Barack Obama and the Bush Tax Cuts-Protected

9-709-037REV: FEBRUARY 23, 2009

________________________________________________________________________________________________________________ Professors Matthew Weinzierl and Eric Werker prepared this case with the assistance of Research Associate Jonathan Schlefer. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

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MATTHEW WEINZIERL ERIC WERKER

Barack Obama and the Bush Tax Cuts

As his inauguration approached, United States President-elect Barack Obama faced an unusually complex economic situation. A global financial crisis, sparked by defaults in the U.S. subprime mortgage market, was well underway. The crisis had eliminated, or drastically changed, a number of major financial institutions, including all five major U.S. investment banks. On September 7, 2008, two massive lending entities with a combined $5 trillion in debt and $1.5 trillion in mortgage assets, Fannie Mae and Freddie Mac, entered into conservatorship as the U.S. government assumed their liabilities.1 The following week, the Federal Reserve bailed out the insurance giant American

International Group (AIG) with an $85 billion credit facility in exchange for warrants worth 80% of the company’s stock.2 As $6 trillion in wealth disappeared across U.S. equity markets,3 credit all but

dried up and investors fled to the perceived security of government bonds, driving the yield on the three-month Treasury to below zero.4

With the financial system under threat, the government—under the stewardship of Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke—put together a sweeping $700 billion bailout plan. They initially conceived the plan as a fund to buy up illiquid mortgage-backed securities.5 Later the plan expanded (following Britain’s lead) to include purchases of major

equity stakes in banks.6 During the campaign, Obama (along with his Republican opponent, Senator

John McCain) supported the Treasury’s bailout package.

The carnage had spread to the real economy. The National Bureau of Economic Research calculated that a recession had begun in December 2007.7 With the stock market off 40% from its

October 2007 high and real estate prices plummeting, the wealth of U.S. households had fallen, as had their ability to take out home equity loans to fund spending. Bankruptcies and home foreclosures were climbing.8 New construction of single-family homes hit its lowest point since 1981.9 The

unemployment rate rose from less than 4.5% in early 2007 to 6.5% in October 2008 as the economy shed over one million jobs.10 As household consumption fell, businesses cut back on investment.

The deteriorating economic situation was generally seen as a major contributor to McCain’s loss in his bid to succeed George W. Bush as president. Indeed, McCain’s comment—following the implosion of the mortgage giants AIG and Lehman Brothers—that the economy was “fundamentally sound,” did not reverberate well with voters.11 Obama seized on the remark, associating the

economic distress with the policies of the Bush presidency.

Therefore, Obama was sure of one thing: the crisis had been instrumental in bringing him into office. Expectations were high. Obama had been elected to fix what Alan Greenspan, former

This document is authorized to be used only in MBA 644: External Environment at Northwood University's DeVos Graduate School of Management.Use outside of this course is a copyright violation.709-037 Barack Obama and the Bush Tax Cuts 2 chairman of the Federal Reserve, called the “most wrenching” financial crisis “since the second world war.”12

Obama had also been elected to bring economic prosperity to middle-class Americans who, some research suggested, had gained little from the economic growth of the past generation. Although analysts debated the details, the data showed that a large share of recent income gains had gone to a small percentage of the richest Americans, while median household income had grown much more slowly (see Exhibit 1).13