- The Great Recession, which ran from December 2007 to June 2009, was one of the worst economic downturns in US history.
- The economic crisis was precipitated by the collapse of the housing market, which was fueled by low interest rates, cheap lending, poor regulation, and hazardous subprime mortgages.
- New financial laws and an aggressive Federal Reserve are two of the Great Recession’s legacies.
Who is responsible for the 2008 Great Recession?
The Lenders are the main perpetrators. The mortgage originators and lenders bear the brunt of the blame. That’s because they’re the ones that started the difficulties in the first place. After all, it was the lenders who made loans to persons with bad credit and a high chance of default. 7 This is why it happened.
What was the primary cause of the United States’ economic catastrophe in 2008?
Years of ultra-low interest rates and lax lending rules drove a home price bubble in the United States and internationally, sowing the seeds of the financial crisis. It began with with intentions, as it always does.
What triggered the financial crisis of 2008?
Deregulation in the financial industry was the primary cause of the financial catastrophe. This allowed banks to engage in derivatives-based hedge fund trading. To support the profitable sale of these derivatives, banks demanded more mortgages.
Defaults on mortgages for homes were a major driver of the US recession that began in 2008.
Human greed and a lack of judgment are the root causes of the subprime mortgage crisis. Banks, hedge funds, investment houses, ratings agencies, homeowners, investors, and insurance companies were the main actors.
Even individuals who couldn’t afford loans were lent to the banks. People took out loans to buy properties they couldn’t truly afford. Investors raised demand for subprime mortgages by creating a market for low-cost MBS. These were packaged into derivatives and marketed to financial traders and institutions as insured investments.
People defaulted on their loans that were packaged in derivatives when the housing market grew saturated and interest rates began to climb. This is how the housing market crisis pushed the financial industry to its knees and triggered the Great Recession of 2008.
What caused the financial crisis in the United States in 2008 quizlet?
What caused the financial crisis in the United States in 2008? The cost of housing in the United States has decreased. What do most Americans consider to be a globalization disadvantage? Jobs are being relocated to cheaper labor markets.
Who profited from the financial crisis of 2008?
Warren Buffett declared in an op-ed piece in the New York Times in October 2008 that he was buying American stocks during the equity downturn brought on by the credit crisis. “Be scared when others are greedy, and greedy when others are fearful,” he says, explaining why he buys when there is blood on the streets.
During the credit crisis, Mr. Buffett was particularly adept. His purchases included $5 billion in perpetual preferred shares in Goldman Sachs (NYSE:GS), which earned him a 10% interest rate and contained warrants to buy more Goldman shares. Goldman also had the option of repurchasing the securities at a 10% premium, which it recently revealed. He did the same with General Electric (NYSE:GE), purchasing $3 billion in perpetual preferred stock with a 10% interest rate and a three-year redemption option at a 10% premium. He also bought billions of dollars in convertible preferred stock in Swiss Re and Dow Chemical (NYSE:DOW), which all needed financing to get through the credit crisis. As a result, he has amassed billions of dollars while guiding these and other American businesses through a challenging moment. (Learn how he moved from selling soft drinks to acquiring businesses and amassing billions of dollars.) Warren Buffett: The Road to Riches is a good place to start.)
What was the impact of the 2008 recession?
When the decade-long expansion in US housing market activity peaked in 2006, the Great Moderation came to an end, and residential development began to decline. Losses on mortgage-related financial assets began to burden global financial markets in 2007, and the US economy entered a recession in December 2007. Several prominent financial firms were in financial difficulties that year, and several financial markets were undergoing substantial upheaval. The Federal Reserve responded by providing liquidity and support through a variety of measures aimed at improving the functioning of financial markets and institutions and, as a result, limiting the damage to the US economy. 1 Nonetheless, the economic downturn deteriorated in the fall of 2008, eventually becoming severe and long enough to be dubbed “the Great Recession.” While the US economy reached bottom in the middle of 2009, the recovery in the years that followed was exceptionally slow in certain ways. In response to the severity of the downturn and the slow pace of recovery that followed, the Federal Reserve provided unprecedented monetary accommodation. Furthermore, the financial crisis prompted a slew of important banking and financial regulation reforms, as well as congressional legislation that had a substantial impact on the Federal Reserve.
Rise and Fall of the Housing Market
Following a long period of expansion in US house building, home prices, and housing loans, the recession and crisis struck. This boom began in the 1990s and accelerated in the mid-2000s, continuing unabated through the 2001 recession. Between 1998 and 2006, average home prices in the United States more than doubled, the largest increase in US history, with even bigger advances in other locations. During this time, home ownership increased from 64 percent in 1994 to 69 percent in 2005, while residential investment increased from around 4.5 percent of US GDP to nearly 6.5 percent. Employment in housing-related sectors contributed for almost 40% of net private sector job creation between 2001 and 2005.
The development of the housing market was accompanied by an increase in household mortgage borrowing in the United States. Household debt in the United States increased from 61 percent of GDP in 1998 to 97 percent in 2006. The rise in home mortgage debt appears to have been fueled by a number of causes. The Federal Open Market Committee (FOMC) maintained a low federal funds rate after the 2001 recession, and some observers believe that by keeping interest rates low for a “long period” and only gradually increasing them after 2004, the Federal Reserve contributed to the expansion of housing market activity (Taylor 2007). Other researchers, on the other hand, believe that such variables can only explain for a small part of the rise in housing activity (Bernanke 2010). Furthermore, historically low interest rates may have been influenced by significant savings accumulations in some developing market economies, which acted to keep interest rates low globally (Bernanke 2005). Others attribute the surge in borrowing to the expansion of the mortgage-backed securities market. Borrowers who were deemed a bad credit risk in the past, maybe due to a poor credit history or an unwillingness to make a big down payment, found it difficult to get mortgages. However, during the early and mid-2000s, lenders offered high-risk, or “subprime,” mortgages, which were bundled into securities. As a result, there was a significant increase in access to housing financing, which helped to drive the ensuing surge in demand that drove up home prices across the country.
Effects on the Financial Sector
The extent to which home prices might eventually fall became a significant question for the pricing of mortgage-related securities after they peaked in early 2007, according to the Federal Housing Finance Agency House Price Index, because large declines in home prices were viewed as likely to lead to an increase in mortgage defaults and higher losses to holders of such securities. Large, nationwide drops in home prices were uncommon in US historical data, but the run-up in home prices was unique in terms of magnitude and extent. Between the first quarter of 2007 and the second quarter of 2011, property values declined by more than a fifth on average across the country. As financial market participants faced significant uncertainty regarding the frequency of losses on mortgage-related assets, this drop in home values contributed to the financial crisis of 2007-08. Money market investors became concerned of subprime mortgage exposures in August 2007, putting pressure on certain financial markets, particularly the market for asset-backed commercial paper (Covitz, Liang, and Suarez 2009). The investment bank Bear Stearns was bought by JPMorgan Chase with the help of the Federal Reserve in the spring of 2008. Lehman Brothers declared bankruptcy in September, and the Federal Reserve aided AIG, a significant insurance and financial services firm, the next day. The Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation were all approached by Citigroup and Bank of America for assistance.
The Federal Reserve’s assistance to specific financial firms was hardly the only instance of central bank credit expansion in reaction to the crisis. The Federal Reserve also launched a slew of new lending programs to help a variety of financial institutions and markets. A credit facility for “primary dealers,” the broker-dealers that act as counterparties to the Fed’s open market operations, as well as lending programs for money market mutual funds and the commercial paper market, were among them. The Term Asset-Backed Securities Loan Facility (TALF), which was launched in collaboration with the US Department of Treasury, was aimed to relieve credit conditions for families and enterprises by offering credit to US holders of high-quality asset-backed securities.
To avoid an increase in bank reserves that would drive the federal funds rate below its objective as banks attempted to lend out their excess reserves, the Federal Reserve initially funded the expansion of Federal Reserve credit by selling Treasury securities. The Federal Reserve, on the other hand, got the right to pay banks interest on their excess reserves in October 2008. This encouraged banks to keep their reserves rather than lending them out, reducing the need for the Federal Reserve to offset its increased lending with asset reductions.2
Effects on the Broader Economy
The housing industry was at the forefront of not only the financial crisis, but also the broader economic downturn. Residential construction jobs peaked in 2006, as did residential investment. The total economy peaked in December 2007, the start of the recession, according to the National Bureau of Economic Research. The drop in general economic activity was slow at first, but it accelerated in the fall of 2008 when financial market stress reached a peak. The US GDP plummeted by 4.3 percent from peak to trough, making this the greatest recession since World War II. It was also the most time-consuming, spanning eighteen months. From less than 5% to 10%, the jobless rate has more than doubled.
The FOMC cut its federal funds rate objective from 4.5 percent at the end of 2007 to 2 percent at the start of September 2008 in response to worsening economic conditions. The FOMC accelerated its interest rate cuts as the financial crisis and economic contraction worsened in the fall of 2008, bringing the rate to its effective floor a target range of 0 to 25 basis points by the end of the year. The Federal Reserve also launched the first of several large-scale asset purchase (LSAP) programs in November 2008, purchasing mortgage-backed assets and longer-term Treasury securities. These purchases were made with the goal of lowering long-term interest rates and improving financial conditions in general, hence boosting economic activity (Bernanke 2012).
Although the recession ended in June 2009, the economy remained poor. Economic growth was relatively mild in the first four years of the recovery, averaging around 2%, and unemployment, particularly long-term unemployment, remained at historically high levels. In the face of this sustained weakness, the Federal Reserve kept the federal funds rate goal at an unusually low level and looked for new measures to provide extra monetary accommodation. Additional LSAP programs, often known as quantitative easing, or QE, were among them. In its public pronouncements, the FOMC began conveying its goals for future policy settings more fully, including the situations in which very low interest rates were likely to be appropriate. For example, the committee stated in December 2012 that exceptionally low interest rates would likely remain appropriate at least as long as the unemployment rate remained above a threshold of 6.5 percent and inflation remained no more than a half percentage point above the committee’s longer-run goal of 2 percent. This “forward guidance” strategy was intended to persuade the public that interest rates would remain low at least until certain economic conditions were met, putting downward pressure on longer-term rates.
Effects on Financial Regulation
When the financial market upheaval calmed, the focus naturally shifted to financial sector changes, including supervision and regulation, in order to avoid such events in the future. To lessen the risk of financial difficulty, a number of solutions have been proposed or implemented. The amount of needed capital for traditional banks has increased significantly, with bigger increases for so-called “systemically essential” institutions (Bank for International Settlements 2011a;2011b). For the first time, liquidity criteria will legally limit the amount of maturity transformation that banks can perform (Bank for International Settlements 2013). As conditions worsen, regular stress testing will help both banks and regulators recognize risks and will require banks to spend earnings to create capital rather than pay dividends (Board of Governors 2011).
New provisions for the treatment of large financial institutions were included in the Dodd-Frank Act of 2010. The Financial Stability Oversight Council, for example, has the authority to classify unconventional credit intermediaries as “Systemically Important Financial Institutions” (SIFIs), putting them under Federal Reserve supervision. The act also established the Orderly Liquidation Authority (OLA), which authorizes the Federal Deposit Insurance Corporation to wind down specific institutions if their failure would pose a significant risk to the financial system. Another section of the legislation mandates that large financial institutions develop “living wills,” which are detailed plans outlining how the institution could be resolved under US bankruptcy law without endangering the financial system or requiring government assistance.
The financial crisis of 2008 and the accompanying recession, like the Great Depression of the 1930s and the Great Inflation of the 1970s, are important areas of research for economists and policymakers. While it may be years before the causes and ramifications of these events are fully known, the attempt to unravel them provides a valuable opportunity for the Federal Reserve and other agencies to acquire lessons that can be used to shape future policy.
What happened in the financial crisis of 2008?
The crisis caused the Great Recession, which was the worst worldwide downturn since the Great Depression at the time. It was followed by the European debt crisis, which began with a deficit in Greece in late 2009, and the 20082011 Icelandic financial crisis, which saw all three of Iceland’s major banks fail and was the country’s largest economic collapse in history, proportionate to its size of GDP. It was one of the world’s five worst financial crises, with the global economy losing more than $2 trillion as a result. The proportion of home mortgage debt to GDP in the United States climbed from 46 percent in the 1990s to 73 percent in 2008, hitting $10.5 trillion. As home values climbed, a surge in cash out refinancings supported an increase in consumption that could no longer be sustained when home prices fell. Many financial institutions had investments whose value was based on home mortgages, such as mortgage-backed securities or credit derivatives intended to protect them against failure, and these investments had lost a large amount of value. From January 2007 to September 2009, the International Monetary Fund calculated that large US and European banks lost more than $1 trillion in toxic assets and bad loans.
In late 2008 and early 2009, stock and commodities prices plummeted due to a lack of investor trust in bank soundness and a reduction in credit availability. The crisis quickly grew into a global economic shock, resulting in the bankruptcy of major banks. Credit tightened and foreign trade fell during this time, causing economies around the world to stall. Evictions and foreclosures were common as housing markets weakened and unemployment rose. A number of businesses have failed. Household wealth in the United States decreased $11 trillion from its peak of $61.4 trillion in the second quarter of 2007, to $59.4 trillion by the end of the first quarter of 2009, leading in a drop in spending and ultimately a drop in corporate investment. In the fourth quarter of 2008, the United States’ real GDP fell by 8.4% from the previous quarter. In October 2009, the unemployment rate in the United States reached 11.0 percent, the highest since 1983 and about twice the pre-crisis rate. The average number of hours worked per week fell to 33, the lowest since the government began keeping track in 1964.
The economic crisis began in the United States and quickly extended throughout the world. Between 2000 and 2007, the United States accounted for more than a third of global consumption growth, and the rest of the world relied on the American consumer for demand. Corporate and institutional investors around the world owned toxic securities. Credit default swaps and other derivatives have also enhanced the interconnectedness of huge financial organizations. The de-leveraging of financial institutions, which occurred as assets were sold to pay back liabilities that could not be refinanced in frozen credit markets, intensified the solvency crisis and reduced foreign trade. Trade, commodity pricing, investment, and remittances sent by migrant workers all contributed to lower growth rates in emerging countries (example: Armenia). States with shaky political systems anticipated that, as a result of the crisis, investors from Western countries would withdraw their funds.
Governments and central banks, including the Federal Reserve, the European Central Bank, and the Bank of England, provided then-unprecedented trillions of dollars in bailouts and stimulus, including expansive fiscal and monetary policy, to offset the decline in consumption and lending capacity, avoid a further collapse, encourage lending, restore faith in the vital commercial paper markets, and avoid a repeat of the Great Recession. For a major sector of the economy, central banks shifted from being the “lender of last resort” to becoming the “lender of only resort.” The Fed was sometimes referred to as the “buyer of last resort.” These central banks bought government debt and distressed private assets from banks for $2.5 trillion in the fourth quarter of 2008. This was the world’s largest liquidity injection into the credit market, as well as the world’s largest monetary policy action. Following a strategy pioneered by the United Kingdom’s 2008 bank bailout package, governments across Europe and the United States guaranteed bank debt and generated capital for their national banking systems, ultimately purchasing $1.5 trillion in newly issued preferred stock in major banks. To combat the liquidity trap, the Federal Reserve produced large sums of new money at the time.
Trillions of dollars in loans, asset acquisitions, guarantees, and direct spending were used to bail out the financial system. The bailouts were accompanied by significant controversy, such as the AIG bonus payments scandal, which led to the development of a range of “decision making frameworks” to better balance opposing policy objectives during times of financial crisis. On the day that Royal Bank of Scotland was bailed out, Alistair Darling, the UK’s Chancellor of the Exchequer at the time of the crisis, stated in 2018 that Britain came within hours of “a breakdown of law and order.”
Instead of funding more domestic loans, several banks diverted part of the stimulus funds to more profitable ventures such as developing markets and foreign currency investments.
The DoddFrank Wall Street Reform and Consumer Protection Act was passed in the United States in July 2010 with the goal of “promoting financial stability in the United States.” Globally, the Basel III capital and liquidity criteria have been adopted. Since the 2008 financial crisis, consumer authorities in the United States have increased their oversight of credit card and mortgage lenders in attempt to prevent the anticompetitive activities that contributed to the catastrophe.
What causes the economic downturn?
Most recessions, on the other hand, are brought on by a complex combination of circumstances, such as high interest rates, poor consumer confidence, and stagnant or lower real wages in the job market. Bank runs and asset bubbles are two further instances of recession causes (see below for an explanation of these terms).
What were the two most important topics in the presidential election of 2008?
What were the most crucial topics in the 2008 presidential election? The government deficit has increased. What impact did Osama bin Laden’s death have on US foreign policy? It strained relations between the United States and Pakistan.