- 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 to blame for the economic downturn of 2009?
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.
In 2009, what went wrong with the economy?
In 2009, the Great Recession’s financial crisis deepened. The stock market fell even further in March, causing panic among investors who assumed the worst was over. Despite government programs that did not go far enough, foreclosures increased. For the first time since 1982, the jobless rate reached 10% in October.
The Obama administration promoted a $787 billion job-creation plan. By the middle of the year, economic growth had finally turned positive. The Great Recession was technically over.
In truth, the damage was so extensive that it took years for things to appear to be improving. Things only grew worse for those who remained unemployed, lost their houses and credit ratings, or were forced to take positions that paid significantly less. The timelines of the financial crises of 2007 and 2008 show how these events unfolded and how the government failed to recognize early warning signs.
What triggered the Great Recession of 2008?
The Federal Reserve hiked the fed funds rate in 2004 at the same time that the interest rates on these new mortgages were adjusted. As supply outpaced demand, housing prices began to decrease in 2007. Homeowners who couldn’t afford the payments but couldn’t sell their home were imprisoned. When derivatives’ values plummeted, banks stopped lending to one another. As a result, the financial crisis erupted, resulting in the Great Recession.
What role did government play in the Great Recession?
The Great Recession, which began in 2008 with the US subprime mortgage crisis, was caused by a number of factors, both directly and indirectly. Lax lending standards contributed to the real-estate booms that have since burst; U.S. government housing policies; and weak supervision of non-depository financial institutions were among the key causes of the original subprime mortgage crisis and the subsequent recession. When the recession hit, a variety of responses were tried, with varying degrees of effectiveness. These included government fiscal policies, central bank monetary policies, measures to assist indebted consumers refinance their mortgage debt, and countries’ differing approaches to bailing out troubled banking industries and private bondholders, such as assuming private debt burdens or socializing losses.
How did the Great Recession come to an end?
Congress passed the Struggling Asset Relief Scheme (TARP) to empower the US Treasury to implement a major rescue program for troubled banks. The goal was to avoid a national and global economic meltdown. To end the recession, ARRA and the Economic Stimulus Plan were passed in 2009.
What was the bailout amount in 2009?
Treasury Secretary Henry Paulson sponsored the Emergency Economic Stabilization Act of 2008, which was passed by the 110th United States Congress and signed into law by President George W. Bush. In the middle of the financial crisis of 20072008, the act was signed into law as part of Public Law 110-343 on October 3, 2008. The $700 billion Troubled Asset Relief Program (TARP) was established by the law to purchase toxic assets from banks. While the Treasury continued to evaluate the value of targeted asset purchases, the money for distressed asset purchases were primarily allocated to infuse capital into banks and other financial institutions.
During 2007 and 2008, a financial crisis emerged, owing in part to the subprime mortgage crisis, which resulted in the failure or near-failure of major financial firms such as Lehman Brothers and American International Group. To prevent the financial system from collapsing, Treasury Secretary Henry Paulson proposed that the US government buy hundreds of billions of dollars in distressed assets from banking companies. Congress initially rejected Paulson’s idea, but the deepening financial crisis and President Bush’s lobbying eventually led Congress to approve Paulson’s proposal as part of Public Law 110-343.
TARP recovered $441.7 billion from $426.4 billion invested, making a $15.3 billion profit or an annualized rate of return of 0.6 percent, and possibly a loss when adjusted for inflation.
What caused the global recessions of 2008 and 2009?
- The Great Recession refers to the global financial crisis that occurred in 2008-2009.
- It all started with the housing market bubble, which was fueled by an overabundance of mortgage-backed securities (MBS) that packaged high-risk loans together.
- Reckless lending resulted in an unprecedented number of defaulted loans; when the losses were added up, several financial institutions failed, necessitating a government rescue.
- The American Recovering and Reinvestment Act of 2009 was enacted to help the economy recover.
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 hastened its interest rate decreases 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” technique was meant to persuade the public that interest rates would remain low at least until specific economic conditions were met, exerting 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.
Why wasn’t Lehman Brothers bailed out?
Treasury Secretary Hank Paulson and other authorities worked feverishly in the days leading up to Lehman’s bankruptcy filing on September 15, 2008, to negotiate a sale or rescue. 2 The regulators declined to offer a federal guarantee or any other form of assistance. Following Bank of America’s decision not to pursue an acquisition, the parties discussed selling Lehman’s brokerage activities and other “good” assets to Barclays while leaving its struggling real estate holdingsthe “bad” assetsbehind. The real estate assets would be funded by the other systemically important banks contributing at least $1 billion apiece. 3 The deal fell through because the Financial Services Administration, the United Kingdom’s securities regulator, declined to waive the shareholder vote required before Barclays could guarantee Lehman’s operations during the sale period.
Regulators pressed Lehman to file for bankruptcy, much to the chagrin of Lehman’s bankruptcy lawyers, because the Barclays transaction was in disarray.
According to a widely circulated narrative of Lehman’s demise, the chief bankruptcy lawyer grumbled, “No one from the Fed was urging us to file yesterday.”
4
Reserve Primary Fund, a prominent money market fund that held a large amount of Lehman’s commercial paper, announced shortly after Lehman filed for Chapter 11 that it would be forced to “break the buck”that is, it would not be able to pay its investors a whole dollar for each dollar they had invested.
This sparked a run on money market funds, which the Fed quelled by offering to guarantee the assets of money market funds.
The Fed bailed out AIG the day after Lehman filed for bankruptcy, and Congress passed the Troubled Asset Relief Program (“TARP”) a few weeks later, allocating $700 billion to financial system stabilization.
Even after ten years, one major question remains unanswered: could regulators have bailed out Lehman if they wanted to?
In the years since the collapse, major regulators have argued that they were unable to save Lehman because the bank lacked sufficient collateral to support a loan under the Fed’s emergency lending authority.
5Skeptics point out that the regulators initially justified their choice on various grounds, that the new lending authority was broad, and that the Fed and other regulators used this authority creatively to bail out Bear Stearns and AIG.6
Although the “could they” or “couldn’t they” issue may never be settled, the bigger implications of Lehman’s default are widely accepted.
There are three aspects to the popular understanding concerning Lehman.
First, while some initially praised regulators for not rescuing Lehman Brothers,7 the narrative gradually evolved.
According to the widely circulated narrative, Lehman’s failure was a pivotal moment in the 2008 financial crisis, and the regulators’ only big blunder.
Second, Lehman’s failure set off all of the subsequent financial chaos in the United States and around the world.
Third, bankruptcy was not an adequate option for resolving the financial difficulty of a systemically important financial institution (SIFI).
Every one of the assumptions is flawed.
Has Lehman Brothers declared bankruptcy?
On September 15, 2008, Lehman Brothers declared bankruptcy. 1 Hundreds of employees, most of them were dressed in business suits, exited the bank’s offices one by one, carrying boxes. It served as a grim reminder that nothing lasts forever, especially in the realm of finance and business.