Damage Control or Damage Creation? The Federal Response to Frozen Financial Markets.

1. Damage Control or Damage Creation? The Federal Response to Frozen Financial Markets. April 24, 2009 Department of Economics University of Kansas Jeffrey Wrase Chief Economist, Senate Republicans Joint Economic Committee All views expressed in this presentation are those of Jeff Wrase and not necessarily those of the Joint Economic Committee or any member of Congress.

2. 1. Output has fallen significantly (-6.3% annualized rate of GDP decline in Q4)

3. 2. Consumer spending has declined recently (largest declines since early 1980s)

4. 3. Household Wealth Down

5. 4. Personal Saving Up

6. 5. Gas Prices ($4/gallon = a Tipping Point?)

8. 7. Growth in exports was more than enough to offset the drag from residential investment declines in the recent past, until last quarter

9. 8. Payroll employment has declined by 5.1 million jobs in the past 15 months, with over one-half of those losses occurring in the past five months

10. 9. The unemployment rate has risen precipitously—for example, to 8.5% in March from 5.1% a year earlier and a near-term low of 4.4% in March 2007

11. 10. Financial indicators showed severe stresses in markets, especially immediately following the collapse of Lehman Brothers—stresses have eased in many segments of markets over time, given policy actions

12. 11. TED Spread

13. 12. Credit costs spiked up, and availability declined markedly, following the collapse of Lehman (this hits main street, as businesses found it hard to finance operations, including payrolls)

14. 13. “Flights to quality,” or “flights to safety,” have driven yields on Treasury securities down to very low levels

15. 14. Deflation fears?

16. 15. Much of the economic and financial difficulties began with deterioration of the housing sector

17. 16. With declines in home sales, inventories of available housing units have risen (well above the long-term average of around six months)

18. 17. And builder activities have declined in response (including large declines in employment in the construction industry)

19. 18. The bursting of the housing bubble around the beginning of 2006 can be seen in indexes of home prices. Declining home prices means: lower household wealth; more mortgagees “underwater” and more defaults; disappearance of the “housing ATM” and consequently lower consumer spending

20. 19. Declining home values has, along with deterioration in the economy and employment, led to increases in mortgage foreclosures (especially for subprime, adjustable-rate mortgages)

21. 20.

22. 21. Federal Reserve responses

23. Fed responses (continued)

24. Fed responses (continued)

25. Fed responses (continued)

26. Fed responses (continued)

29. 22. Treasury response • TARP I • Capital injections in exchange for preferred stock and warrants (allowing Treasury to buy common at a set “exercise price.” • Other stuff (e.g., AIG, Autos) • TARP II (Financial Stability Plan) • Expand Fed’s Term Asset-Backed Loan Facility (in a shift from bank recapitalizations to consumer and other credit) = $100 billion levered to $1 trillion. • Bank Recapitalizations with Stress Tests = amount unspecified • Public/Private Bank = an amount levered up to $500 billion to $1 trillion. • Foreclosure Relief = $50 billion.

30. 23. Fiscal policy response • Roughly $800 billion stimulus bill (over $1 trillion with interest). • Mix of spending (short-term and long-term), aid to states, and tax relief. • Stimulative efficacy of the various components is debatable.

31. 24. Other responses • FDIC • SEC • OCC • OTS • NCUA • FHFA • HUD • FHA • VA • FTC • Oversight • States • International