benefits, unemployment compensation, and welfare compensation), the rise of the unions and collective bargaining, the implementation of a public workforce independent of private business, and changes to the tax codes. A recession hit the nation in 1937 and 1938, with the cause aimed at President Roosevelts stifling of business expansion as a result of the New Deal policies. Ironically, it was in 1937 that the president achieved a balanced budget, and it was his aim in

1938 to spend $5 billion to increase the mass purchasing power of the nation. The nation began to recover with the government running at a deficit. The War Machine Returns to Life The United States was not the only economic market to fall into a depression. Because of world trade, the markets around the globe were tied together, and any trouble with one rippled through the rest. Therefore, the 1930s was a recovery for the world; and not every nation recovered in the same way. In Europe, most nations recovered as best they could, and slowly their markets returned to normal. But, in Germany, whose empire was dissolved following the First World War, a man by the name of Adolf Hitler was elected as Chancellor in 1933. What followed, as Europe continued to recover economically, was the rearmament of Germany and the rise to power of the Nazi Party. The whole of Europe would adopt a doctrine of Appeasement. Political jockeying throughout Europe and Asia saw rising threats from not only from Germany, but also Italy, the Soviet Union, and Japan. The Soviets and the Italians signed pacts with Germany, and the Soviets also signed a pact of non-aggression with China to promote supply lines as the Chinese fought off the invasion of Japan. As Japans war in against China stalled, and their invasion of the Soviet Union met with little success, the empire switched its focus to the islands of the South Pacific. As Europe fell into war in 1939, the United States signed the Neutrality Act, vowing to stay out of the war, but to assist those nations opposing the now named Axis Powers. Through 1941, the United States remained in its neutral state, with continued emendations to the Neutrality Act to allow for more and more war provisions to Britain and China. In the Pacific, Japan invaded Indochina in 1940, and the US responded by establishing an embargo on Japan of iron, steel, and mechanical parts. As the Japanese continued to press their advantages against European colonies, and the Germans successfully captured Paris, President Roosevelt began to not only increase the size of the Navy, but he also established a full oil embargo on Japan. Things were about to come to a head for the United States as Japanese oil reserves fell quickly. Knowing they could not long survive on the remaining oil in the nation, on December 7 th, 1941, the Empire of Japan attacked Pearl Harbor on the Day of Infamy. The United States quickly mobilized; twelve million soldiers headed off to war in Europe and the Pacific, and to make up for them, unemployment nearly disappeared and Rosie the Riveter came alive as women became an integral part of the workforce. Consumer-product production during the war years fell as military needs took top priority, so much so that the Office of Price Administration was created to control consumer-product production to prevent inflation. September of 1945 finally saw the end to six years of war and the return of millions of American soldiers. How would America deal with a world at peace?

The Golden Egg Women went back to the home, returning soldiers used their G.I. Bills to re-educate and get back into the workforce, and $200 billion in war bonds matured. The nation was rich, the economy was expanding rapidly, and the need for building up the suburbs became a top priority. The farm community had another mass exodus as more low-paid farmers moved into the towns and cities to get higher-paying jobs. Jack had climbed the beanstalk of war and returned with the golden egg. For 28 years this golden era of American economics persisted, but it was not without its recessions, and the truth of the cyclic economy was realized. Immediately following the end of the war, in an effort to fend off a post-war depression, the Employment Act of 1946 was passed. This measure created the Council of Economic Advisors and the Joint Economic Committee. Both bodies were charged with overseeing microeconomic issues and providing the White House and Congress with plans to mitigate any problems. Even with these provisions, recession struck the country in 1949. This is partly a result of the government not releasing its hold on the fixed Treasury Bill interest rate, a holdover from the war. President Truman continued favoring this policy in the face of two years of a rising Consumer Price Index (simply a measure of how market goods prices have changed in a certain period with respect to the base price of the period). For two years the recession would last until, finally, bickering between the Federal Reserve and the White House ended in the 1951 Accord, restoring full control of interest rates back to the Fed. The years of 1950 through 1953 saw the fighting of the Korean War. Still war weary from World War II, many Americans did not approve of the hostilities on the Korean Peninsula; and it was looked at as nothing more than a war against Communism, as the Red Scare began around this time. Following the end of the war, another recession affected the US as it stared down the barrel of another post-war economy. Despite the war, the American economy saw the burgeoning of another economic entity, the bank holding company. Bank holding companies are corporations that own one or more banks, but do not engage in banking activities themselves. This allows the companies to easier raise capital and assume the debt of bank shareholders. This was seen as a threat to the stability of the Federal Reserve as bank holding companies were not subject to the restrictions of the banks they owned. So, in 1956, the Bank Holding Company Act was passed, which forced bank holding companies to gain the approval of the Federal Reserve Board of Governors and limit their business to a single state. Additionally, the law severely limited the non-banking activities these corporations were allowed to engage in. The regulatory authority of the Board of Governors also extended to those holding companies that owned banks operating under the cognizance of the Office of the Comptroller of Currency and the FDIC (nonFederal Reserve members). And, for any holding company with 300 shareholders or more, they were required to register with the Securities & Exchange Commission.

This golden era of American economic prosperity peaked in 1957, followed by recessions in 1958 and 1960. In 1965, under President Lyndon Johnson, there were two amendments to the Social Security Act under the new Title XIX. Those amendments were the establishment of Medicare, government subsidized health insurance for persons 65 and older, and Medicaid, government-sponsored health insurance for low-income and disabled families and individuals controlled by the state in which they live. Social Security and Healthcare programs would be constant points of bipartisan arguing in the following decades. Market Decline In 1944, seeing the devastation imparted on a war-ravaged world, many allied nations came together in Bretton Woods, New Hampshire and discussed the establishment of the International Monetary Fund under control of the International Bank for Reconstruction and Development. One year later, in the face of additional devastation and the power of the American dollar, enough allied nations ratified the new system and it became operational. Though the dollar was no longer backed by gold domestically, foreign dollar holders could still exchange the currency for gold. This knowledge and the requirements set forth in the Bretton Woods system for fixed exchange rates made the dollar the internat ional gold standard worldwide. The problem was that the war devastation was so vast that the United States, as the sole driver behind the recovery of the worlds economy, simply did not have enough capital to build up the IBRD. As result, the IRBD, limited to loans only for account deficits, would only lend to those who could assure full loan repayment prior to the actual loan agreement. International recovery was at risk of stagnating. In response, the US government set up a system of grants to nations in need of reconstruction. The Marshall Plan and other Truman Doctrines supplied $17 billion in grants, encouraged economic competitiveness between Europe and Japan, and ran a long-term balance of payments deficit. Following this example, the IBRD expanded its influence by creating the International Finance Corporation in 1956 and the International Development Association in 1960. Together these entities allowed for private corporation investment in the rebuilding of Europe and concessional loan and grant agreements for developing Third World nations. When incorporated into the Bretton Woods system, it set up an economic recovery triangle that had huge benefits for the United States. In essence, the United States would trade with the developing nations at a tremendous profit , expanding those nations industry and acquiring raw materials. The profits would be siphoned to Europe for rebuilding with the knowledge that the American market would be the sole trader of European products. This allowed other industrialized nations outside of Europe to setup trade with the developing nations, placing the US market at the heart of international economic stability. The first of the problems began when, during the 1950s, world economic growth out paced the rise in the gold base. As the decade progressed, the US balance of payments deficit continued to get more negative, and, late in the decade under President Dwight Eisenhower, the

US placed import restrictions on oil and export restrictions on other tradable items. With the start of the John Kennedy administration in 1960, the US began instituting measures to maintain gold prices at $35/ounce. One of those measures was the London Gold Pool established in November of 1961, which provided a for a worldwide gold reserve to be sold or bought on the open market in the attempt to maintain a constant gold price. Here is the dilemma that faced the world. In order to maintain a successful Bretton Woods system, the worlds economy could only grow so much and the US balance of payments deficit could only get so large. The larger the economy grew, the larger the deficit had to be to keep up market liquidity. However, the longer the deficit remained, the lower the confidence in the dollar went. All remained well until 1967, when a run on the gold occurred in the UK. By the end of November, the British were forced to devalue the pound. As the value of the British market decreased, more stress was placed on the dollar to hold close to the price of gold. President Johnson appealed to the western nations to hold the dollar instead of gold, and put in place measures to increase US exports and stifle gold outflow. To no avail, in March of 1968 a gold run took place and the London Pool was dissolved. Several changes in gold policy ensued: the United States repealed the requirement for a 25% gold-backing on the dollar, allowing for a floating price of gold on the market; the United States refused to sell gold to governments that traded it in the private market; and the United States urged former Pool members to trade gold with private entities. The last of these changes was refused by the greater part of the former Pool members, and the market price for gold rose rapidly, well above the price of the dollar. Why the gold runs? As should have been expected during the international market recovery, there became a large interdependence on currency. This interdependence fostered the birth of yet another type of banking institution, the multinational bank. Capable of trading in goods, loan agreements, and currency, they provided the world a means of establishing large flows of capital. The trading of currency, however, was weak because of the fear of changing currency values in the Bretton Woods system. But the viability of multinational bank success was made clear in the mid-1960s, and the ever increasing power of the European and Japanese markets to near US levels placed more stress on the dollar. Adding to the detriment of the US, the world political climate was changing. The Cold War was well underway, and following World War II, the devastated nations of Europe and Japan welcomed the ability of the United States to fund its military protective efforts using the benefits reaped from the Bretton Woods economic plan. However, as the economies of the world rebounded, and the American economy weakened, the cost of maintaining its extended military lines became more difficult. The Vietnam War further exacerbated the situation due to President Johnsons refusal to take on the war cost, intending to let the current economic system pay for it. In concert with high taxation rates to pay for his domestic programs, President Johnsons policies led to the overvaluation of the dollar and the undervaluation of the yen and the deutsche mark. With the floating rate system put in place in 1968, it essentially split the private gold market from the dollar gold market of the Bretton Woods system. It effectively placed a price

on US military defense involvement for other nations. Separating the dollar from the gold forced the IMF to create Special Drawing Rights of the nations involved in the international reserve. The United States continued in their dollar shortage, and the SDRs enforced other nations to hold their gold instead of the dollar by preventing them from buying the gold that remained at $35/ounce and selling it on the open market at a higher price. Any nation that wished to buy the cheaper gold had to have dollar holdings in excess of three times the amount of gold they borrowed and be forced to accrue a 1.5% interest rate on what they borrowed. The Vietnam War put this policy in jeopardy because international popularity of the war quickly evaporated. The cost of a continued international military presence worldwide became more than the United States could pay for. On top of tightened investment controls begun in 1968, in 1970, President Nixon lifted the quota on oil imports in an attempt to lower energy costs. This only made the situation worse, and with US non-gold reserves nearly depleted and the country only holding 22% of world gold reserves, the system was on the verge of failure as confidence was lost in the value of the dollar. The Road to Stagflation President Nixon also had passed the Economic Stabilization Act in 1970, which granted him the authority to stabilize prices, rents, wages, interest rates, etc. What this means is that the President alone chose job cuts and tax cuts in order to gain a hold on inflation, while doing what was in his power to maintain educational programs to re-employ those who were out of work. The president also raised import prices in an attempt to keep Americans buying domestic products. This had a twofold purpose: first, it raised the income of American workers and increased the number of available jobs; second, it was preparation for what he was about to do next. In August of 1971, in a move termed the Nixon Shock, the president, without consulting any of his economic advisors, completely separated the dollar from gold, meaning that the dollar could no longer be converted to gold except on the open market. The devaluation of the dollar had begun as gold now became a floating market commodity. By 1973, the dollar had devalued to $44/ounce. To add to the despair, Egypt and Syria, with the backing of the other Arab nations in the Middle East, launched the Yom Kippur surprise attack on Israel in October of 1973. By providing Israel with armaments and ammunition, the United States incurred the wrath of OPEC, who instituted an embargo of oil, leading to massive oil shortages and skyrocketing fuel prices. In whole, between January of 1973 and December of 1974, the American stock market lost 45%, and the United States entered a period of Stagflation. This term refers to an economic period of high inflation and unemployment with slow economic growth. The crash of the US market affected markets worldwide, and the road to recovery for each nation was a long struggle to pre-crash levels.

While unemployment peaked in 1975 and improved to the end of the decade, economic productivity in the United States stymied and unemployment began to rise again. Lending woes gripped the country as the prime lending rate climbed to 20% in 1981. In a desperate attempt to save the economy, there was a paradigm shift in economic thinking, and the New Deal style economy, with its shifting money supply, was phased out in favor of monetarism and hindering the Federal Reserves control over the money supply. Instead, through economic indicators, it was calculated what the money supply should remain relatively stable, forcing the economy to change around it through pricing of goods to maintain the economy stable. As a result of deteriorating workplace conditions caused by the economic woes, the establishment of the Occupational Safety & Health Administration occurred during this time; two important commissions were also established, the Consumer Protection Commission and the Nuclear Regulatory Commission. While these organizations were a positive during this time, they did nothing to improve the economy, and the rumblings of deregulation began among economists; the government had too much power, and it was time to take it back. Hollywood Comes to Washington, the Republicans Take the Helm Democrat Jimmy Carter took the Presidency in 1976, and in the next year he passed into law the Full Employment Act, which applied more government oversight to the Board of Governors of the Federal Reserve in order to make them more accountable. Additionally, it imposed more stringent reporting and planning efforts to achieve the new goal of the Federal Reserve, price stability. Unfortunately, two years later, in 1979, a second oil crisis struck the world as Iranian oil supplies faltered during political upheaval. Once again, inflation began to rise dramatically, and the Federal Reserve raised interest rates significantly. President Carter countermanded this by instituting his own policies in March of 1980, but the damage had already been done. Former actor Ronald Reagan took over the presidency after winning the election in 1980. His premise? An economic plan that is now known as Reaganomics; on the basis of fiscal expansion, his plan was to perform controlled deregulation of business and industry and cut taxes and government spending to place the country into what was termed supply-side economics. By allowing more freedom on the production side, and more effectively controlling the money supply, then inflation should fall as the economy becomes self-serving instead of selfdemanding. Unfortunately, Reagans hope never panned out, and in no small part due to his spending habits. Under his presidency, the national debt increased from $930 million to $2.6 trillion, the gap between socioeconomic levels widened to unprecedented levels, and the national debt increased as a percentage of the Gross Domestic Product for the first time in over three decades. Trade deficits began to spiral to ever larger values, and the United States went from the worlds biggest creditor to its biggest debtor. In his two-term presidency, three positives were noted: at the end of his reign, unemployment had fallen below 6%; in 1986, in a bipartisan effort,

the tax code was reformed by the Tax Reform Act; because of the reform of the tax code, about half of the revenue lost from the 1981 tax cut had been recovered. But all the troubles were masked by the excesses of the 1980s, for consumer products, especially those in the realm of electronics, were numerous and cheap. And the consumers kept spending at phenomenal rates; it appears that the presidents penchant for spending translated to the public at large. Hidden in all the mix was the technology that would lead to Americas next great boom and it had its home in the world of computers. However, before that happened, the nation had four more years of Republican representation, and a continuation of Reaganomics under the leadership of George H. W. Bush. The big plus for President Bush Sr. was done at the end of his term, when he negotiated the North American Free Trade Agreement, which essentially lifted all trade tariffs between the nations of the United States, Canada, and Mexico. Troubles with Bubbles Following the establishment of the Federal Reserve in 1913 and the end of World War I, the economic system caused such a boom in the 1920s that investors, old and new, were able to take out investment loans to pay for the greater part of their capital. Each loan had a certain interest rate attached to it. So, for the investor to make money, the dividends required from his sale of stock had to be great enough to cover the principle of his loan and the accrued interest before he made a profit. But, because of the incredible gains the stock market was making on the short and long term throughout the 1920s, investors were not afraid to take that chance; money seemed to be coming out of nowhere, and soon there was more money lent out for market investment purchases than was circulating in currency. A bubble had been blown in the stock market because speculated earnings outweighed actual earnings; and, should a crash happen, the investors would not have the currency to repay the banks, which put the banks at risk for the purposes of liquidation of assets. The next bubble occurred following World War II and was due to the sheer amount of manufacturing output which ended up outweighing the demand once the production was no longer needed. But that was not due to speculation, and so should not be accounted among unexpected market bubbles. As a residual of Reaganomics, but firmly established by the time of President Clintons election to office in 1996, was the rollover of the economy from manufacturing-based to servicebased. This became known as the New Economy, and one of the key drivers to this service-based economy was a burgeoning form of information transfer, the Internet. Seen as a new way to connect the country and the world, business executives and entrepreneurs saw this as a grand opportunity for the development of a new business model. And so there came the Dot-Com boom, as investors flocked to the market to pump capital into new internet businesses. As the businesses grew and expanded their stock base widened, and a new term became popular in the business world. The IPO, or initial public offering, was the point at which a company was large

enough to register with a stock exchange and begin selling stock to the general public. During the Dot-Com boom, this was a very frequent occurrence. But, as it turns out, by the year 2000, it was obvious that too much had been pumped into Dot-Com businesses that werent going to survive; it was estimated that 50% to 75% percent of the gains in the Dot-Com market were going to be lost. This bubble had popped, and by the next year the recession had begun. One more bubble had been initiated during Clintons presidency, and that was the housing bubble; the very same bubble that caused the country to fall into the Great Recession beginning in 2008. However, to explain why, we must have another history lesson. Government-Sponsored Enterprise When the Federal Reserve was enacted in 1913, the stipulation of the Federal Reserve Banks was that they must hold collateral equal to the amount of currency they put into circulation. This collateral was in the form of securities, a.k.a. guaranteed capital; and these securities could be in the form of US Treasury Bills, Bonds, and Notes, federal agency holdings, and government-sponsored enterprise securities. Government-sponsored enterprise corporations are financial service corporations whose sole purpose is to provide capital to desired sectors of the economy to maintain the efficient flow of credit for cost reduction, and provide the least amount of risk of capital loss to investors and other suppliers of capital. The targeted sectors were education, agriculture, and home finance. On the home finance front, intense assistance was required once the United States had entered the Great Depression. Its first step was taken in 1932, when, much like the Federal Reserve Banks, The Board of Governors established 12 Federal Home Loan Banks and a FHLB Board to oversee their operations. The purpose of these banks was to provide private banks stable, on-demand, and low cost capital for the purpose of lending for mortgages, small business and agricultural interests, and other economic development interests. By 1938, though, the FHLBs werent enough to spurn the economy, and the Federa l National Mortgage Association (FNMA, or Fannie Mae) was established. It was the first of the secondary mortgage lenders sponsored by the government. Fannie Mae would buy up from the banks mortgages that were backed by the insurance of the Federal Housing Administration (FHA). The ensuing pool of money would then be lent back out to the banks as government insured capital for reissue of more mortgages. But the housing picture becomes more confusing from here on out, prepare yourself. Fannie Mae was created out of National Housing Act amendments under the cognizance of the Federal Loan Agency. But they were far from the only housing authorities created during the New Deal Era. The Home Owners Loan Corporation was established in 1933 to assist in refinancing home mortgages that were in default to prevent foreclosures. The Federal Savings & Loan Insurance Corporation (FSLIC) was created in 1934, and its purpose was to insure mortgages offered by savings and loan banks in much the same way that the FDIC insures its

member banks customer accounts; savings & loan banks (thrifts) were banks that accepted savings accounts only and issued mortgages through that pool of capital. Because they were not regular commercial banks, S&Ls were allowed to pay higher inter est rates on customer accounts, making them more attractive. Enacted during World War I, the United States Housing Corporation (USHC) had the purpose to provide homes for workers employed at shipyards and arsenals. The United States Housing Authority (USHA) came about in 1937 under the cognizance of the Department of the Interior to provide state and local governments with lowcost construction loans. And finally, the Defense Homes Corporation (DHC), established in 1940, provided a more expansive role for housing of wartime workers than did the USHC. The DHC fell under the cognizance of the FHA in 1945. Then, in 1948, all assets were liquidated and the DHC was absorbed by the Reconstruction Finance Corporation (RFC), which was established by President Hoover in 1932 and continued as a New Deal entity the next year. The RFCs purpose was to supply loans to businesses and to provide state and local government aid. In 1945, Congress passed the Reorganization Act, as it saw the large number of agencies that were out there and the dangers involved in having so many. Under this Act, in 1947, the Housing and Home Finance Agency was created and consolidated the USHC, the USHA, the HOLC, the DHC, the FSLIC, and the FHA; the agency consisted of the FHA, the Public Housing Administration (PHA), and the FHLB Board. As of 1950, Fannie Mae was acquired by the Housing and Home Finance Agency from the FLA as a constituent business entity. And four years later, as Fannie Maes stock expanded, Congress passed the Federal Natio nal Mortgage Association Charter Act, which gave to the government Fannie Maes preferred stock while allowing the private investors to continue holding the common stock. By 1968, Fannie Mae had become large enough that its operations affected the federal budget, and it was seen that the urban centers were faltering in their development. President Johnson and Congress then passed the Housing and Urban Development Act, creating the Department of Housing and Urban Development as a Cabinet-level agency. Using its preferred stock, the government split Fannie Mae into a government entity and a wholly private entity. The government portion was named the Government National Mortgage Association (GNMA, or Ginnie Mae) under the cognizance of the Department of Housing and Urban Development (HUD); and it incorporated FHA insured mortgages, as well as those issued by the Veterans Administration (VA) and the Farmers Home Administration (FmHA). The private side remained under the name Fannie Mae, but was still limited to purchasing federally insured mortgages. However, two years later, seeing that Fannie Mae was stagnating, the federal government decided to create competition for Fannie Mae. Therefore, it authorized Fannie Mae to begin purchasing non-government insured mortgages, and it also created the privately owned Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac) under the Emergency Home Finance Act. Mortgage Backed Securities With the authorization to purchase private mortgages to enhance the secondary mortgage market, the full security of government insured home loans was no longer there. Where was the

security to come from? The answer was there would be no additional security outside of the Investment Banks alone and the amount of mortgage aggregate they had. And that amount of aggregate is dependent on two things; the number of private mortgages the investment bank purchases to maintain the aggregate, and the quality of the investments made by the investors who purchase the aggregate. In 1968, Ginnie Mae was the first investment bank to issue a security from the sale of a private mortgage aggregate, referred to at the time as a mortgage passthrough security. In 1971, Freddie Mac issued its first participation certificate, a mortgage passthrough composed mainly of private mortgage aggregate. For Fannie Mae, it wasnt until 1981 that it issued its first mortgage passthrough, which it called a Mortgage-Backed Security. The name stuck, and the secondary mortgage market expanded rapidly. Ponzi Schemes As mentioned earlier, there was another type of important bank involved in the mortgage market, and it was called the savings & loan. These institutions were mutually held, meaning that, even though the bank was privately owned, any customer with a savings account or a loan agreement was a bank member with voting rights on bank issues and policies. Since they were focused more on the individual consumer, by law, they were not allowed to have more than 20% of their loans in commercial real estate. If an S&L were to grow large enough they could offer their stock publicly, but this to the detriment of the customers who would no longer have their voting rights in the company. Parallel to the establishment of the FDIC, under the oversight of the FHLB Board, the Federal Savings & Loan Insurance Corporation (FSLIC) was established as government backed insurance for customers of S&Ls with accounts in excess of a set level. Consumer interest in S&Ls was heightened in 1966 with the Interest Rate Adjustment Act, which allowed the Federal Reserve to grant slightly higher interest rates on active savings accounts, but it wasnt until the 1970s that S&Ls were allowed to offer checking accounts. In 1980, President Carter changed everything with the passing of the Depository Institutions Deregulation and Monetary Control Act. Attempting to streamline the banking community to strengthen the economy, this act forced all banks to abide by Federal Reserve regulations, removed the BoGs ability to control the interest rates on any deposit account with the exception of demand deposits (essentially, money supply accounts), and allowed S&Ls to offer checkable deposits and NOW accounts (essentially your regular checking account, but all in cash). S&Ls were also granted the power to negotiate non-mortgage loans and, along with every other bank in the country, the ability to set its own loan rates. They were now allowed to have 20% of their assets in consumer loans and they were also allowed to issue credit cards. The purpose of this act was to maintain consumer interest in banking, as the popularity of moneymarket accounts on the stock exchange was gaining quickly and taking business away from the banks. Two years later, with the passing of the Garn-St. Germain Depository Institutions Act, S&Ls were upgraded on the percentage of assets they were allowed to hold in consumer and

commercial loans and, by 1984, they were able to invest 10% capital into commercial, corporate, business, and agricultural loans. From a business standpoint, this invited a much larger risk of investment. There are many causes behind the savings and loan collapse of the 1980s, but it all stemmed from S &Ls providing long-term fixed rate mortgages while receiving funds from short-term volatile deposits on top of the doubling of the interest rate by the Federal Reserve in 1979. Coupled with limited and improper oversight, imprudent lending, and the removal of real estate investment losses as a gross income reduction for federal taxes (per the Tax Reform Act of 1986), the stage was set for a very fraudulent practice, Ponzi schemes. When the interest rate doubled, it made the S&Ls unattractive to possible customers and many went into insolvency; having fewer assets than they needed to pay out to customers. Rather than admit to the insolvency, many CEOs decided to attract new investors by guaranteeing high returns on false investments. Instead, these returns were paid by the CEOs from the money of subsequent investors. And, because of deregulation, this practice was harder to detect and went on longer than it should have. With the alteration of the tax code in 1986, many investors in S&Ls had made the decision to pull out, and the insolvency problem was finally discovered. The crisis began, and reform wasnt enacted until 1989. Reform and Recovery As per the Financial Institutions Reform, Recovery, and Enforcement Act, the following major consequences occurred in the mortgage industry: the Federal Home Loan Bank Board was abolished and replaced by the Federal Housing Finance Board to concentrate the governments oversight of the 12 FHLBs; the Federal Savings & Loan Insurance Corporation was also abolished and replaced by the Office of Thrift Supervisors, under the purview of the Department of the Treasury, to concentrate the oversight of the S&L sector; the Savings Association Insurance Fund (SAIF) replaced the FSLIC and was administered by the FDIC; the Resolution Trust Corporation (RTC) was established to provide government insured moneys to those S&Ls which came under regulator control during the crisis for the purpose of maintaining their customers assets. Perhaps the most crucial of the reforms was the provision that Fannie Mae and Freddie Mac take on the added responsibility of supporting more mid- and low-income mortgages. All-in-all, the estimated cost of losses and recovery for the crisis was $160 billion, of which $124 billion was taxpayer paid. The simultaneous slowdown of the finance industry and the real estate market was the leading cause of the 1990-91 recession. Because of the volatility of the S&L sector, a separate fund, the Bank Insurance Fund, was created for Federal Reserve member banks only. The recovery took most of the 1990s, but the Dot-Com boom aided in masking the ongoing difficulties with the recovery.

A Balanced Budget After the Bretton Woods economic system was adopted in 1945, the key factor, developed eleven years earlier, to measuring the status of a nations economy was the Gross Domestic Product. It is defined as the market value of all officially recognized final goods and services produced within a nation over a unit of time, typically one year. The major factors involved in calculation of the GDP are private consumption (C), gross investments (I), government spending (G), and net exports (X M). So, the final equation is nothing more than the sum of these factors:

GDP = C + I + G + (X M)
Ideally, a balanced federal budget and import/export market would allow GDP to be controlled by consumer spending and market investments. However, at the time Clinton took office, investments were down because of the housing drag, the trade deficit was manageable, government spending was high, and consumer spending was in decline. The Dot-Com boom covered for these problems, as it caused investments to rebound, unemployment to drop, and inflation to be held in check. With investments up and consumer spending still in the green, this gave Clinton a chance to balance the budget and eventually gain a surplus. How did he accomplish this? He wanted to add to investments. So, in efforts to expand the Community Reinvestment Act of 1977, which was passed to lower discrimination on loan agreements, Clintons administration passed several other acts making it easier for subprime individuals (those with little or bad credit, and those who had a low standard of living; they represented higher risk investments by the mortgage banks due to the higher possibility of loan defaults and non-payments) and forcing Fannie Mae and Freddie Mac to support to a much greater extent these subprime loans. The result was a housing boom, and the bubble began to grow. With investments up and subprime loans being handed out like candy, consumer spending remained in the green. And even with a rapidly rising trade deficit and the balancing of the federal budget, it was more than enough to allow the GDP to rise by 69% by the time 1999 rolled around. The downfall, however, was also a rapidly rising consumer debt, which more than doubled to $1.75 trillion over the eight years Clinton was president. Key legislation was passed in 1999 in regards to the Community Reinvestment Act regarding bank modernization. Known as the Financial Services Modernization Act, it allowed the banks to enter into the full range of investments, commercial banking, and insurance provisions. An amendment to the Financial Deposit Insurance Act also allowed banks to expand into or merge with other types of financial institutions, being redesignated by the Federal Reserves Board of Governor s as financial holding institutions upon approval and would have full FDIC insurance. A stipulation to this form of new financial business was the requirement that any outside entity wishing to enter into an agreement with said institution would have to be reported under the new CRA guidelines. Smaller banks, though, would get relief from CRA reporting guidelines by being reviewed less frequently.

Riding the Bubble In Clintons final year in office, the Dot-Com bubble finally burst and the economy headed into a recession. Consumer investments faltered, and the government surplus began to dwindle until, by 2002, it finally went negative again. George W. Bush took the presidency in 2001, and because of the housing boom and the federal budget once again in deficit, there was some relief to the GDP, causing investors and consumers to have a false sense of security with regards to the recession and the economy. The unfortunate events of September 11th, 2001 caused a major drop in the stock market, and recession was once again entered from the period of 2002 to 2003. But the economy recovered as expected based on calculated unemployment numbers. With the new financial holdings institutions holding strong, and the market continuing to grow, the Office of Thrift Supervision (OTS) decided to lighten the rules on the S&Ls in 2005. For those S&Ls whose assets were greater than $1 billion, only the stipulation concerning the required 50% of assets being through loans was now required. The 25%-25% split requirement for services and investments was now their option to follow, and the S&L sectors CRA rating was now only based on those S&Ls whose assets were less than the $1 billion. Seeing what the OTS had done, the FDIC, the FRB Board of Governors, and the OCC all banded together for an interim amendment to the CRA for redefinition of the formula used to designate a metropolitan financial institution from a rural one. Upon doing so, the entirety of the banking system now had an adjusted format for what was to be reviewed for their CRA rating, including the option of certain banks which now fell in between the definitions of a small bank and an intermediate small bank to choose the category in which they were reviewed. Threshold determinations for total assets to define the categories were now a function of the Consumer Price Index (essentially the ratio of the present price of good and services to the base price of those goods and services during the time period described). Two years later, in 2007, the OTS further changed S&L rules applying to the CRA rating to fall in line with what the federal banks had. This was to equalize the standards throughout the banking system so that an adequate comparison could be made of the performance of the banking and S&L industries so that more effective changes could be made, as necessary. Why did the housing bubble last so long? One major reason was the ease of credit. Even though the federal trade deficit continued to grow astronomically, the early 2000s saw the boom of many markets in Asia and oil nations. Therefore, the large influx of foreign money and the low US interest rates made credit easy to get and establish. This was a part of the reason why, by 2007, the consumer debt to disposable income ratio had reached 127%. The Great Recession Too many subprime mortgages were of the adjustable-rate variety (the bank holding the mortgage could adjust the lending rate at their discretion); too many mortgage-backed securities

being held worldwide were of the subprime type; home value appreciation and the ease of obtaining credit led to a home-building boom and a surplus of unsold homes; the ability of nonbanking businesses to issue home loans created volatile securities markets in which investors not only faced interest risk on defaulted mortgages, but also the default risk itself (the entire value of the mortgage). Four overlooked risks, and the world would pay for it. As of 2008, American homeowners, consumers, and corporations held $25 trillion of debt, of which 40% was in the securities markets. In mid-2006, the catalyst for the recession was ignited. The unsold home surplus reached a critical point; and after peaking, housing values began to decline. The first of the adjustablerate mortgages were adjusted higher and the first of the subprime defaults began. By the spring of 2007, the securities markets began to close and foreign investors began to report losses on their mortgage-backed securities. The snowball had begun to roll. Home foreclosures continued to rise, interest rates continued to rise, housing values continued to fall, loan defaults continued to rise (including non-mortgage loans), securities sell-offs began to rise (domestically and worldwide), the securities markets nearly shut down, and financial institutions approached insolvency as the values of the defaulted loans could not be covered; the crisis now began to expand to other parts of the economy and to other markets worldwide as the stock market fell by 40% in 2008. Adding insult to injury, due to various political issues overseas, natural disasters in the United States (such as Hurricane Katrina), and increased oil needs by developing countries throughout the world, from 2003 to 2008 oil prices in the United States began to rise sharply, at one point peaking over $4/gallon. Not only did this raise distribution costs of goods nationwide, but the Big Three automakers of Detroit, based on the popularity and high profit level of trucks and SUVs early in the 2000s, maintained high levels of stock in these vehicles. As oil prices rose, these vehicles were no longer in demand, and, when the market crashed in 2008, the Big Three were on the verge of bankruptcy, adding to unemployment levels that peaked around 10% in 2010. Baracks Bailouts The impact of the crisis had many detrimental effects, mainly in the housing and investment sectors. Home values plummeted by 30%, and have yet to recover; total value lost by 2010 in US household net worth was $15 trillion. Residential private investments fell by 50% to $400 billion, and non-residential investments fell by over 30% to $1.3 trillion. International losses on subprime securities were half of a trillion dollars, with that number headed towards as much as $1.5 trillion; the banking crisis hit many countries worldwide, and they were forced to use government capital to mitigate the losses, driving large government deficits. And nowhere was that more prevalent than in the United States.

The first of the attempted mitigations to the crisis was signed into law by President Bush in early-2008 with an economic stimulus package that came in the form of income tax rebate checks. An unfortunate circumstance was that these rebates coincided with the rise in fuel and food prices, and so the effect was minimal. A year later, President Barack Obama signed into law the American Recovery and Reinvestment Act; totaling $787 billion dollars, 9% of it was directly used for homeowner assistance; the rest of the act was dispersed to every other branch of the economy and government-sponsored programs and tax cuts. The Federal Reserve had the major portion of attempting a recovery and stabilizing the economy. By December 2008, the Federal Funds rate had been dropped to 0-0.25%, the lowest rate ever since its establishment nearly a century earlier. Government bonds were once again allowed to be sold on the open market in an attempt to increase the money supply and liquid capital. In response, central banks lowered their discount rate with other banks for short-term loans. They set up facilities to conduct direct lending to banking and non-banking institutions to stabilize the credit market. To stabilize the mortgage-backed securities market, by March of 2009 the Fed had purchased $1.25 trillion of MBSs from government -sponsored enterprises, including Fannie Mae and Freddie Mac. To further stimulate the credit market, the Fed also bought up $300 billion in long-term US Treasury securities. As of February of this year, Ben Bernanke, Chairman of the Federal Reserve, said that the Federal Reserve had bought $3 trillion in Treasury securities and MBSs, with a plan to raise that by $85 billion per month until unemployment drops below 6.5%. In further regards to Fannie Mae and Freddie Mac, even though they are government-sponsored enterprises, as of September 2008 they were placed under government receivership. Together, the two corporations had $5 trillion dollars in directly owed and guaranteed mortgage obligations; with their weak bases of capital, there was no guarantee that they could successfully manage their debt, and they were placed under the protection of the government, specifically the Federal Housing Finance Agency. In parallel efforts, Congress also placed many nationally chartered commercial banks under the receivership of the OCC and many S&Ls under the receivership of the OTS. By taking the responsibility for these institutions, their balance sheets had now become a part of the national budget and were counted into the level of the national debt. However, the security provided by having the government backing of these institutions has raised the confidence of investors, and the stock market value is back above pre-crisis levels. In an effort to prevent bank insolvency, President Bush and Congress established the Troubled Asset Relief Program (TARP) to buy up so-called toxic assets, or mortgages that were active subprime mortgages and held little confidence on the market. By providing cash for these assets it improved the cash bases of many banks and further improved investor confidence. As of April 2012, the government had been repaid nearly 75% of the $414 billion dollars allocated to TARP. In August of 2009, the total of bank insolvencies reached 102, some of those banks being major ones, and convinced the US government to give $700 billion in bailout moneys on top of that given by TARP. Numerous bank mergers took place, most notably Wells

Fargo and Wachovia to prevent the failure of Wachovia. All the activity by the government and Federal Reserve to save the banks resulted in the FDICs reduction of the De posit Insurance Fund to $13 billion dollars. The tightrope was being walked. An additional $273 billion ($200 billion to Fannie Mae and Freddie Mac) was offered to help out homeowners facing foreclosure in 2009. These moneys were on top of the TARP and Bailout packages, and were meant for mortgage principal reduction and refinancing, and for monthly payment assistance on those mortgages. The ongoing automobile crisis of the Big Three throughout the mid -2000s led President Bush and Congress to authorize $25 billion in loans in September of 2008, with an additional $17.4 billion which were distributed by President Obamas administration in January and February of 2009. Most of the money was provided to GM and Chrysler, while Ford established a line of credit with the government as a last resort in preventing possible bankruptcy. While the automobile bailouts were seen by many as unnecessary and unwarranted spending because of the automakers lack of foresight, as a stipulation of these loans, the automobile industry was forced to begin retooling for environmental concerns and increase vehicle fuel economy. But, as a percentage of government spending as result of the overall recession, the $50 billion given to the Big Three was quite small. What If? Well start with the smaller experiment, the fall of the Big Three. Supposing that Ford, GM, and Chrysler all decided to declare bankruptcy at the same time, what would happen? The biggest losses would be in tax revenue and employment. However, more than likely all three would not simply call it quits, but would remain at minimum production levels in the hope of recovery. For the government, because of lost tax revenue and the rise in unemployment, there would be extra moneys paid out in unemployment wages, retirement funds, and health care for jobless workers. It would also be likely, though, that foreign automakers would swoop into Detroit and the rest of the nation and take over some of that legacy, causing a slight rebound in employment. All in all, a bankruptcy of all three has been estimated around $150 billion, three times the money handed out in bailouts. Now for the big one, the potential insolvency of Fannie Mae and Freddie Mac. As stated above, the total assets that the two corporations held was about $5 trillion in mortgage obligations as of 2008, with that value more than likely increasing since then. Had they been allowed to go insolvent as a natural function of the failing market, it would have been another $5 trillion dollars of lost mortgage money. The housing market would have faced complete collapse with no investor confidence in the securities to restore it. The economy as a whole would have suffered Depression Era issues of unemployment and inflation as every sector of the economy would have suffered severely. More financial institutions would have failed due to bank runs and a near total loss of capital. The damage would have been extreme, and the world would have suffered right along with us.

An Angry Public An unfortunate circumstance of the government bailouts and receiverships is the effect it has had on taxation, Social Security payouts, and health care. However, as these three issues are all government run and subsidized, they also represent the most liquid assets the government can get their hands on when money is needed. Anger has also arisen due to the governments proposal last month to merge Fannie Mae and Freddie Mac into one corporation still under receivership. Opponents believe that this is the administrations attempt to corner the housing market and take full control for their benefit. The administration is criticized for still trying to secure low-income mortgages in an effort to boost a market that is not capable of handling it, and the locking out the private corporations from the market. The administration is not looked at fondly for saving the housing market from total collapse; it is seen as an opportunist taking advantage of a bad situation to exact control over a private market. Calls are being made to shut down Fannie Mae and Freddie Mac and establish a new corporation designed to hand the market back over to the private corporations, similar to the establishment of the Resolution Trust Corporation following the S&L crisis in the 1980s. Could that be the whole point to a Fannie Mae-Freddie Mac merger? Could their ideology be to restrict competition on the market in order to facilitate a controlled restoration of the housing market under government control to ensure no predatory practices take place? Only time will tell The Verdict We have now gone through a century of economic and political history in order to answer one question: how did we get here? Every time there is a crisis the finger pointing begins. Who is to blame? Is it a political party and their ideologies? Is it a single politician, namely the president, and his policies? Is he simply trying to give his party a leg up for future elections so that they may retain supremacy in Congress and the White House? Going through the history, it seems as though the actions of both parties with regards to the economy were an attempt to provide stable and safe markets for the American people to invest in. And while political events, domestically and worldwide, certainly affect the markets, the finger pointing can most often be directed at the public. Lets review, shall we? The establishment of the Federal Reserve in 1913 was for worker protection and led to the rise of the Middle Class as fair work practices and market stabilization occurred. The system was new, and its real-world application was not fully understood. Subsequently, market speculation was allowed to take hold in the 1920s. When that speculation failed, the Great Depression followed. Then there followed the time of heavy regulations in an effort to restore the stock market. If not for World War II, the depression may have lasted much longer. Following the war, it was a time of worldwide reconstruction. And, because the American landscape and economy were virtually untouched, we became the gold standard for the rest of the world. When that standard was no longer required, the American political machine took over and tried to prevent the natural hand over of the world economy to the world. Decline

began in the American markets and started to drag down the world market with it. In the early 1970s the Nixon shock occurred, and already unstable worldwide markets fell into recession, as did the United States. Political meanderings in the Middle East led to two fuel shortages, and market regulation in the US ramped up by the end of the decade, stifling the economy. Reaganomics and deregulation followed; world markets flourished and consumer products were numerous and cheap. In the housing market, those responsible for guaranteeing mortgages were given more freedom to invest outside of the market, and a door was open for investment fraud. Coupled with large amounts of political spending and an ever growing trade deficit, another recession was waiting in the wings. Market regulation was once again ramped up, but not to the levels it had been at previously, and the United States began to recover. But, the public was disenchanted with their government being constantly in debt, and the sentiment for a balanced federal budget and tax relief became the new golden apple. The new internet technology provided the kick-start the government needed to achieve not only a balanced budget, but a budget surplus. Fueled by the Dot-Com boom, mortgage regulations were eased significantly to gain more capital to balance the budget. A second and third bubble grew in housing and credit, each one improving the longevity of the other. Then, in 2008, the bottom fell out. Who is to blame? Based on the facts, everybody is And here is why. This is a capitalist society, and the driver is to make money. Very many try to make money in any way they can, whether legal or illegal. And whenever regulations are enacted to protect one group or sector, somebody finds a loophole to keep the money rolling in at the expense of others. The regulation of the capitalist market in America was not meant to remove free enterprise, but to promote fair enterprise. Again, without the Federal Reserve, there would be no Middle Class, the biggest economic class of citizens this nation now has. And, even though it has been a century, market cycles are still not fully understood due to interruptions by political events. So, for a century, we have been fighting over-regulation and under-regulation in an attempt to keep the market fair and the United States economy on top of the world. What will the future hold?...

Reference Materials
For the Federal Reserve
Weblinks
Federal Reserve Reports to Congress The Federal Reserve in Plain English An easy-to-read guide to the structure and functions of the Federal Reserve System ebook: The Federal Reserve System Purposes and Functions Ask Dr. Econ An educational resource from the Federal Reserve Bank of San Francisco Board of Governors of the Federal Reserve Official website "The Federal Reserve System in Brief" at the Federal Reserve Bank of San Francisco "What is the Fed?" at the Federal Reserve Bank of San Francisco.

Decision of the Reserve Bank Organization Committee Determining the Federal Reserve Districts and the Location of Federal Reserve Banks under the Federal Reserve Act Approved December 23, 1913, April 2, 1914; With Statement of the Committee in Relation Thereto, April 10, 1914. 27 pages. Government Printing Office, Washington, D.C., 1914. Federal Reserve District Divisions and Location of Federal Reserve Banks and Head Offices, Hearings before the Reserve Bank Organization Committee United States. Reserve Bank Organization Committee, 1914. Historical Beginnings ... The Federal Reserve by the Federal Reserve Bank of Boston Federal Reserve Districts and Banks Federal Reserve Education Federal Reserve Financial Services The Federal Reserve and the Financial Crisis Chairman Bernanke's College Lecture Series to an undergraduate class at The George Washington University School of Business March, 2012 Related readings "Origins and Mission of the Federal Reserve" includes small fast video "Chairman Ben Bernanke Lecture Series Part 1"includes large slow video Recorded live on March 20, 2012 10:35am MST Lecture materials "The Federal Reserve after World War II" includes small fast video "Chairman Ben Bernanke Lecture Series Part 2" includes large slow video Recorded live on March 22, 2012 10:37am MST Lecture materials "The Federal Reserve's Response to the Financial Crisis" includes small fast video "Chairman Ben Bernanke Lecture Series Part 3" includes large slow video Recorded live on March 27, 2012 10:38am MST Lecture materials "The Aftermath of the Crisis" includes small fast video Lecture materials Board membership

Bibliography
The Federal Reserve System: Purposes and Functions . Board of Governors of the Federal Reserve System. 2005. The Federal Reserve in Plain English. Board of Governors of the Federal Reserve System. 2006. from the St. Louis Fed Epstein, Lita & Martin, Preston (2003). The Complete Idiot's Guide to the Federal Reserve. Alpha Books. ISBN 0-02-864323-2. Greider, William (1987). Secrets of the Temple. Simon & Schuster. ISBN 0-671-67556-7; nontechnical book explaining the structures, functions, and history of the Federal Reserve, focusing specifically on the tenure of Paul Volcker R. W. Hafer. The Federal Reserve System: An Encyclopedia. Greenwood Press, 2005. 451 pp, 280 entries; ISBN 0-31332839-0. Meltzer, Allan H. A History of the Federal Reserve, Volume 1: 1913 1951 (2004) ISBN 978-0-226-51999-9 (cloth) and ISBN 978-0-226-52000-1 (paper) Meltzer, Allan H. A History of the Federal Reserve, Volume 2: Book 1, 19511969 (2009) ISBN 978-0-226-52001-8 Meltzer, Allan H. A History of the Federal Reserve, Volume 2: Book 2, 19691985 (2009) ISBN 978-0-226-51994-4; In three volumes published so far, Meltzer covers the first 70 years of the Fed in considerable detail Meyer, Laurence H. (2004). A Term at the Fed: An Insider's View . HarperBusiness. ISBN 0-06-054270-5; focuses on the period from 1996 to 2002, emphasizing Alan Greenspan'schairmanship during the Asian financial crisis, the stock market boom and the financial aftermath of the September 11, 2001 attacks. Woodward, Bob. Maestro: Greenspan's Fed and the American Boom (2000) study of Greenspan in 1990s.

For United States Economic History

Council of Economic Advisors, Economic Report of the President (annual 1947 ), complete series online; important analysis of current trends and policies, plus statistical tables Bureau of Economic Analysis: Official United States GDP data What Was the U.S. GDP Then? Annual Observations in Table and Graphical Format for years 1790 to Present. Annual Report of the Secretary of the Treasury on the State of the Finances, 1789 1980

Annual Report of the Comptroller of the Currency, 18631980 Annual Report of the Board of Governors of the Federal Reserve System 75 Years of American Finance, a graphic presentation of American financial history from 1861 through 1938 Statistical Abstract of the United States Long Term Economic Growth 18601965: A Statistical Compendium Business Booms and Depressions since 1775, a chart of the past trend of price inflation, federal debt, business, national income, stocks and bond yields for the United States from 1775 to 1943. Budget of the United States Government

For the Subprime Mortgage Crisis

Suggested Reading
Fried, Joseph, Who Really Drove the Economy into the Ditch? (New York, NY: Algora Publishing, 2012) ISBN 978-0-87586942-1. Wallison, Peter, Bad History, Worse Policy (Washington, D.C.: AEI Press, 2013) ISBN 978-0-8447-7238-7. Fengbo Zhang (2008): 1. Perspective on the United States Sub-prime Mortgage Crisis , 2. Accurately Forecasting Trends of the Financial Crisis , 3. Stop Arguing about Socialism versus Capitalism . Archaya and Richardson. Financial Stability: How to Repair a Failed System NYU Stern Project-Executive Summaries of 18 Crisis-Related Papers Committee for a Responsible Federal Budget "Stimulus Watch," (Updated Regularly). Blackburn, Robin (2008) "The Subprime Mortgage Crisis," New Left Review 50 (MarchApril). Demyanyk, Yuliya (FRB St. Louis), and Otto Van Hemert (NYU Stern School) (2008) "Understanding the Subprime Mortgage Crisis," Working paper circulated by the Social Science Research Network. DiMartino, D., and Duca, J. V. (2007) "The Rise and Fall of Subprime Mortgages," Federal Reserve Bank of Dallas Economic Letter 2(11). Dominique Doise, Subprime: Price of infringements/Subprime : le prix des transgressions , Revue de droit des affaires internationales (RDAI) / International Business Law Journal (IBLJ), N 4, 2008 Ely, Bert (2009) Bad Rules Produce Bad Outcomes: Underlying Public-Policy Causes of the U.S. Financial Crisis, Cato Journal 29(1). Don Tapscott, 2010. Macrowikinomics, Publisher Atlantic Books Gold, Gerry, and Feldman, Paul (2007) A House of Cards From fantasy finance to global crash. London, Lupus Books. ISBN 978-0-9523454-3-5 Michael Lewis, "The End," Portfolio Magazine (November 11, 2008). Lewis, Michael (2010). The Big Short: Inside the Doomsday Machine . London: Allen Lane. ISBN 0-393-07223-1. Liebowitz, Stan (2009) "Anatomy of a Train Wreck: Causes of the Mortgage Meltdown" in Randall Holcombe and B. W. Powell, eds., Housing America: Building out of a Crisis . Oakland CA: The Independent Institute. Muolo, Paul, and Padilla, Matthew (2008). Chain of Blame: How Wall Street Caused the Mortgage and Credit Crisis . Hoboken, NJ: John Wiley and Sons. ISBN 978-0-470-29277-8. Woods, Thomas E. (2009) Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse / Washington DC:Regnery Publishing ISBN 1-59698-587-9 Reinhart, Carmen M., and Kenneth Rogoff (2008) "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison," Harvard University working paper. Stewart, James B., "Eight Days: the battle to save the American financial system", The New Yorker magazine, September 21, 2009. Clark, Kenneth E. Legacy of Greed: The Story Behind the Mortgage and Housing Meltdown, Publisher: Author Solutions ISBN 978-1-4520-5439-1 http://www.kennetheclark.com Review of Mark Zandi's book Financial Shock: A 360 Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis from The New York Review of Books Zandi, Mark Book Excerpt: Financial Shock-Chapter 1

Weblinks
Financial Crisis Inquiry Commission Homepage

Report of Financial Crisis Inquiry Commission-January 2011 Reuters: Times of Crisis multimedia interactive charting the year of global change PBS Frontline Inside the Meltdown PBS - What You Need to Know About the Crisis "Government warned of mortgage meltdown Regulators ignored warnings about risky mortgages, delayed regulations on the industry". CNN. December 1, 2008. Retrieved 2010-05-24. "The US sub-prime crisis in graphics". BBC. 21 November 2007. CNN Scorecard of Bailout Funds at CNN Bailout Allocations & Payments Barth, Li, Lu, Phumiwasana and Yago. 2009. The Rise and Fall of the U.S. Mortgage and Credit Markets: A Comprehensive Analysis of the Market Meltdown. Amazon Financial Times In depth: Subprime fall-out The Crisis of Credit Visualized Infographic by Jonathan Jarvis The Economic Crisis: Its Origins and the Way Forward Video of lecture given by Marshall Carter, chairman of the New York Stock Exchange, at Boston University, April 15, 2009 The True American Dream Home Ownership, the Subprime Lending Crisis, and Financial Instability by Masum Momaya International Museum of Women The Financial Crisis: What Happened and Why Lecture 2 Video of lecture given in July 2009, by Yaron Brook, professor of finance and executive director of the Ayn Rand Center for Individual Rights Lectures by Ben Bernanke to an economics class at George Washington University March, 2012

"Chairman Ben Bernanke Lecture Series Part 1" Recorded live on March 20, 2012 10:35am MST "Chairman Ben Bernanke Lecture Series Part 3" Recorded live on March 27, 2012 10:38am MST

For the Automaker Crisis

Weblinks
CAR industry news. Auto Industry Financing and Restructuring Act. Capitalism and the auto crisis. Toyota losses highlight global auto collapse. GM closes plants in Wisconsin and Ohio. Crisis grips German auto industry. Thousands of jobs threatened in Swedish auto industry. European auto industry in crisis. February 2009 Restructuring Plans: General Motors Chrysler