Guarantees and Capital Infusions in Response to Financial Crises A: Haircuts and Resolutions

After the mortgage market meltdown in mid-2007 and during the financial crisis in 2008, major financial institutions around the world were on the verge of collapsing one after another. Faced with these troubles, the government had to respond quickly to contain the crisis as efficiently as possible. It was, however, limited in resources, time, and experience. To make matters worse, the complexity and opaqueness of the financial market and these institutions greatly affected the government's ability to design an efficient and consistent method to contain the crisis. Shortly after Lehman Brothers filed for bankruptcy on September 15, 2008, American International Group (AIG) was also in deep trouble and close to failure when the Federal Reserve decided to bailout the institution. Washington Mutual (WaMu) and Wachovia were also facing collapse due to their exposure in risky mortgage products around the same time. WaMu eventually closed, and the Federal Deposit Insurance Corporation (FDIC), appointed as a receiver, sold parts of its business to JP Morgan Chase & Co. while equity holders and debtors of the institution were left to take a major haircut. On the other hand, Wachovia was able to avoid the same fate as WaMu through a systemic risk exception under the FDIC Improvement Act of 1991. This provision allowed the FDIC to stand behind Wachovia with Citigroup. This case provides details on the background and government response for each troubled financial institution during the financial crisis, and the rationale behind the design of each response.