Your $3 trillion bailout

Washington is waging war on the financial crisis. Mr. Obama: You have to see it through.

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By David Goldman, staff writer

What should be President-elect Obama's first economic priority?
  • Creating jobs
  • Solving the Wall St. crisis
  • Cutting taxes
  • Reducing spending

NEW YORK ( -- Congratulations Mr. President-elect. Now get to work. It's a little more than 10 weeks until Jan. 20, and there's an economy in dire need of fixing.

Here's the executive summary: The economy's cracks started showing a year ago. Home prices plummeted and foreclosures soared. Financial institutions carrying mortgage-backed securities on their books took an enormous hit. Banks wanted to take fewer risks, so lending to businesses and consumers froze up.

Then things really broke down in September. The government took over mortgage giants Fannie Mae and Freddie Mac. The collapse of Lehman Brothers sent investors worldwide into a cold sweat.

To combat the crisis, Congress and the current administration have taken a number of steps aimed at boosting the housing market - providing critical liquidity to financial institutions and saving businesses from collapse.

Thus far, the government has pledged as much as $3 trillion for the crisis, although the ultimate cost to the federal budget won't be known for years to come since much of that money is effectively investment.

"You'd have to go back to the New Deal to find something similar to what the government has done to stop the credit crisis," said Jay Bryson, economist for Wachovia. "It's because the alternative was unthinkable: If it failed, there was potential for another Great Depression."

So, Mr. President-elect, we thought it might be helpful for you to have a primer on the actions your government has taken so far. Of course, you have plenty of smart advisers who could have done this for you. But we wanted to make sure you hit the ground running. We counted 16 separate categories of actions.

Consumers and their homes

Stimulus: In May, stimulus checks worth up to $600 for individuals and $1,200 for couples made their way to about 140 million American tax filers, costing the Treasury $100 billion for individuals and $68 billion in tax breaks to businesses. In separate legislation, Congress increased unemployment benefits to 39 weeks from 26 weeks, costing $8 billion, and gave $4 billion to states and municipalities to buy up and rehabilitate foreclosed properties.

Stimulus resulted in a sizeable increase in consumer spending in May and June, helping the economy grow 2.8% in the second quarter. But the boost didn't last long, and early government reports show the economy shrank from July through September. Support for a second stimulus package is mounting.

Fannie Mae and Freddie Mac: In early September, Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) were on the brink of failure, having racked up nearly $12 billion in losses from declining home prices, mortgage delinquencies and foreclosures.

Federal officials assumed control of the firms and the $5 trillion in home loans they back. The Treasury put up as much as $200 billion to bail them out and placed them in a temporary "conservatorship" overseen by the Federal Housing Finance Agency.

Housing benefits: With foreclosures soaring, lawmakers in July passed legislation that insured up to $300 billion in new 30-year fixed rate mortgages for at-risk borrowers. In turn, lenders had to reduce the loan balances. The bill also included $16 billion in tax credits for first-time home buyers worth up to $7,500. The law put stronger regulation on Fannie and Freddie, and increased the cap on the size of mortgages guaranteed by the firms to $625,000 from $417,000.

In September, the government allowed the Treasury to buy up mortgages and mortgage-backed securities, so it can try to restructure the loans. The Treasury said it hopes to prevent foreclosures by reducing loans' principals or interest rates.

Money-market guarantees: When the credit crisis hit full tilt in September, investors fled money-market funds - long considered the safest investments - and the funds began to buckle. Days later, the Treasury said it would insure up to $50 billion in money-market fund investments for a year.

The Fed began to lend an unlimited amount of money to banks to finance their purchases of certain corporate debt from money-market funds. The Fed then agreed to purchase up to $69 billion in short-term debt from key money-market investments. Then, in October, the Fed said it would loan up to $600 billion directly to money-market funds through a Money Market Investor Funding Facility to keep the funds afloat.

Student loan guarantees: As a result of reduced subsidies and lower rates from the government, as well as higher borrowing costs due to the credit crisis, student loans became unprofitable for a number of lenders in the spring. Scores of lenders stopped issuing the loans, causing a student loan crisis.

In May, Congress passed legislation that gave the secretary of education authority to purchase loans from private lenders to boost liquidity in the market, and has thus far purchased over $9 billion of the loans. The Fed also started accepting student loan-backed securities as collateral for loans.

Deposit insurance: As part of the financial rescue plan passed in September, The FDIC increased its insurance protection on interest-bearing accounts to $250,000 from $100,000. The temporary limit increase will last through the end of 2009.

In an unprecedented move, the FDIC also said it will guarantee newly issued unsecured debt for banks through the end of January, and it removed caps on insurance for non-interest bearing accounts, which many small businesses use to make short-term deposits.

Banks and Wall Street

Cash injections: With financial institutions desperate for liquidity, the Treasury has sent out about $250 billion worth of checks to banks. In turn, the government will get an equity stake in the banks in the form of senior preferred shares.

Regulators hope that the capital injections will spur lenders to dole out loans to consumers and businesses in need of credit. But some of the biggest, most stable banks got the biggest checks. For instance, JPMorgan Chase (JPM, Fortune 500), Citigroup (C, Fortune 500) and Wells Fargo (WFC, Fortune 500) led the pack with $25 billion in federal funding. Smaller banks are getting far less, and,some banks are using their loans to purchase smaller banks.

Mortgage-backed securities purchases: When the government's rescue plan was first proposed, the major initiative was the purchase of troubled assets from banks. In the wake of the housing crisis, assets backed by mortgages have plummeted in value, making lenders hesitant to lend to companies with "toxic" assets on their balance sheets.

But, following Britain's lead, the Treasury instead focused on cash injections. The Treasury has more than $450 billion left to invest with or buy up troubled assets, and it may use some of the remaining money for that program.

Bear Stearns: When struggling Wall Street investment bank Bear Stearns was on the brink of collapse in March, the Federal Reserve orchestrated an 11th-hour deal that allowed JP Morgan to scoop up the company.

The Federal Reserve agreed to guarantee $29 billion's worth of potential losses on Bear's portfolio through a lending facility. The government decided to step in to stop Bear's collapse because it feared the rest of Wall Street would face a severe negative impact.

Rate cuts: Beginning in September 2007, the Federal Reserve began steadily trimming interest rates from 5.25% to 1%, matching the lowest for the overnight bank lending rate ever. The fed funds rate is used to set rates for a wide variety of consumer loans, including home equity lines and credit cards, as well as for many business loans.

By lowering its rate, the Fed said it hopes to encourage lending, easing the recent stranglehold on credit. Though rate cuts tend to be inflationary, Fed Chairman Ben Bernanke said the threat of inflation is minimal now due to the stagnant economy.

Term-auction facility: Since December, the Fed has auctioned off $1.4 trillion in its term auction facility, which accepts financial instruments such as mortgage-backed securities as collateral for lending. The Fed began offering $20 billion per bimonthly auction and has since increased that limit to $300 billion.

Holding droves of hard-to-value assets like mortgage-backed securities, financial institutions have found few lenders other than the federal government, because the unattractive assets on banks' balance sheets raise questions about their overall financial stability.

Discount window: For a long while before the credit crunch, the Fed has offered overnight funding for commercial banks at a rate slightly higher than its targeted funds rate. But after the collapse of Bear Stearns, the Fed for the first time opened its discount window to Wall Street firms like Goldman Sachs and Morgan Stanley, which were in dire need of lending. The discount window has been widely used, as funding needs for commercial banks continue to rise.

Last week, banks borrowed a record $112 billion from the Fed through the discount window. But in an encouraging sign, investment banks have borrowed much less for two straight weeks.

Dollar swap lines: The credit crunch left many banks around the world hoarding dollars to shore up their balance sheets. With dollars -- the "world's currency" -- in demand, the Fed began in December to provide dollars to other central banks through a swap facility. Foreign central banks then lent those dollars to banks in their countries.

What started as a $24 billion cap on swaps with the European Central Bank and the Swiss National Bank ballooned to $620 billion to nine central banks in early October. In mid-October, the total rose to 13 central banks, and the Fed made the unprecedented decision to lend as many dollars as the banks needed.

Bank takeovers: The Federal Deposit Insurance Corp. recently said 117 banks were on its so-called "troubled" list -- a 5-year high -- but there have been just 17 bank failures in 2008.

The FDIC, which insures certain deposits, came out relatively unscathed, as 16 of those banks were acquired by other banks willing to assume their deposits and assets. Even Washington Mutual - by far the largest failed bank in history - was acquired by JP Morgan Chase. Just IndyMac failed without a buyer. The total cost to the government is not yet known, but IndyMac had $32 billion in assets and around $19 billion in FDIC-insured deposits at the time of failure.

Corporate America

AIG: American International Group (AIG, Fortune 500), the world's largest insurer with $1.1 trillion in assets and 74 million clients, said in mid-September that it could not raise sufficient capital to stay afloat. The government offered an $85 billion loan to the company, and in subsequent weeks the Fed offered another $37.8 billion.

The insurer has already borrowed more than two-thirds of its allotment. Though it is paying back the original $85 billion at a high rate -- currently more than 11%, the company recently announced that it paid back $20.9 billion of its debt using the Fed's low-interest commercial paper facility -- with rates at less than 4%.

Automakers: With fuel prices soaring to record highs earlier in the year, lawmakers gave $25 billion in low-interest loans to the struggling auto industry to speed its transition to more fuel-efficient vehicles. Sales at General Motors Corp. (GM, Fortune 500), Ford Motor Co. (F, Fortune 500) and Chrysler are down 20% this year.

About 2 million industry jobs are at stake, and tens of billions of dollars in automakers' debt are held by Wall Street firms and banks. GM and Chrysler said a merger between the two companies could help them stay afloat, but the Treasury told the companies in October they'd have to wait until after the election to be considered for funding.

Commercial paper facility: Since Lehman's collapse the market for commercial paper dried up. Big businesses and financial institutions sell the critical short-term debt to finance day-to-day business operations, but they were finding no buyers.

Beginning in late October, the Fed began buying droves of corporate debt through its so-called Commercial Paper Funding Facility. So far, the central bank has purchased $143.9 billion in paper. The Fed's actions have been criticized by some analysts who believe the facility doesn't address the sellers of lower quality paper, who have suffered the most since the credit crisis put a stranglehold on lending.

Did you vote for Obama? How do you think the new president will affect your wallet? What do you think Obama needs to do to fix the economy - both in the short run and the long term? What should be first on the new Congress's agenda? E-mail us your thoughts, including your name, photo and contact info; the best answers will be featured in an upcoming article. To top of page

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