From the Great Recession to the Covid-19 Pandemic

A Financial History of the United States 2010-2020

Jerry W. Markham

• Publisher: Routledge
• Year: 2022
• ISBN:
  9781000550481
• Edition: 1
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

This volume narrates the financial history of the United States during a period of great upheaval in the early part of the 21st century.

It is divided into three chronological sections: the first section describes the recovery of financial markets after the Great Recession. It begins with an overview of the state of the economy at the start of the new decade, including some of the political storms affecting the economy and financial markets. It explores the uneven nature of the recovery and volatility in the Treasury during these years. The second section sets forth regulatory responses to the Financial Crisis of 2008, including the massive fines imposed on large banks by a swarm of regulators. It examines the "too big to jail" prosecution model, cases involving Libor and foreign exchange manipulation and the impact of rogue traders. It also looks at the developments in payment systems, rise of crowdfunding as a source of capital, and high-frequency trading. The third section describes the rules adopted under the Dodd-Frank Act of 2010 that broadly affected financial markets. It also recounts the Trump trade wars and ends with an account of the financial and economic turmoil that occurred during the Covid-19 pandemic in 2020.

The volume will be an essential addition to academic and public libraries with readers drawn from business schools, departments of economics and finance, and historians.

Part I The Aftermath of the Financial Crisis

1 PostDodd-Frank Issues

DOI: 10.4324/9781003247043-3

Financial Crisis Inquiry Commission Report

Before turning to governmental efforts to restore markets from the effects of the Great Recession, it is helpful to consider some continuing fallout from Financial Crisis of 2008. The Financial Crisis Inquiry Commission (FCIC) that was created by Congress in May 2009 was assigned the task of determining the causes of that crisis. The FCIC interviewed over 700 witnesses, reviewed millions of documents and held 19 days of hearings across the country including Washington, DC, New York and Miami. The FCIC issued its report, belatedly, on January 27, 2011. Although the FCIC was supposed to be a bipartisan body, it split deeply on political and ideological grounds in assessing the root causes of the crisis. The six Democrats on the ten-member FCIC used their 410-page report to engage in extended banker bashing. Each chapter in the FCIC majority report was followed by comments that pointed the finger of blame at regulatory failures, rating agencies and Wall Street firms of varying stripes without providing any real factual nexus to the Financial Crisis.

Three Republican members on the FCIC prepared a separate report that listed ten factors they believed were instrumental in causing the crisis. The Democrat members refused to publish the Republican’s full views in the FCIC report. Nevertheless, those Republicans were able to summarize their perception of the causes of the crisis. Those factors included the existence of a global credit bubble that was spurred by surplus trade balances with China and the oil-producing nations; a housing bubble; the growth of non-traditional mortgages; failures in credit ratings and securitization; concentrated correlated risk in assets held by financial institutions; too much leverage and liquidity risk; and financial shock and panic. These three Republican minority members asserted that while US monetary policy was unfocused and amplified the crisis, it did not cause it.

The remaining Republican member of the FCIC, Peter Wallison, took a different path. Wallison, a Fellow at the American Enterprise Institute and former White House counsel, had closely followed events in the residential mortgage market for years. He co-authored a prescient book in 2000, titled Nationalizing Mortgage Risk: The Growth of Fannie Mae and Freddie Mac. That book warned, eight years in advance of the Financial Crisis of 2008, that Fannie Mae and Freddie Mac were, in their role of government-sponsored enterprises (GSEs), acquiring the vast majority of conventional residential mortgage loans. That meant that taxpayers would be implicitly guaranteeing several trillion dollars of such debt. Wallison’s book further predicted that, “as they grow beyond their traditional market segment, Fannie and Freddie will have to purchase increasing amounts of lower-quality loans and hold more of those loans in portfolio, increasing their risks.”¹ That warning proved to be all too correct as witnessed by the subprime mortgage problems and the failure of Fannie Mae and Freddie Mac in 2008. Wallison wrote a lengthy dissent to the FCIC majority report, which the Democrats refused to publish. He blamed the Financial Crisis of 2008 on mismanagement at Fannie Mae and Freddie Mac. Wallison also concluded that a decline in mortgage underwriting standards caused by faulty government housing policies was primarily responsible for the fact that approximately one-half of all US mortgages (totaling 27 million) were subprime or otherwise of poor quality. The New York Times called Wallison’s dissent “a lonely, loony, cri de coeur.”²

In the end, the FCIC report added little to the picture that had already been painted about the causes of the crisis in several mass marketing books. Particularly perceptive was a book by The New York Times reporter Gretchen Morgenson and Joshua Rosner that pointed out that government housing policy had fostered, indeed forced, the massive growth in subprime lending that was behind the Financial Crisis of 2008.³ Among their culprits were Clinton administration officials, including Andrew Cuomo, the HUD Secretary. In that role, Cuomo imposed subprime quotas on the lending activities of Fannie Mae and Freddie Mac. Cuomo later became the New York Attorney General (NYAG). He used publicity from his prosecution of banks and other financial services firms in the wake of the Financial Crisis to become governor of New York.

Another banker bashing report, 650 pages in length, was issued in April 2011 by the Senate Subcommittee on Investigations that was headed by Senator Carl Levin (D-Mich). There were no new revelations in the report, only more finger pointing at the usual suspects, namely large banks dealing in subprime mortgages. The Levin Report also condemned the credit rating agencies for overrating mortgage-backed security issues that failed. The report also placed blame on regulatory failures by the Office of Thrift Supervision, which was abolished by the Dodd-Frank Act of 2010. No fault was placed on government housing policies that had forced subprime lending quotas that led to the failures of Fannie Mae and Freddie Mac. The Wall Street Journal called Levin’s report and complaints a “political witch hunt” that had come “a cropper.”⁴ Nevertheless, Senator Levin requested that the Department of Justice (DOJ) investigate the veracity of the testimony before Congress of Goldman Sachs CEO Lloyd Blankfein. Blankfein had testified that Goldman did not take on a large speculative short position during the crisis in subprime mortgages. Rather, Blankfein asserted that Goldman’s short positions in subprime exposures were mostly hedges. Goldman’s stock price tumbled after it was revealed that Blankfein hired a criminal lawyer to advise him with respect to Levin’s charges. The New York Times and its reporter Andrew Ross Sorkin came to the defense of Goldman. They asserted that Levin’s committee had misconstrued the evidence. In August 2012, the DOJ announced that it would not be bringing criminal charges against Goldman Sachs or its executives in connection with its activities in collateralized debt obligations (CDOs).

TARP and Other Rescue Programs

The bank bailouts during the Financial Crisis of 2008 had been, at the time, staggering in their amounts. The controversial Troubled Asset Relief Program (TARP) that bought toxic, illiquid assets from banks and other financial institutions is described in a prior volume in this Financial History series. The Congressional Budget Office estimated early on that TARP would cost taxpayers about $34 billion in loans or other investments that would not be repaid. In fact, participants in that program returned $390 billion in TARP funds and the bailout program provided profits to the federal government totaling over $30 billion. The federal government also reported in March 2012 that it had earned $25 billion on the $225 billion in mortgage-backed securities it purchased during the Financial Crisis of 2008 as bailout and liquidity measures. The Fed’s profits were up by 65 percent in 2010, and it returned from its coffers some $150 billion to taxpayers between 2010 and 2011. In total, the government made $110 billion in profits from all of its bailout programs.

The Fed disclosed that during the Financial Crisis of 2008, it had made emergency loans totaling $3.3 trillion from its Term Auction Facility (TAF). Those loans were issued on very favorable terms to financial institutions in order to allow them to maintain liquidity. Among others, the Fed loaned $212 billion to Bank of America, $154 billion to Wells Fargo and $147 billion to Wachovia Bank that had been acquired by Wells Fargo during the Financial Crisis. Eyebrows were raised when the Fed disclosed that more than half of TAF’s largest loans were made to foreign financial institutions. They included Barclays Bank ($232 billion), the Bank of Scotland ($181 billion), Société Générale ($124 billion), Dresdner Bank, ($123 billion), BayernLB ($108 billion) and Dexia Credit ($105 billion). Hedge funds received large loans under the Fed’s Term Asset-Backed Securities Lending Facility (TALF). It allowed those often speculative ventures to buy distressed asset-backed securities in order to foster a market in those securities. Those purchases provided an opportunity for the participating hedge funds to experience huge gains.

The largest seller of commercial paper to the Fed under its Commercial Paper Funding Facility (CPFF), another liquidity program created during the Financial Crisis in 2008, was a foreign bank, UBS. Five of the top ten users of CPFF were foreign financial institutions. On the other side of the coin, 47 percent of the outstanding debt of the US government was held by foreign investors. Japan and China were the largest holders of those securities.

American International Group, Inc. (AIG), the mega-sized insurance company that was at the center of the storm during the Financial Crisis, was a leading user of the CPFF program. During the Financial Crisis, the Fed had purchased some $40 billion in distressed securities from AIG’s stock lending operations. The Fed initially faced uneven interest in the sale of the subprime securities it had taken over from AIG and placed in its Maiden Lane II portfolio. Those subprime bonds had a face value of $30 billion but were valued at only about half that amount when the government began auctioning them off in April 2011. AIG had offered to buy the entire package of bonds back from the government for $15.7 billion, and a private equity group had offered $17 billion. The government thought it could do better by piecemeal auctions. Those auctions initially appeared to be unsuccessful and quickly saturated the market. Only 64 percent of the bonds offered for auction on May 12, 2011 were sold. Subsequent auctions were more successful. The New York Fed completed the sale of the AIG “toxic” assets in August 2012. The Treasury Department also sold its common stock holdings in AIG, completing those sales in December 2012. In total, the Treasury Department made $5 billion in positive returns from its investment in AIG, and the Fed made $17.7 billion. The Treasury Department reported in March 2011 that it planned to sell $142 billion in mortgage-backed securities that it had acquired during the Financial Crisis of 2008. The Treasury Department was expected to make as much as $20 billion in profits from those sales.

The Fed continued its efforts to inflate the economy in the wake of the Great Recession. It maintained low interest rates and continued quantitative easing through asset purchases totaling $600 billion. This purchasing program was nicknamed “QE2,” because this was the second quantitative easing program since the Financial Crisis of 2008. The first program was conducted in 2009 and involved asset purchases totaling $300 billion. QE1 had little apparent effect on the economy. Fed Chairman Ben Bernanke’s QE2 program was widely criticized as posing a danger of igniting inflation. Actually, inflation was then at the lowest level since 1957, when records were first kept on core inflation. QE1 and QE2 did not result in inflation, but they also failed to reignite the economy. The Fed’s balance sheet continued to grow after the Great Recession ended. The Fed’s $84 billion in assets in 2009 increased to $2.4 trillion in 2010. The Fed reported on June 20, 2012 that it was extending its Operation Twist. Under that program, the Fed would be buying $267 billion in long-term Treasury securities and selling a similar amount of short-term Treasury instruments. That action was taken after the Fed observed that the economy was continuing to slow.

President Obama proposed a plan to allow refinancing at lower rates of home mortgages that were underwater (those with a mortgage of 25 percent or more over the appraised value of the home). Appraisals and other normal refinancing requirements would be waived as long as the homeowners were current on their mortgages payments. A similar, but more restricted, program introduced in 2009 called the Home Affordable Refinancing Program (HARP) had attracted some 890,000 applicants, of which only some 70,000 had homes that were underwater. Another government relief program was faltering. The Dodd-Frank Act had set aside $1 billion that was be used as grants to homeowners who were unable to meet their mortgage payments. Applicants were able to qualify for only about half that amount.

The mortgage modification program created by TARP was deemed by all to be a failure. Only about 600,000 of the predicted 4 million modifications were made, and many of those mortgages later defaulted. The Obama administration’s Home Affordable Modification Program (HAMP) granted banks $1,000 for each mortgage they restructured that reduced the homeowner’s payments. HAMP was funded with $46 billion, but only about $2 billion was spent over the next two years in restructurings. Many of the homeowners who initially enrolled in the program subsequently dropped out. Three of the largest lenders, Bank of America, JPMorgan and Wells Fargo, received $24 million in HAMP fees in May 2011. The Obama administration then announced that it would withhold further such payments because of the slowness of the banks in carrying out restructurings.

A Treasury Department program that was established to allow persons losing their jobs to defer their mortgage payments for three months attracted only some 7,300 participants. The program was not of much help in any event because the average time that individuals remained unemployed had increased to nine months. Second mortgages were another concern. The homes of about 40 percent of homeowners with second mortgages were underwater in May 2011, about twice the percentage of homes with only a primary mortgage.

Fannie Mae and Freddie Mac hit more headwinds after being taken over by the federal government during the Financial Crisis. Freddie Mac posted a third quarter loss in 2011 of $4.4 billion and asked for an additional $6 billion in funds from the federal government. Fannie Mae had a $5.1 billion loss in that quarter and sought another $7.8 billion from the government. The Obama administration declared that it planned to dismantle Fannie Mae and Freddie Mac over a ten-year period and that their affordable housing goals would be curbed. That did not happen. Those entities remained as wards of the government even after they regained profitability. Losses from the takeover of Fannie Mae and Freddie Mac were initially expected to result in a cost of $389 billion to taxpayers by 2021. That figure was revised downward to $124 billion in 2014 and later revised further downward to $22 billion. All of these forecasts proved to be wildly inaccurate. In the decade following the Financial Crisis of 2008, the federal government had recovered all of the $190 billion in bailout funds given to Fannie and Freddie, plus profits of $88.3 billion and growing.

Financial Stability Oversight Council Operations

As described in a prior volume in this Financial History series, the Dodd-Frank Act created the Financial Stability Oversight Council (FSOC). It was given the task of facilitating information sharing and coordination among financial services regulators. FSOC’s brief included policy development for rulemaking, examinations, reporting and enforcement actions. FSOC was intended to supplant the President’s Working Group on Financial Markets (PWG). The PWG members included the Fed, Treasury, Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC). The PWG was notable for bickering among its members and for blocking the CFTC from regulating the swaps market before the Financial Crisis of 2008. Its members had also clashed with each other over what actions were needed to deal with that crisis and its aftermath.

Dodd-Frank sought to create a more formal and broader-based decision-making body through FSOC. It is composed of ten voting members and five non-voting members and is headed by the Secretary of the Treasury. The voting members of FSOC are Treasury Secretary, the Fed Chair; the Comptroller of the Currency (OCC); the chairs of the FDIC, the SEC, the CFTC and the National Credit Union Administration (NCUA); the director of the Federal Housing Finance Agency (FHFA); the director of the Consumer Financial Protection Bureau (CFPB); and an independent member knowledgeable about insurance appointed by the President and confirmed by the Senate for a term of six years. The five FSOC non-voting members are the directors of the Federal Insurance Office and the Office of Financial Research, both of which were created by Dodd-Frank. An additional three delegates to FSOC that serve terms of two years were to be selected by organizations of state insurance commissioners, banking supervisors and securities commissioners.

FSOC reported on July 26, 2011, that the nation still faced systemic risks. In particular, it was concerned with the repo market that had caused liquidity problems at major firms like Bear Stearns and Lehman Brothers during the Financial Crisis of 2008. In 2013, FSOC warned again that the tri-party repo market was still vulnerable. Lenders could touch off another run and dry up liquidity in that market if a large broker-dealer failed. That was problematic because many broker-dealers relied heavily on repos for short-term funding. FSOC also filed a number of reports ordered by Dodd-Frank on such things as the effects of the size and complexity of financial institutions on market efficiency, contingent capital requirements for certain non-bank financial companies, efficacy of the regulation of corporate credit unions by the NCUA and concentration limits on large financial companies.

FSOC pressured the SEC to adopt reforms for money market funds. Those funds had exacerbated the Financial Crisis of 2008 when some “broke-the-buck” by trading at less than the amount invested. An SEC study revealed that money market funds had been bailed out some 300 times by their sponsoring companies between 1970 and 2012. Among the regulations considered by the PWG in the wake of that crisis was for the money market funds to have a floating net asset value (NAV), rather than the traditional stable $1 redemption price. Another proposal considered by FSOC was for the money market funds to set aside a reserve for daily price fluctuations. The SEC later adopted rules that required institutional prime money market funds to “float” their NAV but allowed other “stable” money market funds to keep their NAV at $1....

Table of contents

• Cover
• Half Title Page
• Series Page
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• About the Author
• List of Illustrations
• List of Abbreviations
• Preface
• Acknowledgments
• Introduction
• Part I The Aftermath of the Financial Crisis
• Part II Post-Financial Crisis Regulatory Actions
• Part III Trump Administration (2017–2020)
• Conclusion
• Notes
• Selected Bibliography
• Index