What the US Treasury did...

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Neel Kashkari, Assistant Secretary US Treasury 2008

Neel Kashkari: In the spring and summer of 2007 we began to see stresses and strains, especially in the subprime market, housing more broadly but really in subprime. Secretary Paulson, when we first got the Treasury, put us all on alert for the possibility of financial crises because they happen periodically. So both Treasury and the regulators were always on the watch looking for stresses and strains in the markets and always talking to market participants. So we saw that this was happening, and we didn’t know how big it was going to get, how severe it was going to get. It was in August of 2007 when it was clear that it was becoming quite severe, and that it was having real impact on the credit markets, that he asked me to lead the department’s work on housing.

What the Treasury decided to do

Neel Kashkari: It became very clear though that we had a housing bubble, housing prices had gotten too high, and we needed to allow that correction to progress. So as we unravelled this very complex topic we realised we need the housing correction to take place but we want to minimise damage from the correction to the economy and we want to try to reach and help homeowners who want to stay in their homes and who have the basic ability to do so. So it was very difficult, of all the policy issues I’ve looked at, housing is probably the most complex in terms of the number of different participants that have to come together to try to implement a policy. So we were watching it carefully, gathering data, we didn’t know how severe it would become.

The crisis spreads into the financial sector

Neel Kashkari: In March of 2008, when Bear Sterns collapsed, that happened almost out of the blue. In the matter of a couple of weeks, it went from everything seemed to be fine on the surface to Bear Sterns literally collapsing, and we had to arrange a sale to JP Morgan. Now Secretary Paulson sent me to New York that weekend on his behalf to work on the transaction, to work with our colleagues at the Federal Reserve, to try to find a way to stabilise Bear Sterns and ultimately arrange the merger with JP Morgan Chase. It was an incredibly intense weekend, we didn’t know if we were going to be successful. Fortunately we were successful, we were able to stabilise the situation. But that was an indicator to us of how severe the crisis had become, that a major investment bank had now failed, and it really raised our attention, as you can imagine, and actually a few months before Bear Sterns failed we had become doing some contingency planning work. If the crisis really got bad, and we had to do a massive intervention in the capital markets, what we would do, but Bear Sterns really focused us to sharpen our work and make sure that we’d done our homework.

The severity of the crisis

Neel Kashkari: If you think about between March 2008 and September 2008, eight major US financial institutions effectively failed: Bear Sterns, IndyMac, Fannie Mae, Freddie Mac, Lehman, AIG, Washington Mutual, Wachovia. Eight major US financial institutions failed, six of them in September alone. So the actions of stabilising Fannie and Freddie were absolutely imperative. Those didn’t add to the crisis, they provided some stability to housing finance. But while we were doing that the rest of the credit markets were getting much, much more severe and much more impaired, and one week after we took over Fannie and Freddie, obviously Lehman failed, then AIG, and then we went to Congress.