September 18th, 2008, was a very important date in economic policy history.This date legislators
from the house and the senate met to discuss with the federal reserves, a 700 million dollar plan to stop
the credit freeze of the financial market. This controversial decision impacted the financial market
greatly and has changed economics from that point on. This situation stemmed from Wall Street
gambling heavily on the risky housing market. When the housing market crashed it had an domino
affect on the financial markets.
Bear Stearns was a global investment bank. A rumor arose stating that they were running out of
money. It quickly came to the light that Stearns bought huge amounts of mortgages and then turned
them into securities. This term is called toxic assets.
Tim Geithner head of Federal Reserve, initially thought to just let Bear Stearns go bankrupt, but quickly learned that doing that would not be a wise option. The feds learned that Bears had a lot of deals incorporating credit default swaps. Credit default swaps are insurances on bonds, for if they go bad the insurer would pay the own of the insurance. Bear Stearns failure to repay their debt would have directly affected all of Wall-Street, and all around the world. Systemic risk as some would say. The idea that the risk to the financial system as a whole would be too great if Bear Stearns would be allowed to go bankrupt. Unfortunately the Federal Reserve was unable to directly give money to Bear Stearn. So they thought up a plan to give the money to JP Morgan, the bank that backed Bear, and then they would pass it on to Bear Stearns.
Former Secretary of the Treasury Henry Paulson got involved. Paulson believe that the market was doomed to fail if an actual fix was not made. Paulson another believer of systemic risk, realized Bear needed to be bought out. Therefore they constructed a deal in which JP Morgan bought out Bear Stearns. From this though Paulson wanted to send a warning, he brought up moral harzard, the idea that if you bail someone out from a self inflicted problem, what incentive would they have to not commit the same problem again. Paulson wanted to send the message to Wall-Street that this bailout will not happen for everyone on the...