This May Hurt a Little

Depicted as a doctor, Secretary of the Treasury Henry Paulson gives a “bailout” shot, or capital injection, during the “Great Recession.”
Depicted as a doctor, Secretary of the Treasury Henry Paulson gives a “bailout” shot, or capital injection, during the “Great Recession.”

In the wake of dramatic financial deregulation (e.g. the repeal of the Glass-Steagall Act, see McDonald) that occurred in the late 20th century, questionable financial practices (e.g. over-the-counter derivatives, see Beers) and outright corruption (e.g. the Credit Rating Controversy, see CFR Staff), were abundant in many companies on Wall Street. Due to loose lending/borrowing practices, many credit rating companies that were in charge of analyzing bank’s credit and checking eligibility for loans, failed to oversee many banks on Wall Street. By the Fall of 2007, prices of homes in the US were at their highest, which enabled homeowners to use their property as equity to borrow more and more money. Due to prices of homes being so high, many homeowners applied for loans for homes that actually were out of their price range—a major step on the path towards the subprime loan crisis. A subprime loan is “a type of loan offered at a rate above prime to individuals who do not qualify for prime rate loans” (Investopedia). They were given to “borrowers with impaired credit records” because such borrowers were turned away from traditional lenders (CFPB). These loans had higher interest rates compared to the normal rate for conventional loans. Giving subprime loans was “intended to compensate the lender for accepting the greater risk in lending to such borrowers” (CFPB).  As the use of subprime loans continued, an economic downturn began when bad accounting and poor management of investment banks and other institutions were revealed among many companies on Wall Street.

Known as the “Great Recession,” it was the most “severe, prolonged economic downturn” the US had experienced since the 1930’s (Rouse). Secretary of the Treasury, Henry Paulson (2006-2009), was called in to aid the failing financial system. Paulson, with the help of the Chairman of the Federal Reserve, Ben Bernanke (2006-2014), oversaw several forms of bailout, including the $700 billion Troubled Asset Relief Program (TARP). Contrary to his conservative economic philosophy, circumstances forced Paulson to implement capital injections into big banks, to bring America out of its financial crisis.

By early Spring of 2008, many homeowners had accrued so much debt that they were not able to pay their mortgages anymore. As mortgages became too high, many people were forced to foreclose their homes, which led big financial institutions to stop buying mortgages. Big institutions such as the banks, Bear Stearns, and Lehman Brothers, and the insurance company, American International Group, or AIG, were “too big to fail;” if they failed the rest of country was at major risk of an economic downfall.

Paulson dealt with many dilemmas, including “moral hazard,” “the idea that a party protected in some way from risk will act differently than if they didn’t have that protection” (Beattie). Institutions were held to the standard, that if they are bailed out, they were not going to be bailed out again. The bailed-out companies were expected to learn from their mistakes, rather than make that mistake again. Paulson was also in charge of the Troubled Asset Relief Program, or TARP, which purchased “troubled companies’ assets and equity” for $700 billion” (Investopedia). However, along with many other conservatives, the Secretary of Treasury could not have been any more against TARP. He was a firm believer in the government refraining from intervention, and TARP did just that. Along with the use of TARP, the highly debated capital injections were implemented. Again, although very against it, Henry Paulson infused capital injections into banks, which was “an investment of capital into a company,” in return, the government would own stock in their company (Investopedia).

Warnings about a possible recession were given many times before by Brooksley Born, Chairman of the Commodity Futures Trading Commission (1996-1999). Born knew that Wall Street’s lack of regulation and over-the-counter derivatives were causing a threat to the American public (Beers). Over-the-counter derivatives were “private contracts that [were] traded between two parties without going through an exchange,” therefore posing a credit risk for many companies due to the absence of a clearing corporation (Beers). Alan Greenspan, the former Chairman of the Federal Reserve (1987-2006), refused to believe what Born had brought to the table. Greenspan’s unwillingness to believe Born would be our country’s biggest mistake.

Before the stock market crashed in 2008, unemployment was at its highest, peaking at “10 percent,” which was just “15 percent less than that of the Great Depression” (Horton). In the housing sector, supply and demand was uneven, meaning more houses were on the market than there were buyers. This caused commercial and investment banks to suffer large from the loss of payments from their borrowers.

Goldman Sachs’ former CEO, Henry Paulson, was Secretary of Treasury, while Ben Bernanke, expert on the Great Depression, was Chairman of the Federal Reserve during the recession. Bernanke and Paulson were called in to combat the panic on Wall Street. They both knew that something needed to be done immediately, but how were they going to do it? Bear Stearns was their first item of business. On March 10, 2008, Bear Stearns, one of the smallest investment banks on Wall Street, could not open for business due to lack of financial capital (Inside the Meltdown). Bernanke and Paulson agreed that the Federal Reserve was not going to interfere with banks by aiding them with money, but money was what Bear Stearns needed desperately. Bernanke was able to find a way to provide the funds to assist Bear Stearns. He persuaded JP Morgan and the Federal Reserve Bank to give secure funding to Bear Stearns, which almost immediately backfired. Other banks did not like that Bear Stearns was given money and they weren’t. Despite the bailout, Bear Stearns was back to normal for just seven days before shutting down permanently.

After Bear Stearns shut down, came the ethical concerns associated with moral hazard and the rapid decline of the economic system. Moral hazard entailed, if the government bailed out a corporation, what incentive would they have to not make that mistake again? The administration of Bernanke and Paulson was “accused of allowing the creation of moral hazard risk from its bailout of Bear Stearns” thus “raising expectations that other firms facing failure would also be bailed out” (Markham). Therefore, Bernanke issued a warning to Wall Street that they were not to loan money to any other banks.

Almost a week later, on March 17, 2008, Lehman Brothers, the “fourth largest investment bank in the United States,” went into bankruptcy, this signaled the coming of the largest financial crisis since the Great Depression (Horton). Paulson, exhausted and under immense political pressure, was searching for a buyer for Lehman Brothers. The problem was that no banks wanted to lend to another bank for fear they would not get paid back. Bankruptcy was a certainty and the government wasn’t going to intervene any further. After Lehman Brothers went into bankruptcy, Wall Street froze, and the pressure to solve the economic decline returned (Kessler).

In September 2008, AIG, the largest insurance company on Wall Street, was next to call for Paulson and Bernanke’s help. AIG did not have enough money in the bank to honor the commitments they had made with their clients (Manning). Their crisis was so severe that members of Congress were brought in to help Bernanke and Paulson. They came to the decision to save AIG by bailing them out from the US government with over $183 billion (Manning). After the efforts given to save Wall Street’s largest corporations, many believed the government was reacting but not acting (Manning). With the criticism of the government’s lack of intervention, Bernanke then called in Paulson to explain that it was time for them to do something more direct; something that would hit all investment banks.

Bernanke and Paulson went to a congressional leadership meeting held at Capitol Hill to deliver the news. Paulson told Congress that, “Unless you act, the financial system of this country and the world will melt down in a matter of days” (Inside the Meltdown). Paulson brought the Emergency Economic Stabilization Act of 2008, to Congress that stated he needed $700 billion from taxpayer dollars “to be used to buy the kinds of toxic mortgage securities that were creating so many problems for the banks” (Inside the Meltdown). Moreover, those funds were needed in a matter of days. Capitol Hill was furious, “It was an unprecedented, unaffordable and unacceptable expansion of federal power” (Inside the Meltdown). Thus, when the House voted on the bill, it failed, leading to an immediate and dramatic drop in stock prices.

After the act failed, the idea of capital injections came into play. Capital injections entailed inserting “billions of dollars into ailing banks in order to boost confidence and unfreeze credit” (Inside the Meltdown). There were insiders in Congress who liked the idea and believed it was what they needed to save the banks. Authorization of capital injections was added into the Emergency Economic Stabilization Act of 2008, but Paulson could not have been any more against it. The bill passed, and Paulson reluctantly had to “step in directly with government capital” (Inside the Meltdown).

Due to the act passing, Bernanke and Paulson had to sit down with executives from the top banks on Wall Street at the time, such as Wells Fargo, Bank of America, and Goldman Sachs. Paulson told them he would be giving each bank tens of billions of dollars in return for the government being a major stockholder in their companies; “Paulson would spend $125 billion that day” (Inside the Meltdown). For Paulson and Bernanke, government intervention was not morally right, but it was their only option. Along with enforcing capital injections, the Troubled Asset Relief Program (TARP) was created to make up for lost capital in banks.

Against Paulson’s beliefs, he was assigned as head of TARP, which “stabilize[d] the country’s financial system, restore[d] economic growth, and mitigate[d] foreclosures” (Investopedia). It allowed the government to buy stake in banks, in return, companies would lose certain tax benefits, and have limits placed on executive compensation, in order to protect funds being spent. By 2010, Paulson would spend $350 billion to save the financial system.

During the time of the Great Recession, many cartoons were printed in newspapers regarding the 21st century’s worst economic crisis. For example, in Gary Varvel’s cartoon above, Paulson is depicted as a doctor giving a shot with the term “bailout” written on it. Varvel incorporated a humorous play on the word injection, by creating a parallel image between government intervention and a shot.  Paulson is shown saying “this may hurt a little,” meaning not only the pain of a needle but portraying a poke at the government’s administrations ego and outlook. There is a play on words with capital injection, by the word “injection” being represented as a needle to symbolize companies getting a shot of capital “bailout,” as an immediate cure to the failing financial system.

The cartoon by Gary Varvel resonates with the 1930s’ era cartoon titled, “What This Congress Needs,” published in the Dallas Morning News (Knott). These cartoons depicted the main influencers during the time of the major financial crises: President Herbert Hoover and Secretary of the Treasury, Henry Paulson. Knott’s cartoon and the accompanying editorial, “Mr. Hoover Reproves,” discussed saving America’s economy and the efforts needed in order to end the financial crisis (Dallas Morning News). Varvel’s cartoon about capital injections related to Knott’s cartoon, “What This Congress Needs,” by showing how each era was in desperate need of funds and the efforts gone to preserve these funds. Both men depicted in the cartoons were harshly criticized by their peers and the people of America for their efforts in aiding their country.

The “Great Recession” was unlike anything America had seen since the Great Depression of the 1930’s. When banks started to have lack of regulation and poor accounting, it caused the beginning of the financial crisis on Wall Street. Sadly, had the advice of Brooksley Born been applied earlier on, the disaster could have been avoided. Rather than being prevented, however, the Great Recession had begun when an influx of homeowners received such large loans that they were unable to pay the banks back. Henry Paulson and Ben Bernanke did everything in their power to bring America’s finances back to normal, by loaning funds, establishing bills, and injecting capital into companies. As shown in Knott and Varvel’s cartoon’s, the efforts given in order to fix the failing financial system were actions Hoover and Paulson thought were necessary for the United States. Hoover and Paulson had many different successes and failures during their terms in the US government. Their efforts have given modern-day government an outlook on how to avoid and handle another disastrous stock market crash.

 

Works Cited:

Beattie, Andrew. “What Is Moral Hazard?” Investopedia, Investopedia, 3 Jan. 2018, www.investopedia.com/ask/answers/09/moral-hazard.asp.

Beers, Brian. “What Is an Over-the-Counter Derivative?” Investopedia, Investopedia, 2 Apr. 2018, www.investopedia.com/ask/answers/052815/what-overthecounter-derivative.asp.

CFR Staff. “The Credit Rating Controversy.” Council on Foreign Relations, Council on Foreign Relations, www.cfr.org/backgrounder/credit-rating-controversy.

Horton, Ron. “The Great Recession.” St. James Encyclopedia of Popular Culture, edited by Thomas Riggs, 2nd ed., vol. 2, St. James Press, 2013, pp. 541-543. Gale Virtual Reference Library, http://link.galegroup.com.ezproxy.lib.utexas.edu/apps/doc/CX2735801140/GVRL?u=txshracd2598&sid=GVRL&xid=87cd5064. Accessed 12 Apr. 2018.

“Inside the Meltdown.” Frontline, produced by Michael Kirk, Jim Gilmore, and Mike Wiser, PBS, 2009.

Investopedia. “Subprime Loan.” Investopedia, Investopedia, 22 Feb. 2018, www.investopedia.com/terms/s/subprimeloan.asp.

Kessler, Andy. “What Paulson is Trying to Do.” The Wall Street Journal. 2008. Factiva. https://global-factiva-com.ezproxy.lib.utexas.edu/ha/default.aspx#./!?&_suid=152528787598900347533194525429.

Manning, Robert D., and Anita C. Butera. “Consumer Credit and Household Debt.” Encyclopedia of Contemporary American Social Issues, edited by Michael Shally-Jensen, vol. 1: Business and Economy, ABC-CLIO, 2011, pp. 33-45. Gale Virtual Reference Library, http://link.galegroup.com.ezproxy.lib.utexas.edu/apps/doc/CX1762600011/GVRL?u=txshracd2598&sid=GVRL&xid=635eef03. Accessed 16 Apr. 2018.

Markham, Jerry W. “The Crisis Begins.” A Financial History of the United States, vol. 6: From the Subprime Crisis to the Great Recession (2006-2009), M.E. Sharpe, 2002, pp. 473-523. Gale Virtual Reference Library, http://link.galegroup.com.ezproxy.lib.utexas.edu/apps/doc/CX1723800208/GVRL?u=txshracd2598&sid=GVRL&xid=5e26353e. Accessed 15 Apr. 2018.

McDonald, Oonagh. “The Repeal of the Glass-Steagall Act: Myth and Reality.” Cato Institute, 16 Nov. 2016, www.cato.org/publications/policy-analysis/repeal-glass-steagall-act-myth-reality.

“Moral Hazard.” International Encyclopedia of Organizational Studies, edited by Stewart R. Clegg and James R. Bailey, vol. 3, SAGE Publications, 2008, pp. 917-919. Gale Virtual Reference Library, http://link.galegroup.com.ezproxy.lib.utexas.edu/apps/doc/CX2661400320/GVRL?u=txshracd2598&sid=GVRL&xid=7d7982a8. Accessed 15 Apr. 2018.

Rouse, Margaret. “What Is Great Recession (Great Recession)? – Definition from WhatIs.com.” SearchCIO, Mar. 2012, searchcio.techtarget.com/definition/The-Great-Recession.

“The Warning.” Frontline, produced by Michael Kirk, Jim Gilmore, and Mike Wiser, PBS, 2009.

“What Is a Subprime Mortgage?” Consumer Financial Protection Bureau (CFPB), 24 Feb. 2017, www.consumerfinance.gov/ask-cfpb/what-is-a-subprime-mortgage-en-110/.

Varvel, Gary. “This May Hurt a Little.” 28 September 2008. Found, Cartoonist Group, 20 April 2017,  http://www.cartoonistgroup.com/store/add.php?iid=26948