As shown in the previous 3 articles on the event (Parts 1, 2 and 3), the 2008 financial crisis was nothing short of the worst economic disaster in modern times, and certainly one of the worst in history. Such catastrophic circumstances call for a rapid and profound response. Governments, through extensive economic measures, countered with a herculean effort dedicated to helping their economies get back on track.
These recovery policies can be roughly broken down into 4 categories:
Stimulus programs
The purpose of these policies was to provide the economy with urgent support, usually just enough to prevent it from completely collapsing. As such, many of these policies were enacted in the immediate aftermath of the stock market crashes and bankruptcy declarations. Among these were as follows:
2008 European Union stimulus plan: A total of 200 billion euro ($258.7 billion USD), this 2-year long plan involved, among other things, prompted European Central Bank (ECB) to lower interest rates, for member states to extend (and if need be, expand) their unemployment benefits and to increase their fiscal spending as a means of economic stimulus. Most EU countries spent around around 1-2% of their GDP but a select few had to spend a whole lot more, such as Spain who dedicated a whopping 8% of their GDP (90 billion euros) to the recovery
Chinese economic stimulus program: Over doubling the EU’s spending bill, the CCP set aside RMB¥ 4 trillion ($586 billion USD) towards their economy’s restoration. The areas in which all these funds ended up in were varied to say the least - almost everything from rural infrastructure to housing were key areas of investment. Although the plan was generally seen as a success - GDP growth recovered from -6% in Q4 2008 to 8% in Q1 2009 - critics have blamed it for the country’s surging debt since its implementation
Economic Stimulus Act of 2008: This enactment, unlike the previous 2, didn’t necessarily inject money into the economy per se, but more so initiated a series of tax rebates, which are essentially just refunds for taxes you’ve already paid. Eligible taxpayers received $600 each ($1200 if married filing jointly) plus an additional $300 for each of their dependent children under the age of 17. Moreover, the policy restructured existing tax incentives in order to propel business investment and increased the limits on the mortgages that government-sponsored enterprises such as Fannie Mae and Freddie Mac could purchase. All in all, around $152 billion USD was spent
American Recovery and Reinvestment Act of 2009: Ratified by the recently-elected President Obama in February of 2009, this stimulus package was far more extensive than President Bush’s 2008 stimulus. A grand total of $831 billion USD was allocated for the American Recovery and Reinvestment Act of 2009. The primary goal was to protect existing jobs and create new ones as soon as possible, as well as providing aid to those most affected by the recession. This was accomplished through tax incentives for both individuals and companies, extended unemployment benefits, increased Medicaid funding - the package followed through basically every available avenue in working towards its original goal
Bailouts
The rationale for the bailouts in the aftermath of the 2008 financial crisis can be mainly attributed to the “too big to fail” doctrine.This theory posits that certain companies, particularly those involved in finance, are so large and interconnected to the country’s economy that their failure could be the catalyst to a much larger economic crisis. It was believed that it could be so catastrophic, that for the greater economic good, the company simply cannot be allowed to fail. As such, if they were to be on the verge of bankruptcy, then government support in the form of bailouts - where the government provides for the business in order to prevent it from going under - is required.
It goes without saying that these policies are quite controversial among both policy makers and the general public. Supporters say that bailouts in the case of the 2008 recovery especially was a necessary evil, while critics argue that the very possibility of bailouts created a moral hazard for the banks - a situation where someone engages in more risky behavior because they know they wouldn’t have to bear the full consequences of their actions if things went sour.
The Troubled Assets Relief Program (TARP) was the main bailout project in the United States. It was proposed by Treasury Secretary Hank Paulson and authorized via the Emergency Economic Stabilization Act of 2008, allowing the Treasury to buy up to $700 billion USD (later reduced to $475 billion) in bad assets and thus increase liquidity (how easily an investment can be turned into cash) in American financial markets. Investment banks such as Goldman Sachs, Morgan Stanley, and JP Morgan, among others, were the main beneficiaries of TARP, receiving billions in stock purchases from the US Treasury. Bank of America and Citigroup, however, sold $118 billion and $306 billion, respectively, in decayed assets to the Treasury.
The UK passed a similar bailout package of around £500 billion, but unlike TARP, Her Majesty’s Treasury approached the issue via purchasing shares of and providing loans to the affected banks (which included Barclays, HSBC, and Standard Chartered) rather than relieving them of toxic assets.
Quantitative easing
When central banks “print money”, it is done so for the purpose of that money being injected into the economy to spur activity. But exactly how does that happen? Quantitative easing (QE) is where the central bank purchases large amounts of government bonds (or really any kind of assets bought and sold on the open market), hence infusing all that money into the rest of the economy.
The response to the 2008 financial crisis saw the surge of QE policies across the developed world, with central bank balance sheets (the total assets being held by the central bank) being dramatically increased as a means of getting liquid cash into the economy. At its peak in June 2010, the Federal Reserve held $2.1 trillion USD in bank debt, mortgage-backed securities, and Treasury notes (bonds issued by the US Treasury with a fixed interest rate and a maturity period of up to 10 years). This was later referred to as QE1.
QE2 commenced in November 2010, when the Fed announced that they’d be purchasing $600 billion USD in Treasury securities. QE3, beginning in September 2012, consisted of a $40 billion per month spending program of agency mortgage-backed securities (the ones created by government agencies). The monthly budget was increased to $85 billion 2 months later, and then lowered to $65 billion in June 2013. The program was put to an end in October 2014; $4.5 trillion in assets ended up being accumulated.
The UK proceeded with QE in a similar fashion. The Bank of England purchased around £175 billion in assets by October 2009. 2 years later, another round of QE involving £75 billion was announced, with a third and fourth round each consisting of an additional £50 billion starting in February and July 2012, respectively.
Regulatory responses
As complex and cataclysmic as 2008, arguably the most important part of the response was to ensure that it won’t happen again. Doing this would mean implementing systemic changes especially in regards to regulation. The key policy in this sense was the Dodd-Frank Wall Street Reform and Consumer Protection Act. President Barack Obama described it as a “sweeping overhaul of the United States financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression.”
With the entire thing being categorized into 16 titles, he probably wasn’t wrong. It goes without saying that going through all the provisions would take forever, so here are really the only 2 things you need to know about Dodd-Frank:
Re-implemented various regulations on America’s financial sector and introduced stricter rules on at-risk areas such as mortgage-lending, investment banking and derivatives. Essentially undoing as much as possible the deregulation that occurred in the decades leading up to the crisis
Expanded the powers of financial regulators such as the US Securities and Exchange Commission (Wall St police, enforces law against market manipulation) and the Federal Deposit Insurance Corporation (prevents bank runs by providing insurance for bank deposits) as well as establish entirely new departments such as the Financial Stability Oversight Council (FSOC), a federal agency tasked with identifying and checking up on risky behavior in the US financial sector. That way, the next time investment banks decide to build up worthless MBSs in their portfolio, the FSOC would be able to at least recommend a course of action to be taken
Econ IRL
It’s no secret that managers are by far among the top income earners and increasingly so in the last 40 years. The reason, however, is because managers (at least the successful ones) end up making other workers more productive, increasing the firm’s profitability and in turn the manager’s value to the firm. But the question of why certain firms are large (thus having more market power) and productive remains rather unanswered. This week’s paper notes an interesting correlation - the rise in market power over the last 4 decades was accommodated with a rise in manager pay, which raises the big question of whether managers are paid for market power.
The authors divide manager pay into 2 components: firm size and market power. They find that how managers are compensated is relatively even between those 2 factors, with 45.8% of manager pay being attributed to market power and the remainder as a result of firm size. Between 1994 and 2019, the years covered by available executive compensation data, 57.8% of the growth in pay is due to corresponding growth in market power. Thus, there is a clear relationship between manager pay and the market power of the firm they work at.
‘Till next time,
SoBasically