We can all probably recite the story by heart at this point. Easy credit terms -- encouraged by a low federal funds rate -- led to a massive expansion of credit in the years leading up to 2007. Major mortgage lenders like Countrywide and Fannie Mae
Meanwhile, investment banks like Morgan Stanley
Then it all came crashing down.
Scene: Dust fills the air, fires rage, and people run through the streets screaming. Out of the chaos step three suit-clad men armed with a simple, yet powerful weapon -- a printing press that can churn out unlimited amounts of money.
The three caballeros take action
In a whirlwind of rapidly drying credit and extreme financial fear, Federal Reserve Chairman Ben Bernanke, former Treasury Secretary Hank Paulson, and current Treasury Secretary Tim Geithner possessed the three sets of shoulders that people all over the world hoped could hold up the U.S. economy during the worst financial crisis since the Great Depression.
The crew's actions were of a magnitude and swiftness unheard of for these normally behind-the-curtains government agencies. The major salvo against deflationary spiral and depression came from the Troubled Asset Relief Program (TARP). Designed to buy troubled assets from at-risk financial institutions, the program was used primarily to inject capital by buying chunks of preferred stock from major financial institutions such as Citigroup
But this was far from the only capital these government magicians summoned. Nearly $610 billion has been spent on mortgage-backed securities from Fannie Mae and Freddie Mac to help bring down mortgage rates. More than $220 billion has been committed to the Term Auction Facility, which allows banks to borrow against hard-to-sell assets. An amazing $116 billion has been invested in struggling insurer AIG
According to CNNMoney, the government has invested $2.8 trillion in recovery efforts, while it has outstanding commitments of a staggering $11 trillion.
The results so far have suggested that -- with the exception of letting Lehman Brothers sing its swan song -- Bernanke, Paulson, and Geithner have staved off a second U.S. depression. As I wrote yesterday, the Treasury positions that primary dealers are carrying, as well as the movements in credit spreads, tell us that credit markets are starting to come back to life after their frightening deep freeze.
However, as I also noted yesterday, we're far from the last chapter. We've felt the consequences of the sirens' call, and we might have successfully navigated Scylla and Charybdis, but just like Odysseus, plenty of challenges lie ahead.
With massive amounts of new money injected into the economy, the Fed faces the daunting challenge of getting the economy humming along with a comfortable rate of inflation without letting all that capital turn into a raging inflation inferno. At the same time, a significant amount of deleveraging still needs to take place, and the Fed and Treasury could still end up feeling like they're pushing a string trying to fight off deflation.
Meanwhile, even if monetary efforts do what they're supposed to do, gunshy consumers, a persistent unemployment problem, and that same darn deleveraging issue could leave us with an economy that plods along at a growth rate notably lower than the 2.9% we've seen over the past 20 years.
Grading the gang
If you're thinking that I'm about to toss a letter grade at Bernanke, Paulson, and Geithner, I'm sorry to disappoint. At best we're at the halfway point of a full examination of the government's policies, so what I'll do is issue the trio an interim report that reads, "Shows promise, but keep your noses to the grindstone."
But I want to know what you think. Scroll down to the comments section below and share your thoughts on how the Federal Reserve and Treasury have handled the financial crisis.
For another assessment of the last year, see "Fannie and Freddie: 1 Year Later."