The health of the credit system is crucial

Periods of healthy credit growth bear no psychological resemblance to the extreme exuberance of manias or the extreme caution or fear of debts (debtophobia).

The health of the credit system in 2008

When the global financial crisis hit in 2008, countries like the United States were vulnerable because they had been running up debt too fast.

In Southeast Asia, however, the opposite story was unfolding.  Indonesia, Thailand, Malaysia and the Philippines had manageable debt burdens and strong banks ready to lend, with total loans less than 89% of deposits.

Over the next 5 years, post 2008, the health of the credit system would prove crucial:

• nations such as Spain and Greece, which had seen the sharpest increase in debt before 2008, would post the slowest growth after the crisis;
• nations such as the Philippines and Thailand, which had seen the smallest increase in debt during the boom, would fare the best.

How the credit cycle works in brief

Rising debt can be a sign of health growth, unless debt is growing much faster than the economy for too long.

The size of the debt matters, but the pace of increase is the most important sign of change for the better or the worse.

The first signs of trouble often appear in the private sector, where credit manias tend to originate.

The psychology of a debt binge encourages lending mistakes and borrowing excesses that will retard growth and possibly lead to a financial crisis.

The crisis can inspire a healthy new caution, or a paralyzing fear of debt (debtophobia).

Either way, the period of retrenchment usually lasts only a few years (usually 4 to 5 years). #  

The country emerges with lower debts, bankers ready to lend, and an economy poised to grow rapidly.

Additional notes:

# On average, credit and economic growth remained weak for about four to five years.

In Asia, credit fell in the five years after 1997 by at least 40 percentage points as a share of the GDP in Indonesia, Thailand and Malaysia.  But within about four years, the gloom had started to lift as debts fell, government deficits declined, and global prices for the region's commodity exports rose.  Credit growth picked up, and the average GDP growth rate in these three Southeast Asian economies rose from around 4% between 1999 and 2002 to nearly 6% between 2003 and 2006.

Australia is caught in a credit crunch and the banks just made it worse, not better.

Banks' rate moves reveal system cracks

David Llewellyn-Smith

February 13, 2012

The media reaction to the banks' Friday rate hikes has been dominated by a schoolyard binary construction of the problem: the banks versus the government.

Some have taken the side of the government, that the banks are a greedy bunch of so and sos. Most have taken the side of the banks, that the government has no right to interfere in private business decisions.

Laudable sentiments if the banks are private. Which they are not. But let that pass.

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This columnist has already written that what's really at stake here is the political economy of banking and the government's failure to openly address that fact is now coming back to haunt it.

Instead this column will argue a much simpler point: Australia is caught in a credit crunch and the banks just made it worse, not better.

How so? To understand you have to have a handle on the basic tenets of banking. Like all businesses, banks have a balance sheet. There are two halves to the balance sheet: assets and liabilities.

For banks it's a little confusing because outgoing loans - for houses, cars etc. - are in fact assets. They are the stuff from which banks draw an income.

The bank's liabilities are also loans, but those taken from others, like deposits or bonds. The difference between these two is the bank's equity or capital base.

The ratio between the amount of capital and total assets is called the leverage. It's the number of times against which the bank's capital has been multiplied in its outgoing lending book.

That's it, not so hard.

Trouble triggers

There are two ways in which a bank can find itself in trouble. The first and most common is when its assets - the loans it has given to its clients - deteriorate in quality.

This problem happens when the folks who borrowed the money struggle to repay it. They might have lost their job, or the asset they offered as collateral against the loan - say, a house - may have lost value and their own balance sheet is under pressure.

If they sell, they can't repay the whole loan amount. You can see how this process can feed upon itself as distressed sales leads to more falling prices.

At a certain stage the banks themselves get into trouble as enough assets are impaired and their capital begins to decline. They must then restrict lending and the problem gets worse again. This is called a credit crunch.

This is what happened in the US. Australia is also in the early stages of such a process with falling house prices, rising unemployment and rising impaired loans at the banks. It's difficult to judge how far into this we are and whether it can be reversed.

The jobs generated by the mining boom offer the hope that it is possible to arrest the decline and instead of a credit crunch we get a stall in housing and a redistribution of capital elsewhere.

The primary protection against the process getting out of control is monetary policy, or interest rates, which can be lowered to alleviate the borrower stress at the heart of the problem.

Nervous creditors

The second way in which a bank can find itself in trouble is on the other side of the balance sheet: the liabilities. This happens when the people lending money to the bank - depositors or investors - get nervous and want a higher interest rate to give the bank their money.

In the past this was not much of a problem for Australian banks as they relied upon steady deposits. However, after the new millennium began, the banks went a bit nuts borrowing less stable money from investors here and abroad and loaned that money largely to punters betting on houses.

Now, through a combination of the troubles in Europe, the fact that the process of deteriorating assets is under way, and through their own incompetence in the mishandling of covered bonds, investors want much higher interest rates to lend our banks money.

So yes, they need to raise interest rates to extract more money from the other side of the balance sheet to compensate. If they don't then they'll not be able to lend money on unprofitable loans and the credit crunch still transpires as the banks limit the supply of credit.

In short, whichever way the banks turn right now, whether they pass on their borrowing costs to mortgagors and put downward pressure on their assets, or they absorb the higher funding costs and stop making unprofitable loans, we edge further into a credit crunch. And indeed, as you can see, the two halves of the balance sheet aren't at all separate.

Credit crunch

As risk builds in one then it has a deleterious effect on the other and so another feedback loop threatens. This is systemic stress and is exactly where we are now, whether you want to blame the government or the banks (or, in this writer's case, the politico-housing complex).

So, the only question that matters right now is this: can the RBA arrest this developing feedback loop by cutting interest rates?

To my mind it is now clear that the central bank, which handled its actions flawlessly last year, erred dramatically last week in staying on hold.

By pushing the banks to hike unilaterally, the first time in history, the banks have shaken the foundation of the one commonly (and sensibly enough) held truth in Australian asset markets, that when asset prices decline, unemployment or other economic adversity threatens, the RBA will save us by cutting interest rates.

The insurance is still there but a nasty crack now runs through its base and this commentator can only see this making asset markets worse.

We're into a credit crunch all right.

David Llewellyn-Smith is the editor of MacroBusiness and co-author of the Great Crash of 2008 with Ross Garnaut. This is an edited version of a longer article available free at MacroBusiness.

Read more: http://www.smh.com.au/business/banks-rate-moves-reveal-system-cracks-20120213-1t0ce.html#ixzz1mIsQMilO

All the Big Banks lift Rates

Eric Johnston

February 13, 2012 - 5:46PM

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ANZ won't rule out more job cuts

Despite slashing 1000 jobs and raising mortgage rates to protect profit margins, ANZ Australia CEO Philip Chronican says there could be more pain.

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The Commonwealth Bank and National Australia Bank have become the latest banks to raise their variable lending rates outside the Reserve Bank's regular monthly cycle.

National Australia Bank this evening said it would lift its standard variable home loan interest rate by 9 basis points to 7.31 per cent.

• ANZ to cut 1000 jobs by September

Earlier, the Commonwealth Bank, Australia's biggest mortgage bank, announced that its standard variable mortgage rate will rise 10 basis points to 7.41 per cent from February 20.

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Commonwealth Bank and regional lender Bendigo and Adelaide Bank become the latest banks to break ranks with the RBA. Photo: Jessica Shapiro

The moves round out the out-of-cycle rate rises among the big four banks.

Also today, Bendigo and Adelaide Bank increased its standard variable mortgage rate 15 basis points to 7.45 per cent.

Westpac and the ANZ defied Treasurer Wayne Swan and lifted variable rates 0.10 and 0.06 percentage points respectively, on Friday, despite a decision by the Reserve Bank to hold its cash rate steady. The ANZ bank today announced it would cut 1000 jobs by September 30 to cope with weaker demand for banking services.

Rising costs

As with other banks, CBA blamed today's rate increase on rising funding costs, adding that greater uncertainty emanating from Europe was exacerbating the situation.

“In making this decision, we have been cognisant of our total funding costs, of which the official cash rate is only one factor,’’ said CBA group executive of retail banking Ross McEwan.

‘‘The Commonwealth Bank believes Australian banks should continue to price sensibly, taking into account factors both on and offshore, rather than experience similar problems to those that many banks overseas have experienced,’’ Mr McEwan said.

"Whilst we understand that any increase in interest rates is not favourable to borrowers, our millions of deposit customers are favoured and since the commencement of the GFC we have seen significant competition in retail deposits pricing," he said.

CBA said it would raise the interest rate on its six-month term deposit account by 20 basis points, also effective February 20.

National Australia Bank, the last of the four big banks to announce its interest rate stance, said it is reviewing its rates.

Commonwealth Bank shares rose 41 cents, or 0.8 per cent, to $50.29, slightly less than the overall market's gain. Bendigo and Adelaide Bank shares rose 6 cents, or 0.7 per cent, to $8.19.

Bendigo move

Bendigo, like ANZ, has also said it would review interest rates independently of the Reserve Bank. Westpac's new variable mortgage rate is 7.46 per cent and ANZ's is 7.36 per cent.

Bendigo managing director Mike Hirst said current banking margins are not sustainable and adjustments to interest rates must be made.

“This is not a popular move, we know that, but it is the right thing to do to restore a proper balance between depositors, borrowers, the Bank’s shareholders and our community partners. At current funding cost levels that balance is out,” he said.

At current pricing levels banks were “subsidising mortgages,” Mr Hirst said.

“If you look at the traditional role of a bank this makes no sense and is unsustainable,” he added.

Mr Hirst said banks had a fundamental choice to make: adjust the pricing on loans or restrict lending. He added the latter option would have significant implications for the economy and would not be the right thing to do at this point in time.

He also said many staff at Bendigo have taken unpaid leave to help reduce costs, while no new back office staff are being hired.

Bendigo’s new mortgage rate will apply from February 21.

ejohnston@theage.com.au, with Chris Zappone

Read more: http://www.smh.com.au/business/all-the-big-banks-lift-rates-20120213-1t1ae.html#ixzz1mIuF0oCu

Khan Academy - Credit Crisis

Credit Crisis
The housing price conundrum
Housing price conundrum (part 2)
Housing Price Conundrum (part 3)
Housing Conundrum (part 4)
Mortgage-Backed Securities I
Mortgage-backed securities II
Mortgage-backed securities III
Collateralized Debt Obligation (CDO)
Bailout 1: Liquidity vs. Solvency
Bailout 2: Book Value
Bailout 3: Book value vs. market value
Bailout 4: Mark-to-model vs. mark-to-market
Bailout 5: Paying off the debt
Bailout 6: Getting an equity infusion
Bailout 7: Bank goes into bankruptcy
Bailout 8: Systemic Risk
Bailout 9: Paulson's Plan
Bailout 10: Moral Hazard
Bailout 11: Why these CDOs could be worth nothing
Bailout 12: Lone Star Transaction
Bailout 13: Does the bailout have a chance of working?
Credit Default Swaps
Credit Default Swaps 2
Wealth Destruction 1
Wealth Destruction 2
Bailout 14: Possible Solution
Bailout 15: More on the solution
Banking 1
Banking 2: A bank's income statement
Banking 3: Fractional Reserve Banking
Banking 4: Multiplier effect and the money supply

Leadership needed over continental toxins

April 7, 2009

Leadership needed over continental toxins

David Wighton: Business Editor's commentary

Everyone at last week's G20 meeting was pretty much agreed — detoxing the banks of their poisonous assets was a necessary condition for global economic recovery. Curious then that so little was said about the issue in the official communiqué.

The world leaders pointed to what had already been done in terms of recapitalising banks and dealing with their impaired assets. And they underlined their commitment to do whatever was required in the future to restore the normal flow of credit. But that was it.

Experience of previous banking crises suggests that what is required is a comprehensive and systematic approach to bank balance sheets. Yet the approach we have at the moment remains ad hoc and piecemeal.

In Britain great strides have been made both in recapitalising the banks and ring-fencing their toxic assets. The taxpayer has put £37 billion directly into RBS and Lloyds; Barclays has raised £7.3 billion from investors and is expected to bring in another £3 billion from the sale of iShares; and HSBC has just wrapped up a very successful £12.5 billion rights issue. In terms of toxic debt, RBS and Lloyds have taken out insurance with the Government covering potential losses on almost £600 billion of assets.

Even so, some analysts believe more will be needed. Yet Britain is much further down the road than many other countries. And meanwhile, the scale of the problem just keeps mounting.

Only in January the International Monetary Fund doubled its forecast of total losses on US credit assets to $2,200 billion (£1,490 billion). As a result, it estimated that US and European banks would need to raise $500 billion to prevent their balance sheets from deteriorating further.

Now I hear that the IMF's economists are preparing to increase that figure to $3,100 billion, with a further $900 billion for assets originated in Europe and Asia.

This escalation reflects the spreading of the downturn from US property-related securities to the real economy around the world. Banks exposed to the crisis in central and eastern Europe look particularly vulnerable.

In a joint report by Morgan Stanley and the consultants Oliver Wyman, the authors argue that continental European governments need to come up with a more comprehensive approach to bolstering their banks, many of which have perilously thin capital cushions.

Meanwhile in the US, Mike Mayo, a veteran banking analyst now at Calyon Securities, warns that the worst is yet to come. He says that government action on impaired assets could trigger the need for further large capital increases for US banks.

The problem is that ploughing more taxpayers' money into their undeserving banks is politically toxic. What politicians need is the cover provided by concerted global action. And they need it before the next G20 summit. Now that Mr Sarkozy and Ms Merkel have their crackdown on tax havens, perhaps they can show some leadership on more urgent problems.

http://business.timesonline.co.uk/tol/business/columnists/article6047880.ece

The End of the Credit Crisis

The End of the Credit Crisis
by: Alex Trias
February 27, 2009

Now sit around in a circle, kiddies, and let me tell you the story of the credit crisis. It goes like this.


Homeowner owns a $400,000 home secured by a $500,000 mortgage. Homeowner is very concerned that the value of the home could drop to $300,000 in the next few years, which is when he plans to sell the home, and he does not have the $200,000 in cash to make up the balance and pay off the full mortgage. Currently, Homeowner is thinking foreclosure is the best and only option to avoid going into further debt.


Bank has a worse problem, because Bank has a $500,000 mortgage on its balance sheet but no investor is willing to buy it for more than $100,000. The reason why is because investors know that the security on this loan is worth $400,000 and that it will probably continue to deteriorate in value. More importantly, the investors know that Homeowner has a strong incentive to let this thing go to foreclosure soon, at a time when the underlying property is rapidly losing value. Finally, investors see the value of other mortgages falling rapidly, and don’t want to catch a falling knife.


Now we’re getting to crux of Bank’s biggest problem, which is that under some clever accounting rules, Bank needs to mark this mortgage to market. Bank knows that the mortgage is not worth $500,000, but right now if they went to foreclosure, Bank would get $400,000 because that is what the collateral would sell for. However, under the mark to market rules, the value of this mortgage is not $400,000 – it’s $100,000 because that is what an investor would pay for it.


You see where this is going. Under banking regulations, Bank needs $1 in the vault for every $10 that Bank lends out. If Bank’s $500,000 mortgage is worth $100,000, that translates to $4,000,000 that Bank can no longer lend out. Bank must curtail its lending dramatically, which means less profits for Bank, and less liquidity in the system. No good. And even worse, Bank just reported a $400,000 write-down to its overjoyed shareholders, and hedge funds are now taking Bank’s market capitalization down by 90%. The public watches the 90% decline in the price of Bank stock, and forms a view that the banking system may be failing. Hedge funds act on this fear by short selling Bank stock with verve and confident greed, sending the share price down further still, and reinforcing a sense of panic among the public. Other investors are jumping on the bandwagon, too, and short interest on Bank’s stock is now close to 50%! (Pssst – remember that short interest thing for later, okay?).


Bank management has an idea. They believe that foreclosure is the best solution to this problem because by forcing Homeowner into foreclosure, the mark to market accounting rules permit Bank to report that $500,000 mortgage not as an asset worth $100,000, but rather, as $400,000 in cash. Moreover, Bank is concerned that if the secondary market for mortgages deteriorates, further write downs will become necessary, feeding the downward spiral in its share price and profitability.


This story plays out across the economy, and results in foreclosure rates that surpass those during the Great Depression, and the sharpest and worst decline in bank capital in history. The world, it feels, may be ending.


Time to short Citibank (C)? Bank of America (BAC)? What about JP Morgan (JPM)? Well hold on, kiddies, let me finish the story.


Some clever folks who work for President Obama have an idea. They say, let’s order the banks to renegotiate all those underwater mortgages! It’ll look like we’re punishing Bank, and helping the little guy. But what we’re really doing is solving the credit crisis, and tossing Bank a nice juicy bone in the process.


See, right now, Bank has a $500,000 mortgage that is about 50% likely to go into default, and nobody will buy that mortgage because it’s got lousy creditworthiness. Bank doesn’t want to mess with renegotiating any mortgages in a bankruptcy court, so Bank goes straight to Homeowner and says “Homeowner, now you only owe us $300,000, which you can afford to pay us back.” Homeowner is delighted, and now has no incentive to go into default. This fact is not lost on investors who like to buy mortgages that are a good credit risk. Anything will beat those Treasuries that only pay 2.5% a year.


Suddenly, this $300,000 mortgage is a very good credit risk, and investors are far more willing to buy it – in fact, investors will pay a whole lot more for a high quality $300,000 mortgage than a very low quality $500,000 mortgage. In fact, investors are ready to pay $300,000 for that high quality $300,000 mortgage. So what does Bank get to do?


You guessed it. Bank takes a WRITE UP. For tax purposes, Bank claims a tax deduction for the $200,000 it just wrote off the mortgage (which boosts up Bank’s balance sheet right on the spot), but for accounting purposes, Bank writes the mortgage up from $100,000 to $300,000. Bank announces these write ups as a surprise profit next quarter, completely stunning the stock market in the process – most investors had just assumed Bank was going to fail or be nationalized. But nobody expected WRITE UPS!


And this adjustment to Bank’s balance sheet frees up ten times as much capital that Bank can now lend out. The news of increased lending is equally surprising, and the stock market greets the news with enthusiasm. Yes, the clever people in President Obama’s administration are starting to look rather clever indeed.


Hey, turning to reality for a minute, do you want to know what? Some bank executives this author talks to actually GET IT, see? This is really the plan.


But back to my story. Remember what happened with Volkswagon stock last year?


The U.S. Treasury has been purchasing Bank’s common equity. There just aren’t that many shares of Bank stock available to buy. Turning back to reality for a moment here, anyone notice what Treasury said about buying Citigroup stock? WONDER WHAT THAT’S ABOUT, KIDDIES? Let me finish the story and you soon will.


When Bank reports that surprise write up of the mortgage on its balance sheet, some short sellers decide to cover. Quickly. The problem the short sellers have is, they are all trying to cover their short positions all at once! And the even bigger problem is that because Treasury has been buying up Bank stock quietly, THERE IS NOT ENOUGH BANK STOCK ON THE MARKET TO COVER THE SHORT INTEREST. This is a case where demand for Bank stock is larger than the supply, and the higher the price of Bank stock goes, the higher the demand for the stock goes. Only Treasury won’t sell Bank stock. And momentum traders have just figured out what’s going on and have decided to ride this trend to the moon. Short sellers, one by one, go bankrupt.


And then the big bad wolf eats them.


The end.


Disclosure: Author owns shares of BAC and JPM.

http://seekingalpha.com/article/123194-the-end-of-the-credit-crisis?source=yahoo

Credit Crisis -- The Essentials

Credit Crisis -- The Essentials
Latest Developments: Updated: Feb. 7, 2009

The Obama administration has settled on a plan to inject billions of dollars in fresh capital into banks and entice investors to purchase their most troubled assets. Feb. 6, 2009

Senate Democrats reached an agreement with Republican moderates on Friday to pare a huge economic recovery measure, clearing the way for approval of a package that President Obama said was urgently needed in light of mounting job losses. Feb. 6, 2009

With the economic downturn taking a toll on industries that employ more men, women are close to surpassing men on the nation's payrolls. Feb. 6, 2009

A plan backed by the Obama administration would help desperate homeowners stay in their houses while they renegotiate their debt. Feb. 6, 2009



Overview

By THE NEW YORK TIMES
In the fall of 2008, the credit crunch, which had emerged a little more than a year before, ballooned into Wall Street’s biggest crisis since the Great Depression. As hundreds of billions in mortgage-related investments went bad, mighty investment banks that once ruled high finance have crumbled or reinvented themselves as humdrum commercial banks. The nation’s largest insurance company and largest savings and loan both were seized by the government. The channels of credit, the arteries of the global financial system, have been constricted, cutting off crucial funds to consumers and businesses small and large.

In response, the federal government adopted a $700 billion bailout plan meant to reassure the markets and get credit flowing again. But the crisis began to spread to Europe and to emerging markets, with governments scrambling to prop up banks, broaden guarantees for deposits and agree on a coordinated response.

Origins

The roots of the credit crisis stretch back to another notable boom-and-bust: the tech bubble of the late 1990’s. When the stock market began a steep decline in 2000 and the nation slipped into recession the next year, the Federal Reserve sharply lowered interest rates to limit the economic damage.

Lower interest rates make mortgage payments cheaper, and demand for homes began to rise, sending prices up. In addition, millions of homeowners took advantage of the rate drop to refinance their existing mortgages. As the industry ramped up, the quality of the mortgages went down.

And turn sour they did, when home buyers had to leverage themselves to the hilt to make a purchase. Default and delinquency rates began to rise in 2006, but the pace of lending did not slow. Banks and other investors had devised a plethora of complex financial instruments to slice up and resell the mortgage-backed securities and to hedge against any risks — or so they thought.

The Crisis Takes Hold

The first shoe to drop was the collapse in June 2007 of two hedge funds owned by Bear Stearns that had invested heavily in the subprime market. As the year went on, more banks found that securities they thought were safe were tainted with what came to be called toxic mortgages. At the same time, the rising number of foreclosures helped speed the fall of housing prices, and the number of prime mortgages in default began to increase.

The Federal Reserve took unprecedented steps to bolster Wall Street. But still the losses mounted, and in March 2008 the Fed staved off a Bear Stearns bankruptcy by assuming $30 billion in liabilities and engineering a sale to JPMorgan Chase for a price that was less than the worth of Bear’s Manhattan skyscraper.

Sales, Failures and Seizures

In August, government officials began to become concerned as the stock prices of Fannie Mae and Freddie Mac, government-sponsored entities that were linchpins of the housing market, slid sharply. On Sept. 7, the Treasury Department announced it was taking them over.

Events began to move even faster. On Sept. 12, top government and finance officials gathered for talks to fend off bankruptcy for Lehman Brothers. The talks broke down, and the government refused to step in and salvage Lehman as it had for Bear. Lehman’s failure sent shock waves through the global banking system, as became increasingly clear in the following weeks. Merrill Lynch, which had not been previously thought to be in danger, sold itself to the Bank of America to avoid a similar fate.

On Sept. 16, American International Group, an insurance giant on the verge of failure because of its exposure to exotic securities known as credit default swaps, was bailed out by the Fed in an $85 billion deal. Stocks dropped anyway, falling nearly 500 points.

The Government’s Bailout Plan

The bleeding in the stock market stopped only after rumors trickled out about a huge bailout plan being readied by the federal government. On Sept. 18, Treasury Secretary Henry M. Paulson Jr. publicly announced a three-page, $700 billion proposal that would allow the government to buy toxic assets from the nation’s biggest banks, a move aimed at shoring up balance sheets and restoring confidence within the financial system.

Congress eventually amended the plan to add new structures for oversight, limits on executive pay and the option of the government taking a stake in the companies it bails out. Still, many Americans were angered by the idea of a proposal that provided billions of dollars in taxpayer money to Wall Street banks, which many believed had caused the crisis in the first place. Lawmakers with strong beliefs in free markets also opposed the bill, which they said amounted to socialism.

President Bush pleaded with lawmakers to pass the bill, but on Sept. 29, the House rejected the proposal, 228 to 205, with an insurgent group of Republicans leading the opposition. Stocks plunged, with the Standard & Poor’s 500-stock index losing nearly 9 percent, its worst day since Oct. 19, 1987.

Negotiations began anew on Capitol Hill. A series of tax breaks were added to the legislation, among other compromises and earmarks, and the Senate passed a revised version Oct. 1 by a large margin, 74 to 25. On Oct. 3, the House followed suit, by a vote of 263 to 171.

When the bill passed, it was still unclear how effective the bailout plan would be in resolving the credit crisis, although many analysts and economists believed it would offer at least a temporary aid. Federal officials promised increased regulation of the financial industry, whose structure was vastly different than it had been just weeks before.

The first reactions were not positive. Banks in England and Europe had invested heavily in mortgage-backed securities offered by Wall Street, and England had gone through a housing boom and bust of its own. Losses from those investments and the effect of the same tightening credit spiral being felt on Wall Street began to put a growing number of European institutions in danger. Over the weekend that followed the bailout’s passage, the German government moved to guarantee all private savings accounts in the country, and bailouts were arranged for a large German lender and a major European financial company.

And even as the United States began to execute its bailout plan, the tactics continued to shift, with the Treasury announcing that it would spend some of the funds to buy commercial paper, a vital form of short-term borrowing for businesses, in an effort to get credit flowing again.

Continued Volatility

When stock markets in the United States, Europe and Asia continued to plunge, the world’s leading central banks on Oct. 8 took the drastic step of a coordinated cut in interest rates, with the Federal Reserve cutting its two main rates by half a point.

And after a week in which stocks declined almost 20 percent on Wall Street, European and American officials announced coordinated actions that included taking equity stakes in major banks, including $250 billion in investments in the United States. The action prompted a worldwide stock rally, with the Dow rising 936 points, or 11 percent, on Oct. 13.

But as the prospect of a severe global recession became more evident, such gains were impossible to sustain. Just two days later, after Ben S. Bernanke, the Federal Reserve chairman, said there would be no quick economic turnaround even with the government’s intervention, the Dow plunged 733 points.

The credit markets, meanwhile, were slow to ease up, as banks used the injection of government funds to strengthen their balance sheets rather than lend. By late October, the Treasury had decided to use its $250 billion investment plan not only to increase banks’ capitalization but also to steer funds to stronger banks to purchase weaker ones, as in the acquisition of National City, a troubled Ohio-based bank, by PNC Financial of Pittsburgh.

The volatility in the stock markets was matched by upheaval in currency trading as investors sought shelter in the yen and the dollar, driving down the currencies of developing countries and even the euro and the British pound. The unwinding of the so-called yen-carry trade, in which investors borrowed money cheaply in Japan and invested it overseas, made Japanese goods more expensive on world markets and precipitated a steep plunge in Tokyo stock trading.

Oil-producing countries were hit by a sudden reversal of fortune, as the record oil prices reached over the summer were cut in half by October because of the world economic outlook. Even an agreement on a production cut by the Organization of the Petroleum Exporting Countries on Oct. 24 failed to stem the price decline.

Stock markets remained in upheaval, with the general downward trend punctuated by events like an 11-percent gain in the Dow on Oct. 28. A day later, the Fed cut its key lending rate again, to a mere 1 percent. In early November, the European Central Bank and the Bank of England followed with sharp reductions of their own.

Federal officials also moved to put together a plan to aid homeowners at risk of foreclosure by shouldering some losses for banks that agree to lower monthly payments. Detroit’s automakers, meanwhile, hard hit by the credit crisis, the growing economic slump and their belated transition away from big vehicles, turned to the government for aid of their own, possibly including help in engineering a merger of General Motors and Chrysler.

The leaders of 20 major countries, meanwhile, agreed to an emergency summit meeting in Washington on Nov. 14 and 15 to discuss coordinated action to deal with the credit crisis. The group agreed to work more closely, but put off thornier questions until next year, in an early challenge for the Obama administration.

The Crisis and the Campaign

The credit crisis emerged as the dominant issue of the presidential campaign in the last two months before the election. On Sept. 24, as polls showed Senator John McCain’s support dropping, he announced that he would suspend his campaign to try to help forge a deal on the bailout plan. The next day, both he and Senator Barack Obama met with Congressional leaders and President Bush at the White House, but their efforts failed to assure passage of the legislation, which went down to defeat in an initial vote on Sept. 29, a week before it ultimately passed.

The weakening stock market and growing credit crisis appeared to benefit Mr. Obama, who tied Mr. McCain to what he called the failed economic policies of President Bush and a Republican culture of deregulation of the financial markets. Polls showed that Mr. Obama’s election on Nov. 4 was partly the fruit of the economic crisis and the belief among many voters that he was more capable of handling the economy than Mr. McCain.

As president-elect, Mr. Obama made confronting the economic crisis the top priority of his transition. Just three days after his election, he convened a meeting of his top economic advisers, including the billionaire investor Warren Buffett; two former Treasury secretaries, Lawrence H. Summers and Robert E. Rubin; Paul A. Volcker, a former Federal Reserve chairman; and Eric E. Schmidt, the chief executive of Google. After their Nov. 7 meeting, he called quick passage of an economic stimulus package, saying it should be taken up by the the lame-duck Congressional session, and that if lawmakers failed to act, it would be his main economic goal after assuming office Jan. 20.

Mr. Obama also faced a host of other demands as president-elect, including calls to bail out the auto industry, particularly General Motors, which warned that it would run out of cash by mid-2009. And some economists and conservatives questioned whether, given the economic crisis, he could still meet some of his pledges from the campaign, like rapidly rolling back the Bush tax cuts, which some felt would hurt demand, and pushing ahead with his planned expansion of health care coverage, which could greatly increase a soaring deficit.

Deeper Problems, Dramatic Measures

With credit markets still locked up and investors getting worried about the big banks, Wall Street marked a grim milestone in late November when stock markets tumbled to their lowest levels in a decade. In all, the slide from the height of the stock markets had wiped out more than $8 trillion in wealth. The markets inched back in the weeks that followed as investors looked forward to a new administration and a huge economic stimulus package, but key indicators of the economy only got worse.

In December, an obscure group of economists confirmed what millions of Americans had suspected for months: the United States was in a recession. The economy had actually slipped into recession a year earlier, a committee of economists said, putting the current downturn on track to be the longest in a generation. Unemployment rose to its highest point in more than 15 years. Trade shrank. Home prices fell farther. As inflation virtually halted, economists began to worry about deflation, the vicious cycle of lower prices, lower wages and economic contraction.

Retailers suffered one of the worst holiday seasons in 30 years as worried consumers cut back, raising the likelihood that dozens more would join stores like Sharper Image, Circuit City and Linens 'n Things in bankruptcy.

On Dec. 16, the Federal Reserve entered uncharted waters of monetary policy by cutting its benchmark interest rate to nearly zero percent and declaring that it would deploy its balance sheet and essentially print money to fight the deepening recession and locked credit markets. Investors cheered, sending the Dow up more than 300 points, but many economists began to worry about the world's appetite for hundreds of billions of dollars in new Treasury debt.

Other countries followed the Fed with rate cuts of their own. Britain’s central bank a wave of refinancing that nevertheless skipped many homeowners.

But as Mr. Obama took office, investors were just as worried as ever, as evidenced by Wall Street’s worst Inauguration Day drop ever. The fourth-quarter corporate earnings season was marked by billion-dollar losses and uncertain outlooks for 2009. The economy showed no sign of turning around. And many lawmakers and analysts began to wonder whether the first $350 billion in bailout money had any effect at all. Banks that received bailout funds sat on their money, rather than lend it out to consumers or home buyers.

And bailout recipients such as Citigroup and Bank of America were forced to step forward for additional lifelines, raising one of the most uncomfortable questions a new president has ever had to address: Would the government nationalize the American banking system?

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