5 lessons of the Great Recession
Five years after the worst crisis since the 1930s, America has devised safeguards and changed the rules of Wall Street. But could the country really avoid another financial collapse?
(Page 4 of 8)
When such doubts start spreading systemwide, the panic is generally stopped by the entry of a "lender of last resort." In other words, by the government or central bank. It's a lesson that led to the Federal Reserve's creation after a banking panic in 1907. And it's a lesson that proved vital to quelling the panic of 2008.Skip to next paragraph
As the mortgage crisis evolved into a financial crisis, the Fed and later the Treasury swung into action. From late in 2007 through early in 2009, the Fed gradually rolled out a succession of programs designed to provide credit where private-sector confidence had evaporated. They had abbreviations only a banker could love: the TAF, the TSLF, the PDCF, the AMLF, the CPFF, the MMIFF, the TALF.
If the alphabet soup sounds a bit like the New Deal, that's not by accident. The Fed's vice chairman at the time, Donald Kohn, recalls that Bernanke liked to say that although he didn't agree with everything Franklin Roosevelt did to overcome the Great Depression, he did admire the way the president kept trying new ways to strengthen the economy.
When the investment bank Lehman Brothers went bankrupt, financial markets reached their point of maximum uncertainty. Was the crisis spinning out of control? The fear spread into money-market funds, where some 30 million Americans held cash. "When that market dried up and came under pressure," recalls Paulson, "my phone was ringing off the hook."
Corporations relied on money-market investors for short-term borrowing needs, from making payroll to dispensing dividends. Paulson, acting as President George W. Bush's wartime general of finance, tapped a rarely used emergency power to backstop money-market funds, a key step toward containing the post-Lehman panic.
Another giant step – and a highly controversial one – was to win congressional backing for a $700 billion Troubled Asset Relief Program (TARP) at the Treasury's disposal. This was the legislation that was the subject of the Sept. 18 meeting in Ms. Pelosi's office.
By the time the TARP legislation passed, Paulson and other frontline crisis managers were looking to do something quicker and more powerful than buying troubled bank assets. They decided to use TARP to inject capital directly into financial firms – investing taxpayer dollars to give them an added cushion against loan losses.
Despite all this, the crisis – and the flow of money – continued into 2009, as Mr. Bush handed the presidency to Barack Obama.
"At that point, the US government had already provided a mix of guarantees and capital that backstopped between $10 [trillion] and $30 trillion in financial assets. It was the most extraordinary set of broader guarantees and funding commitments deployed ever ... no precedent for it," says one former senior member of the Obama economic team. "But even with all that, the economy was shrinking."
The Obama team, with Timothy Geithner as Treasury secretary and Lawrence Summers as top economic adviser, launched another wave of rescue efforts for the economy. It would include a massive fiscal stimulus from tax cuts and government spending. It also included new efforts within the Group of 20 nations to inject liquidity into banks from Asia to Europe. At the same time, the Treasury announced that major US banks would undergo "stress tests" to see if they needed more capital.