The Economic Collapse of 2008, Term Paper Example

The economic collapse of 2008 resulted in a U.S. financial bailout issued by the United States government. Many of the factors leading to a perceived need for the financial bailout and the economic concepts believed to improve the economy through the use of the bailout can be attributed to macroeconomic theories. U.S. financial bailout Macroeconomics entails a branch of economics that deals with structure performance, behavior, and decision making within the economy as a whole as oppose to just focusing on individual markets. Macroeconomics involves economies in local, national and global regions (Boyd, Gomis, Kwak, and Smith, 2001). Macroeconomists tract the behavior of aggregated indicators like the price indexes, GDP, and the unemployment rate such as GDP, unemployment rates, and price indexes to understand how the whole economy functions. Macroeconomists develop models to define how financial instruments function, such as unemployment, inflation,  output, trade, investment, consumption, and international finance (Boyd, Gomis, Kwak, and Smith, 2001). Microeconomics differs from macroeconomics in that microeconomics focuses primarily on individual agents and their actions. Many of the aggregated indicators which macroeconomicst monitor were all dramatically influenced by the economic collapse and some even predicted the event, which resulted in the inevitable U.S. financial bailout. The following will take a deeper look at the U.S. financial bailout and the macroeconomic factors that played a role in its culmination and perceived value as a resolution during trying economic times.

President Bush first announced the details of his financial bailout plan on September 19, 2008. The plan which he called the Emergency Economic Stabilization Act of 2008, was designed specifically as his plan to deal with the financial crisis but was rejected on September 29, upon first evaluation by the U.S. House of Representatives (Reinhart and Rogoff, 2008). On October 1st, the bailout was passed after an extensive amount of lobbying. The bill was amended and resulted in the creation of a $700 billion dollar Troubled Assets Relief Program (TARP) program.  The bailout was structured to counterbalance the adverse affect of the $700 billion Troubled Assets Relief Program (TARP). Businesses in the financial sector, specifically investment and  commercial organizations that invested primarily in credit default swaps and mortgage-backed securities found themselves in a tough situation when the market crashed as investors stopped trading mortgaged backed securities causing financial institutions to not know their true value but assess across the market that they were valued less than their face value. This resulted in a reduction in lending.  The initial TARP plan sought to have the Treasury purchase toxic assets from commercial banks in the hopes that it would incite lending. a majority, had been conducted by the so-called shadow banks, many of those had converted (or were in the process of converting) to commercial bank holding companies, making them eligible for TARP funds. As Evans and authors note in their university study on the U.S. Bailout, “the Treasury intended to buy mortgage-backed securities at a discount from banks, which hopefully would induce banks to start lending again since lenders would know where they stood financially and borrowers would no longer have the taint of toxic assets” (Evans et al., 2009). The plan was to set a finite price for the mortgage back securities, but the price had to be right, somewhere less than the face value but more than the depressed market value.

One major consequence of the plan that arose was that if bank capital fell below the levels mandated by the law, the government would be required to shut down those particular banks. This resulted in banks being hesitant to take on the capital loss that would come with selling mortgaged backed securities to the Treasury for a discounted price as they were willing to wait out the the potential market value rise of the securities (Evans et al., 2009). Banks based this theory on the inability of the market to show real market value of the securities. Evans and authors point out however that due to the fact that accurate information rarely conveyed in a thinly traded market, banks were still reluctant to sell mortgaged backed securities. There was also the issue of corporate culture that made banks unlikely to sell the mortgaged backed securities to the Treasury as they would be viewed as being desperate, which could significantly impact their ability to perform in the financial sector moving forward. Following up with the complexity of implementing TARP the Treasury began working on setting up  TARP II, on October 14th 2008, which sought to setup a $250 billion Capital Purchases Program, or TARP II, a program that enabled banks to sell equity to the Treasury as they saw fit to boost potential capital (Reinhart, Rogoff, 2008). TARP II was equally unsuccessful.

U.S. Bailout under the Obama Administration

The Federal bailout under the Obama administration refocused the bailout back to its initial objective through a Public-Private Investment Program where mortgage-backed securities would be purchased from banks. This proposal, titled  TARP III, as Evans notes (2009), notes  Obama’s new program differed from the initial TARP in that it was structured “to leverage tax revenue by introducing private investment as well as other government agencies, like the Federal Reserve and the FDIC (Evans et al., 2009).  It was anticipated that an estimated $1 trillion of troubled assets could be removed from banks, while enabling the US Treasury to only provide $75 to $100 billion in investments. The main issue presented  by the first TARP was the obligation it placed on banks to sell mortgaged backed securities at a specific price that had to be selected by the government. As the government is not economically savvy enough to identify the necessary price o purchase toxic assets in TARPI, TARP III was able to refocus objectives back to the original goal of TARP I, which was to give the banks the confidence to keep lending by providing them some some minor support for the mortgage backed securities. The authors note that, “the government has no particular expertise at identifying price and that TARP III was structured to get around the pricing issue, through allowing private investors to identify the price” (Evans et Al., 2009). The main reason why private investors were seen as the ideal alternative for supporting the TARP III bank bailout is because they are more experienced with identifying market trends and value than the government.  The authors note that, “the government would finance up to 85% of the investment. The remainder would be covered by half private equity and half US Treasury equity” (Evans et al., 2009). It should also be noted that the government finance worked in the form of the  non-recourse loan, which meant in the case of a default, the government claimed ownership of the buildings. Revenue earned profits were also setup through a 50-50 program with private investors, but still the government would not take on any risk until  all private equity was lost.

In sum, the financial crisis, as a result of banks heavily investing in mortgaged backed securities. Since the adoption of TARP III, banks have been able to increase capital without the sale of bad assets early June 2009, TARP III had produced minimal results and was appearing to be complicated to enact, but financial conditions started to improve from their initial setbacks during the economic crisis throughout the recession. TARP III has proven to be successful at garnering new capital in the market, specifically $100 billion in new capital has been raised. This resulted in renewed investor confidence in the banking system (Evans et al., 2009). As time has progressed, there has been no additional problem with the economy since TARP III was implemented, which has led economists to estimate the economy will return to original conditions.

Work Cited

Boyd, J. H., Gomis, P., Kwak, S., & Smith, B. D. (2001). A user’s guide to banking crises. Manuscript, University of Minnesota.

Evans, J., et. al (2009)   the 2008 financial crisis <Retrieved from>

Reinhart, C. M., & Rogoff, K. S. (2008). Is the 2007 US sub-prime financial crisis so different? An international historical comparison (No. w13761). National Bureau of Economic Research.