1. Chapter 1 To Rescue, Rebalance, and Rebuild Recession begins December 2007 Financial Crisis Begins September 2008 Jan 2009 12 million unemployed, GDP falls precipitously American Recovery and Reinvestment Act of 2009 (signed January 2009) 2000s were an Age of high Consumption and Government Spending (need to rebalance – higher investment, saving, and exports) Major US problems: --- health care --- stagnating middle incomes --- continued use of fossil fuels --- need to revitalize innovation and R&D --- improve K-12 education, community colleges --- expand clean energy economy

3. Housing Prices Doubled 1997 – 2006 --- this led to complex financing and expansion of credit derivatives --- housing prices begin falling in early 2007 --- start of financial strain --- early 2008 economy begins to show downturn First 8 months of 2008 employment fell by 137,000 people/month September 2008 Lehman Brothers fails due to CDS exposure AIG threatened due to CDS exposure Credit spreads increase, stock market falls 24% in Sept and Oct 2008 January 2009 loses in employment reaches 544,000 people/month Real GDP growth -2.7% QII 2008, -5.4% QIV 2008, -6.4% QI of 2009

5. Basic Outline of the ERP 2010 Chapter 2 Actions Taken to Rescue the Economy Chapter 3 Worldwide Actions Taken in Response to the Recession Chapter 4 Transition from High C and G to High I and Net Exports Chapter 5 US Fiscal Deficit and Debt and Health Care Reform Chapter 6 Financial Reform Chapter 7 Health Care Reform Chapter 8 Strengthening the Labor Force Chapter 9 Energy Usage Reforms Chapter 10 Boosting Productivity

6. Recession Begins December 2007 due to the fall in housing prices Bubble housing prices fall from 200 (index) to 125 (index) 2007 - 2010 S&P stocks also had a bubble but not as important as housing Subprime Market, Alt-A Market are threatened with meltdown Housing prices ----- 3.5% fall in Jan-June 2007 6.0% fall in June –Dec 2007 Tax cut in early 2008 successful (consumption constant even though real wealth falling) Chapter 2 Rescuing the Economy from the Great Recession

8. During IIIQ 2008 economy and financial markets fall heavily Risk Spreads increase dramatically

9. S&P falls 29% and housing falls 11% during the fall of 2008 20% fall in net worth of household wealth from Dec 2007 to Dec 2008 CP market froze in fall 2008, transactions cut in half Securitization loans reduced -- auto loans -- credit cards -- student loans -- commercial loans GM and Chrysler needed loans in Dec 2008 and Jan 2009 to avoid bankruptcy Job loss got worse through January 2009

10. Commercial Paper (CPs) used to finance payrolls and suppliers. -- short term credit very important for doing business -- changes in the supply of short term credit affects long term investment Obama Administration seeks to make financial firms more responsible and less risky

11. Policies Used to Rescue the Economy --- Monetary Policy --- Financial Policy --- Fiscal Policy --- Housing Policy

12. Monetary Policy Federal Funds Rate was Reduced from 2007 to 2009

14. March 2008 Special Lending Facility to Banks and Financial Institutions CP Lending Facility Created in Oct 2008 March 2009 -- QEI $300b of long term debt purchased by the Fed Fed buys Fannie Mae and Freddie Mac Debt Fed Assets tripled between Jan 2008 – Dec 2008. Dramatic move away from short term securities.

16. Dramatic Increase in Reserves in the Banking System Some claim that inflation could rise in the future This fear is not credible because – (1)Fed Funds rate should be 5% lower than it is (but it cannot be negative) (2)Fed can easily retire the reserves through open market sales, also rate paid on reserves can be raised

17. Financial Policy Sept 7 2008 Fannie Mae and Freddie Mac placed under conservatorship When referring to government control of private corporations such as Freddie Mac or Fannie Mae, conservatorship implies a more temporary control than does nationalisation. Sept 16 2008 AIG given $85b in credit line Sept 19 2008 Money Market Mutual Funds given guarantees by US Treasury Oct 03 2008 Emergency Economic Stabilization Act of 2008 ($700b) -- $350b used to buy preferred equity shares in financial institutions -- $350b requires Presidential notification of Congress

18. Jan 12 2009 President Bush released second half of TARP funds (Obama agrees) Feb 10 2009 Treasury Secretary Geithner establishes Financial Stability Plan --- creates stress tests for 19 largest banks --- Treasury adds $100b to Fed to increase credit to firms --- reduce troubled (toxic) assets from balance sheets of financial institutions --- actions taken to reduce mortgage rates and reduce foreclosures --- auto industry financing $20b GMAC, Chrysler financing, etc. Chrysler bankrupt April 30, 2009 GM bankrupt June 01 2009 As of Sept 20, 2009 US government gave $80b for restructuring of car companies

19. Fiscal Policy American Recovery and Reinvestment Act 2009 (ARRA) signed Feb 17, 2009 Cost is $787b and involves tax cuts and spending increases = 2% of GDP

20. Design: --- spread over 2 years --- well diversified --- directed at long term needs (enduring capital investments)

21. Individual Tax Cuts – 1/3 of ARRA was tax cuts -- typical family $800 per couple -- $250 to seniors, veterans, disabled (total of $14b) Business Tax Cuts – tax cuts on investment (tax deductions) -- carry back of losses An accounting technique with which a company retroactively applies net operating losses to a preceding year's income in order to reduce tax liabilities present in that previous year -- 75% exclusion from capital gains on small business -- better and expanded lending through SBA Fiscal Relief to State and Local Governments -- $140b to states and localities Direct Support to Individuals -- $90b --extension of unemployment benefits, subsidies to health insurance, increased food stamps -- reduced taxes on unemployment benefits

22. Direct Government Investment Spending -- investment in transport and basic scientific research -- greater spending in health technology -- expansion of smart electric grid -- tax credits for energy related investment and spending Additional Programs – Cash for Clunkers -- old car + $4500 when buying new car originally $1b for program but $3b added after exhaustion November 2009 Worker, Homeownership and Business Assistance Act 2009 --- cut taxes on business --- provided additional 20 weeks unemployment --- COBRA program expanded to help unemployed keep health insurance Congress passed the landmark Consolidated Omnibus Budget Reconciliation Act (COBRA) health benefit provisions in 1986. The law amends the Employee Retirement Income Security Act, the Internal Revenue Code and the Public Health Service Act to provide continuation of group health coverage that otherwise might be terminated.

23. Housing Policy Make Home Affordable Program March 2009 --- Fed buys GSE debt, MBS --- Refinancing simplified --- Loan modifications $75b --- $8000 tax credit helps to move purchases forward --- aid to states and local housing finance

24. Have the Policies Been Effective? Interest Rate Spreads Have Come Down

25. S&P Stock Index Has Risen

26. Small Business Loans Have Increased

27. Mortgage Rates Have Come Down

28. House Prices Are Turning Around

29. Real GDP Growth is Positive and Rising

30. Investment Remains Weak

31. Stimulus Saved Jobs

32. Employment Growth in Health and Federal Government

33. Challenges Ahead --- Employment --- Housing --- Deficits and Debt