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Context of 'March 15, 2008: US Federal Reserve: Bear Stearns ‘Too Big to Fail,’ Makes Billion-Dollar Bailout Loan'

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The United States Federal Reserve has lent Wall Street’s largest investment bank billions of dollars, as the credit crisis threatens to spiral into a full-blown banking crisis. In developments currently rocking the world’s financial markets, the Fed and rival Wall Street bank, JP Morgan Chase, are funneling emergency loans to Bear Stearns, whose exposure to battered credit markets has led to a crisis of confidence in its ability to continue trading. In accelerating numbers, clients and trading partners are pulling business from Bear Stearns, after rumors of its solvency began circulating. During a last-minute conference call with investors, management at the investment bank warned that its emergency lending facility with the Federal Reserve has failed to staunch the bleeding. “We have been subject to a significant amount of rumor and innuendo in the past week,” says Bear Stearns chief executive Alan Schwartz. “We attempted to provide some facts but, in the market environment, the rumors intensified and a lot of people wanted to act to protect themselves first from the possibility that the rumors were true, and wait till later for the facts.” Bear Stearns appears most fragile of Wall Street’s major investment banks, since the July 2007 collapse of two internal hedge funds, providing initial clues about the scale of the unfolding credit crisis. Shares across the banking sector plunge as analysts fear that the Fed’s willingness to intervene suggests that Bear’s future is pivotal to the banking system, and that its failure precipitates losses that may cascade through its trading partners. Bear Stearns stocks are in freefall, closing down 47 percent. Pierre Ellis at New York’s Decision Economics said, “Clearly the Fed is addressing what they feel is a systemic risk very aggressively.” [Belfast Telegraph, 3/15/2008]

Entity Tags: US Federal Reserve, Alan Schwartz, Bear Stearns, JP Morgan Chase, Pierre Ellis

Timeline Tags: Global Economic Crises

Lehman Brothers, the fourth largest investment bank in the US, files for liquidation after huge losses in the mortgage market, a crippling loss of investor confidence, and its inability to find a buyer. Lehman’s collapse began as the mortgage market crisis unfolded in summer 2007, when its stock began a steady fall from a peak of $82 a share. Fears were based on the fact that the firm was a major player in the market for subprime and prime mortgages, and that as the smallest of the major Wall Street firms, it faced a larger risk that large losses could be fatal. As its crisis deepened in 2007 and early 2008, the investment bank defied expectations more than once, as it had many times before, such as in 1998, when it teetered after a worldwide currency crisis, only to strongly rebound. Lehman managed to avoid the fate of fellow investment bank Bear Stearns, which was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy in March 2008 (see March 15, 2008). By summer, however, Lehman’s roller-coaster ride began to have more downs than ups. A series of write-offs accompanied new offerings to seek capital to bolster its finances. [New York Times, 9/16/2008]

Entity Tags: Bear Stearns, Lehman Brothers

Timeline Tags: Global Economic Crises

AIG logo.AIG logo. [Source: American International Group (AIG)]In an historic move, the federal government bails out insurance corporation AIG with an $85 billion loan, giving control of the firm to the US government. After resisting AIG’s overtures for an emergency loan or other intervention to prevent the insurer from falling into bankruptcy, the government decided AIG, like the now-defunct investment bank, Bear Stearns, was “too big to fail” (see March 15, 2008). The US government will lend up to $85 billion to AIG. In return, the government gets a 79.9 percent equity stake in warrants, called equity participation notes. The two-year loan will carry a LIBOR interest rate plus 8.5 percentage points. LIBOR, the London InterBank Offered Rate, is a common short-term lending benchmark. The bailout comes less than a week after the government allowed a large investment bank, Lehman Brothers Holdings Inc., to fold (see September 14, 2008). As part of the loan agreement, Treasury Secretary Henry Paulson insists that AIG’s chief executive, Robert Willumstad, steps aside. Willumstad will be succeeded by Edward Liddy, the former head of insurer Allstate Corp (see September 18, 2008). [Wall Street Journal, 9/16/2008] Shares in AIG drop to $3.75 on the news. [Bloomberg, 3/5/2009]

Entity Tags: Henry Paulson, AIG (American International Group, Inc.), Edward Liddy, Robert Willumstad, US Federal Reserve

Timeline Tags: Global Economic Crises

Henry Paulson, the former secretary of the treasury, explains how the recession and market destruction came about on his watch. Part of his problem was his admitted lack of knowledge about regulation and regulatory authorities. “I easily could imagine and expected there to be financial turmoil,” he says. “But the extent of it, okay, I was naive in terms of—I knew a lot about regulation but not nearly as much as I needed to know, and I knew very little about regulatory powers and authorities. I just had not gone into it in that kind of detail. This’ll be the longest we’ve gone in recent history without there being turmoil, and given all the innovation in the private pools of capital and the over-the-counter derivatives and the excesses around the world, we figured that when there was turmoil, and these things were tested for the first time by stress, it would be more significant than anything else. I said at the time, I have a concern that every rally we’re going to have in the financial markets will be a false rally until we break the back of the price correction in real estate. And these things are never over until you have a couple of institutions go that surprise everyone. Bear Stearns can hardly be a shock (see March 15, 2008). But having said that, it’s one thing to see it intellectually and it’s another to see where we are.” [Vanity Fair, 2/2009]

Entity Tags: Bear Stearns, Henry Paulson, US Department of the Treasury, Bush administration (43)

Timeline Tags: Global Economic Crises

US Treasury Secretary Timothy Geithner announces a much bigger plan to rescue the US financial system than previously predicted or envisioned, including a much greater government role in markets and banks since the 1930s (see March 15, 2008). Although the administration provides few details, one central portion of the plan that investors most desired to learn about creates bad banks that rely on taxpayer and private investor funds to purchase and hold bad assets racked up by the banks from subprime mortgages, derivatives, and credit defaults. An additional focal point of the plan stretches the final $350 billion that the Treasury may use for the bailout, relying on the Fed’s capability to create money. This last tranche of funding allows the government to be involved in the management of markets and banks. For example, with the credit markets, the administration and the Fed propose to expand a lending program that spends as much as $1 trillion as a replacement for the $1.2 trillion decline between 2006 and 2008 for the issuance of securities backed primarily by consumer loans. The third component of the plan gives banks new capital to lend, but banks that receive new government assistance will have to cut the salaries and perks of their executives and limit dividends and corporate acquisitions. Banks must also publicly declare more information about their lending practices. With the newly proposed Treasury requirements, banks will have to give monthly statements on how many new loans they make, yet the plan stops short of ordering banks to issue new loans or requiring them to account in detail for the federal money. The Obama administration’s commitment to flood the banking system with funds will combine the $350 billion left in the bailout fund; the rest of the money will be from private investors and the Federal Reserve. Some market observers, along with some federal legislators and economists, criticize the plan for its lack of details. [New York Times, 2/10/2009]

Entity Tags: Obama administration, US Federal Reserve, US Department of the Treasury, Timothy Geithner

Timeline Tags: Global Economic Crises

Citigroup CEO Vikram Pandit is in talks with the US government to increase the amount of public ownership of the bank in a move both politicians and bank bosses hope will avert the need for the ailing corporation to be taken into FDIC receivership (see March 15, 2008). Talks commenced after Citigroup shares dropped more than 20 percent in late trading on Friday, leaving the business with a share value of $10.6 billion, with balance sheet assets of $1.95 trillion. Government receivership of Citigroup is seen as politically unpalatable, and US taxpayers could conceivably own up to 40 percent of Citigroup. Economists see government takeover of the corporation as evidence of other major banks struggling with insolvency. The failure of major banks will have calamitous repercussions. The US treasury says it remains committed to helping the banking industry recover without taking complete control. “Because our economy functions better when financial institutions are well managed in the private ¬≠sector, the strong presumption… is that banks should remain in private hands,” the Treasury Department said in a joint statement with the Federal Reserve. Speculation that a major Wall Street institution could be taken into public ownership toppled the market on Friday, February 20; likely targets were heavily rumored to be Citigroup and Bank of America. Bank of America lost nearly half its share value in three days before rallying late Friday afternoon. The latest talks center on a Treasury Department proposal to convert preference shares in Citigroup into new ordinary shares. This move would not involve additional taxpayer funds, but taxpayers would surrender the guaranteed dividends that come with preference stock, as well as some degree of protection in the event of a corporate collapse. Serious questions remain, such as the price at which new shares are issued. Estimates of the size of the government’s eventual stake range from 25 percent to 40 percent. With this move, Barack Obama’s administration would become a major presence on Citigroup’s ordinary share register, thus diluting the interests of existing investors, and heightening fears of political pressure being brought on US banks. Some analysts suggest that banks relying on taxpayer bail-outs are being encouraged to focus lending and liquidity on the national US market. [Guardian, 2/23/2009]

Entity Tags: Obama administration, Citigroup, Vikram Pandit, US Department of the Treasury, US Federal Reserve

Timeline Tags: Global Economic Crises

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