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The Federal Reserve

2008 Annual Report pdf logo PDF version

Tough Times: The Southeastern Economy in 2008

Banking buffeted by financial storm

Introduction
Employment
Real Estate
Banking and Consumer Spending
Energy, Tourism, and International Trade
Manufacturing and Agriculture
Little Good News
Economic Crisis Timeline
 
A Day in the Life

Photo of Galina AlexeenkoGalina Alexeenko
Senior economic research analyst


Shock waves emanating from Wall Street and residential real estate markets rattled the financial sector in the Southeast and the nation in 2008.

Many of 2008's problems surfaced in 2007—falling home prices, rising mortgage defaults, and foreclosures that led to losses at banks and other financial institutions. During 2008, U.S. financial firms absorbed write-downs and credit losses totaling more than $650 billion, according to Bloomberg News.

Financial and economic currents in 2008 fed a vicious cycle that played out in the region and throughout the nation: Poor economic conditions and weak employment contributed to further deterioration in residential mortgage loans and reduced the quality of many other types of loans. Riskier borrowers led cautious lenders to tighten underwriting standards and demand higher interest rates, further restraining economic growth.

Financial institutions in the Southeast were not spared. At large banking companies, deteriorating real estate loan portfolios led to higher loan losses and lower earnings. Many banking firms reduced their dividends to shareholders. The situation was equally difficult for community banks, defined as those with under $10 billion in assets. Among sixty-one community banks the Atlanta Fed supervises, the number of troubled institutions, as classified by the Federal Deposit Insurance Corporation (FDIC), more than doubled during 2008.

Other financing mechanisms, such as commercial paper, also were sharply curtailed. The Federal Reserve in 2008 took numerous steps to try to address this lack of liquidity in the economy (see the sidebar).

Financial institutions in the Southeast particularly suffered in 2008. During the fourth quarter, for instance, the share of unprofitable banks in the region rose 27 percent from a year earlier, to just under 50 percent. A key measure of bank profitability, return on average assets (ROAA), tells the tale. Since its cyclical peak in the middle of 2006, the median ROAA for banks in the region had dropped by 87 basis points by the fourth quarter of 2008, a much steeper decline than for banks outside the Southeast.

Chart 3
Retail Sales Tax Revenues
Chart 3: Retail Sales Tax Revenues
Source: State Departments of Revenue (for Alabama, Florida, Georgia, Louisiana, and Tennessee) and Mississippi State Tax Commission

An ROAA of at least 1 percent is generally considered a mark of strong profitability. By the October–December period of 2008, nearly 80 percent of southeastern banks, compared to just over half a year earlier, reported an ROAA below 1 percent.

The major reason for this decline was a deterioration in asset quality as the year progressed. By the fourth quarter, 3.83 percent of all loans were noncurrent—more than ninety days past due and not accruing interest. That number was more than double the percentage a year earlier and well above the peak during the 2001 recession.

As the financial crisis deepened, some banks closed and reopened under different banners. Seven banks in the Southeast failed and were shut down by regulators in 2008, equal to the number in the previous eight years combined.

Meanwhile, companies had trouble securing financing from sources other than banks. Firms turning to the corporate bond market found it costlier to issue debt to investors, who were skittish about the economic outlook. Consequently, many companies apparently deferred issuing new bonds. In August 2008, for instance, investment grade bond issuance totaled just $26.5 billion nationally compared to average monthly issuance of about $83 billion in 2007, according to the Securities Industry and Financial Markets Association.

Consumer spending slumps
In some previous recessions, consumer spending remained strong and helped the economy turn toward recovery. But in 2008, consumer spending suffered along with the rest of the economy, in part because more people were out of work and because shoppers cut back as prices climbed for commodities like food and energy. Nationally, retail sales fell 8 percent year over year in the fourth quarter of 2008. In Florida and Tennessee, state sales tax revenue, a useful proxy for spending, was down in each quarter of 2008 compared to 2007 (chart 3). In Georgia, sales tax revenue rose slightly in the fourth quarter after declining during the previous three quarters. Mississippi and Louisiana collected more sales taxes during 2008 than in 2007, yet even in those states growth was down from 2006.

As in virtually every other measure of economic activity, Florida suffered the region's biggest hits in consumer spending. Florida's sales tax revenues, which have declined steadily since a peak in 2005, slipped 4.1 percent for 2008 compared to 2007.

Auto sales were especially weak. From January through December, the number of new vehicles registered in the Southeast plummeted 21.5 percent from a year earlier compared to an 18.3 percent drop nationally.

The Fed devises unprecedented responses

The Federal Reserve in 2008 took several innovative steps to address strains in the financial system. While the Fed actions in many cases went beyond traditional monetary tools, they are grounded in a coherent strategy of targeted credit policy.

A series of cuts in the federal funds rate, totaling more than 500 basis points, that began in September 2007 brought the rate to a range of 0 to 0.25 percent as of December 2008.

The Federal Reserve also enacted a variety of policies to help systemically important credit markets resume normal functioning. Starting in August 2007, these measures have been designed to address problems in three critical areas of the financial system—financial institutions, borrowers and investors in key credit markets, and longer-term securities.

Programs to support financial institutions included changes in the Federal Reserve discount window: lowering the discount rate relative to other interest rates; an auction program allowing financial institutions to access funds without some of the stigma associated with discount window lending; longer-term loans and availability of credit to a wider range of institutions; and the acceptance of less liquid collateral. In addition, the Federal Reserve initiated a series of reciprocal currency swaps with sixteen foreign central banks to improve dollar liquidity in global financial markets.

Meanwhile, the Fed targeted two key credit markets. Some of the strain in the market for short-term debt could be traced to money market funds, which are significant buyers of commercial paper—short-term promissory notes that corporations and financial institutions use to finance day-to-day operations. Significantly, money market funds link investors seeking a return with businesses looking to sell their short-term debt.

To help stabilize the commercial paper market and money market funds, the Federal Reserve created three facilities. The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility provides funding to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper from money market mutual funds. The Commercial Paper Funding Facility provides liquidity to U.S. issuers of commercial paper. And the Money Market Investor Funding Facility supports a private-sector initiative to provide liquidity to investors in U.S. money markets.

Finally, to support longer-term securities, the Fed announced programs to purchase asset-backed instruments, including mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae, and student loans, small business loans, and credit card receivables. The ability to package and sell such credits in the form of securities is essential to ensure that consumers and businesses have broad access to credit.