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Great Recession: What It Was and What It Caused


A recession is a decline in economic growth. The economic indicators used to define the term “recession” have changed over time. The greatest crisis that affected the global economy was in 2008-2009 and is commonly referred to as the Great Recession. The United States of America and Europe were the most impacted areas by the Great Recession. It was a period in time when the housing bubble burst and every figure related to employment, GDP, stock market, and price point plummeted for the longest time frame since the peak of World War II. Since the Great Recession, the International Monetary Fund or IMF has described a “global recession” as a decline in real per-capita world gross domestic product (GDP), as supported by other macroeconomic indicators such as industrial production, trade, oil consumption, and unemployment, for at least two consecutive quarters (The Great Recession of 2008: What Happened, and When?, 2022). This article will address the Great Recession's causes, policies, and outcomes to offer a better understanding of its impact on the American economy and the lessons drawn from it.


Causes

The primary and leading cause of the Great Recession was the fund shortage that struck the global banking and renting financial system (The Great Recession of 2008: What Happened, and When?, 2022). The drought led to a severe decline in the banks` ability to lend and loan. A scarcity in liquidity followed the causes (Rich, n.d.). Along with liquidity loss, a fall in consumer and business trust and confidence was caused by the unstable situation (Rich, n.d.). The global recession eventually led to a decrease in the number of exports as well as a severe decrease in house prices. The price reduction negatively and heavily impacted wealth worldwide, seeing as real estate ownership and management was one of the most profitable businesses of that time.


GDP began declining and its initial fall was consolidated by fiscal austerity in Europe. Fiscal austerity is when a government uses a contractionary fiscal policy to decrease its budget deficit (Fiscal Austerity, n.d.). Since the most economically stable and advanced European countries share a single currency, additional problems originated thanks to over-valued exchange rates and extremely high bond yields. Eurozone experienced a double-dip recession accompanied by fiscal austerity and unemployment. A double-dip recession occurs when an economy sees two periods of contraction, separated by a brief period of expansion (Jackson, 2022).


Figure 1: An illustration of the causes of the Great Recession (Polk, 2021).

Subprime Crisis

In the United States, banks made large increases in sub-prime mortgage loans that were quite risky because the belief that house prices would carry on rising was strong. American mortgage companies sold bundles known as “risky mortgages” to global banks. As the US interest rates rose, owners of houses and properties in the US started defaulting on them. American banks lost a lot of money as worldwide banks realized their bundles were useless.


The mortgage crisis was years in the making before it broke out in late 2007. Home prices began to fall gradually in late 2005 and steadily dropped through 2006 however, the belief that it would recover remained strong. Bankruptcy and collapse began as early as 2007 in the US, showing signs that the reckoning was overdue for a years-long binge on cheap credit. Two Bear Stearns hedge funds collapsed simultaneously with the warnings from BNP Paribas that investors might not be able to withdraw money from three of its funds. The British bank Northern Rock was left in need of seeking emergency funding from the Bank of England. Despite the warning signs, few investors suspected that the worst crisis in nearly eight decades was about to engulf the global financial system, bringing Wall Street's giants to their knees and triggering the Great Recession.


New Century Financial declared bankruptcy in April 2007 wreaking havoc and panic throughout the US housing market (Pettinger, 2019). A couple of months earlier, in February, the Federal Home Loan Mortgage Corporation, commonly known as Freddie announced that it would no longer purchase risky subprime mortgages or mortgage-related securities. A subprime mortgage is issued to borrowers with low credit ratings and scores (Subprime Mortgage, 2022). With no market for them it was renowned for owning, and therefore no way to sell them to recoup its initial investment, New Century Financial collapsed. In August 2007, American Home Mortgage Investment Corp collapsed for the same reason, becoming the second major lender to crack under the pressure of the subprime crisis and the declining housing market (Pettinger, 2019).


Figure 2: An illustration of the economic collapse in 2008-09 (Cagle Cartoons, Inc. - Editorial Cartoon 40689, n.d.).

To seal off the hardships of the situation in Europe and the US, a rise in oil prices joined the economic and financial situation of 2008. Matters are complicated further due to the cost-push inflation caused by the oil price peak. Lower spending and discretionary income accompanied the US and Europe as they entered a recession meanwhile the rising demand for oil in China and India kept the prices of oil and commodity high (Pettinger, 2019).


In order to rescue their respective countries governments intervened in the banking sector to prevent financial institutions from going broke. Exceptions had to be made, as the US allowed the Lehman Brothers to fall while the UK saved Northern Rock, and Lloyds TSB (Pettinger, 2019).


Drop in Interest Rates

On October 9, 2007, the U.S. stock market reached its all-time high, as the key Dow Jones Industrial Average exceeded 14,000 for the first time in history (The Great Recession of 2008: What Happened, and When?, 2022). Interest rates had to be drastically cut to allow cheaper borrowing and strengthen consumption and investment. The UK rates went from 5% to 0.5%, in hopes of quick recovery, although the method failed (Rich, n.d.).


Figure 3: An illustration of declining interest rates (J., 2020).

As government tax revenues diminished, budget deficits grew (Pettinger, 2019). The UK introduced a cut in value-added tax (VAT) as the US introduced a moderate fiscal stimulus to face the situation (Rich, n.d.). During the Great Recession, two main focal points were performed differently from the Great Depression. The first was the large bankruptcy digits. In the 1930s over 500 American commercial banks went bust, whereas in 2008 around 25 banks went bankrupt. the large difference in number is because the banks at the highest risk were those offering risky mortgages, a loan the capacity of which could mostly be afforded by large banks and multinational investors instead of commercial banks. the second was the lack of a trade war. In the 1930s, a tariff war was waged as countries sought to protect their national industries, whereas in 2008 international regulations and organizations had been built and were used as a focal point for rebuilding the economy. Economic packages and aid from the European Union and the IMF served as key regulators (Rich, n.d.).


Drop in Stock Prices

The Standard and Poor's 500, or the S&P 500, is a stock market index that tracks the performance of the 500 largest companies listed on the stock exchanges in the United States. It is considered one of the world’s most accurate indexes, covering about 80% of the available market capitalization, benchmarking on the index around $16 trillion annually (Yahoo Maakt Deel Uit Van De Yahoo-merkenfamilie, n.d.).


The bear market from 2007 to 2009 lasted 1.3 years and sent the S&P 500 down by 51.9%. The U.S. economy slipped into a recession in 2007, due to the crisis caused by subprime mortgages, with increasing numbers of borrowers unable to meet their obligations as scheduled. This eventually snowballed into a general financial crisis by September 2008, due to systemically important financial institutions, abbreviated as SIFIs entering the risk of insolvency. Massive injections of liquidity by governments and international organizations such as the EU and the IMF were what saved the entire financial system from collapsing. The process of capital injection is carried out through quantitative easing and its a form of monetary policy to prop up the economy and the prices of financial assets. The Great Recession is considered one of the worst bear markets in history, second only to the Great Depression. A bear market is a prolonged drop in investment prices —when a broad market index falls by 20% or more from its most recent high (Yahoo Maakt Deel Uit Van De Yahoo-merkenfamilie, n.d.).


On March 6th, 2009 the S&P hit its lowest intraday price of the financial crisis, March 9th, 2009, the Dow Jones Industrial Average and the S&P 500 closed at their lowest levels of the Great Recession, the S&P 500 closed at 676.53 and the Dow closed at 6,547.05, both losing significant value. Neither President George W. Bush's $700 billion Troubled Asset Relief Plan in October 2008 nor President Obama's $787 billion stimulus package in February 2009 could put an end to the decline. The Federal Reserve took unprecedented measures to support the economy as well, cutting interest rates to 0% for the first time in history (Yahoo Maakt Deel Uit Van De Yahoo-merkenfamilie, n.d.).


By the time the S&P 500 bottomed in March 2009, the index had wiped out more than a decade of profit, generating an overall negative return of -47.1% from March 9, 1999, to March 9, 2009 (Yahoo Maakt Deel Uit Van De Yahoo-merkenfamilie, n.d.). Fortunately for investors, the financial system didn’t collapse and stocks eventually recovered. Investors who bought into the S&P 500 generated a 394.2% total return over the next 10 years.


Too Big to Fail

Bear Sterns was founded in 1923 and was the fifth-largest global investment bank in the world. It was located in New York City and prior to its collapse owned over $18 billion in assets (Egan, 2018). Even with strategic methods of intervention in March 2008, investment banking giant Bear Sterns, after attributing its financial troubles to investments in subprime mortgages, its assets were acquired by JP Morgan Chase at a cut-rate price (Too Big to Fail: Definition, History, Examples, and Reforms, 2021).


JPMorgan Chase & Co. is an American multinational financial services company, the largest bank in the United States, and the world's largest bank by market capitalization (JPMorgan Chase & Co., n.d.). A few months later, financial behemoth Lehman collapsed due to the same, creating the largest bankruptcy filing in U.S. history (Too Big to Fail: Definition, History, Examples, and Reforms, 2021).


Figure 4: A picture of the American International Group (AIG) building in Manhattan, NYC (Crain Communications Inc., 2021).

Within days of the collapse of the Lehman Brothers, the United States Federal Reserve System, abbreviated as the Fed, announced that they would lend insurance and investment company American

International Group (AIG) $85 billion to remain afloat. Leaders of the Fed at the time justified the decision in front of the media saying that AIG was “too big to fail,” and that its collapse would further destabilize the U.S. economy and expand the roots of panic and instability amongst the people (Too Big to Fail: Definition, History, Examples, and Reforms, 2021).


Stimulus Package

Lowering the target interest rate wasn’t the only thing the Fed and the U.S. government did to combat the Great Recession and minimize its effects on the economy (The Great Recession of 2008: What Happened, and When?, 2022).


In February 2008, President Bush signed the Economic Stimulus Act into law. This legislation provided taxpayers with rebates ($600 to $1,200), and encouraged them to spend them; the document also reduced taxes; and increased the loan limits for federal home loan programs such as Fannie Mae and Freddie Mac. The purpose was to generate new home sales and provide a boost to the economy. The legislation was commonly referred to as a “Stimulus Package” and it also provided businesses with financial incentives for capital investment (The Great Recession of 2008: What Happened, and When?, 2022).


Figure 5: An illustration of the American efforts in the face of recession (ProPublica., 2021).

The recession was deep enough that countries concentrated on paying off debt via the use of the saving rate which rose from 0% to 7%, this is known as a balance sheet recession. The shortage of credit didn’t increase bank lending mainly because commercial banks decided not to pass the low-interest rate and the credit remained tight and difficult to loan (The Great Recession of 2008: What Happened, and When?, 2022).


In the Eurozone, panic set off in between countries as a rise in EU bond yields occurred (The Great Recession of 2008: What Happened, and When?, 2022). European governments saw it fit and necessary to present austerity measures that involved reducing government spending and implementing higher taxes.


A productivity crisis came as no surprise at a time like the Great Recession. Countries such as the UK, and Ireland struggled in terms of productivity by facing low wage growth, a flexible labor market, lack of technological novelties and investment (The Great Recession of 2008: What Happened, and When?, 2022).


TARP Program

The Congress of US proposed and approved the Troubled Asset Relief Program (TARP) which was passed by President Bush on October 2008 to mend the financial stability of the US after the recession focusing on improving and strengthening banks, general markets, industries, and financial institutions. TARP provided the U.S. government with $700 billion to purchase the assets of struggling companies. The deals would enable the government to sell these assets at a later date, hopefully at a profit. Within a few weeks, the government spent $125 billion in TARP funds in acquiring assets from nine U.S. banks. In early 2009, TARP funds were also used to bail out automakers General Motors, Chrysler, and banking giant Bank of America (Troubled Assets Relief Program (TARP), 2023).


Figure 6: A picture of Henry Paulson, one of the key figures in the establishment of TARP (The Wall Street Journal, 2008).

January 2009 brought the Obama administration to the White House. In his first few weeks in office, President Obama signed a second “Stimulus Package”, earmarking $787 billion for tax cuts as well as spending on infrastructure, schools, health care, and green energy (Troubled Assets Relief Program (TARP), 2023).


TARP allowed the US Treasury to put together a bailout plan for all American troubled banks, aiming to secure an end to the national and international recession. ARRA (The American Recovery and Reinvestment Act) of 2009 along with the Economic Stimulus Package was passed shortly after TARP to aid the United States` recovery as well as rebuild consumer confidence, and investment trust and to ensure liquidity (Troubled Assets Relief Program (TARP), 2023).


Dodd-Frank Act

The Dodd-Frank Act was signed into law by President Obama in 2010 and was designed to restore at least some of the U.S. government’s regulatory power over the financial industry. Dodd-Frank enabled the federal government to assume control of banks deemed to be on the brink of financial collapse by implementing various consumer protections designed to safeguard investments and prevent “predatory lending”—banks that provide high-interest loans to borrowers who likely will have difficulty paying (Dodd-Frank Act | CFTC, n.d.).


Figure 7: A picture of President Obama and fellow US Congressman in 2009 when the Dodd-Frank Act was signed into power (Markovich, 2013).

After he was inaugurated, President Trump some members of the US Congress made several efforts to gut key portions of the Dodd-Frank Act, which would remove some of the rules protecting Americans from another recession (Dodd-Frank Act | CFTC, n.d.). This move caused fear, uncertainty, and insecurity among the American people since the aftermath of the crisis was still present in people's memories.


The Aftermath of the Great Recession

Although the Great Recession was officially over in the United States in 2009, many people in America and other countries around the world, suffered through its aftermath for many more years. From 2010 through 2014, multiple European countries— highlighting Ireland, Greece, Portugal, and Cyprus—defaulted on their national debts, forcing the European Union to intervene with “bailout” loans and other cash investments. The experience of aftermath of the crisis in Greece is an infamous case in the Balkans Peninsula, as the country faced a sovereign debt crisis after 2008. The reforms and austerity measures adopted led to impoverishment, loss of income and property, and a small-scale humanitarian crisis leading to more concern, panic, and fear of further recession (The Great Recession of 2008: What Happened, and When?, 2022)..


From 2007 to 2009 American households estimated a total loss of 16 trillion USD, a quarter of households lost a minimum of 75% of their net worth whilst more than half of the total number of households lost a minimum of 25% (The Great Recession of 2008: What Happened, and When?, 2022).


Figure 8: An illustration of the struggle that followed the aftermath of the Great Recession (Khan,2022).

In terms of global loss, the Great Recession amounted to a global loss of economic growth of 2 trillion dollars, which is equivalent to a 4% drop. At the end of 2009, most countries were affected by the Great Recession. All of the affected areas underwent a slow, unstable, and uneven recovery that was predisposed to vast social downturns such as a decrease in fertility, impossibly high student debts, and diminishes job vacancies and positions (saymedia.com, n.d.). The aftermath of the recession was forecasted to linger for several years, and so it did. The economic crisis of 2008-2009 taught the world and its governments valuable lessons on how to handle economic crises in the future.



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Mariza Laci

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