The Great Recession, as it has been dubbed, was caused by the worst global financial crisis since World War II. Its effects, including unemployment and public debt, will continue to haunt economies for years.
When discussing recession, it's difficult to avoid thinking of the Great Recession of 2008, which remains big in many people's thoughts due to the devastation it caused to the global economy.
In reality, many industries and generations still feel the effects, especially those who graduated during the chaos and had problems finding employment.
There's no question that the coronavirus has pushed the nation into a recession, but it's not yet clear how severe it will be or how long it could persist. Now is a good moment to reflect on the previous global recession and see what lessons may be drawn from it.
What caused the 2008 Recession?
Although it is frequently referred to as the Great Recession of 2008, its roots were planted in 2006, when warning signs of an economic crisis in the housing and financial industries first surfaced.
Let's look at what happened before the recession.
1. The subprime mortgage crisis caused a spike in housing prices followed by a decline.
Many mortgage lenders broadened their definition of creditworthiness during the last housing bubble and boom in the early to mid-2000s. They began to provide mortgages to purchasers with bad credit histories who didn't meet the prior criteria for an appropriate borrower.
Banks took these high-risk loans and began purchasing them as "mortgage-backed securities" (investments guaranteed by mortgages). This product grew immensely popular but was often misunderstood by common investors.
The high demand for this new investment product caused a rise in dangerous and predatory bank lending practices and an expansion in the housing market. The Federal Reserve Bank started raising interest rates while house prices were growing, and they finally did, reaching 5.25 percent by June 2006.
Millions of new borrowers had adjustable-rate mortgages, which meant that while their initial payments were originally lower and more manageable, their monthly interest payments quickly skyrocketed along with the higher interest rates. In contrast, those with fixed-rate mortgages were unaffected.
Many people failed on their loans because they couldn't make payments or sell their properties for a profit.
As a result, housing prices began falling, and more inventory entered the market. Prices kept falling. Finally, in December 2008, the housing market reached its lowest point.
2. Banks had a crisis.
Banks stopped lending to one another because they were concerned they would be forced to hold subprime mortgages as collateral if home values declined. Mortgage-backed securities proved to be no longer the solid gold investments they had once been. The Fed drastically reduced interest rates in August 2007 to boost confidence, but this was insufficient.
The U.S. Treasury launched a superfund in November 2007 to purchase troubled subprime mortgage portfolios, calm the panic, and give banks and hedge funds access to cash.
Then, in December 2007, the Fed established the Term Auction Facility (TAF), providing banks with short-term funding for subprime mortgages.
Yet again, it was too late and too little.
Famous investment firms like Bear Stearns and Lehman Brothers failed, while mortgage behemoths Freddie Mac and Fannie Mae were on the verge of failure.
3. The stock market crashed, wiping out fortunes.
As foreclosures increased, the stock market fell and eventually crashed in September 2008, losing more than half its value. The collapse of both the home market and the stock market caused Americans to lose a shocking amount of money. Over half of all households lost at least 25% of their wealth between 2007 and 2011, while one-fourth of American families lost at least 75% of their value.
4. Errors in regulation and policy.
MBS products and subprime loans were subject to too little regulation. The organizations that produced and offered sophisticated, complex MBS to investors needed more oversight.
Not only were too many financial firms and individual borrowers given risky loans that were too big to manage, but fraud was also becoming more prevalent. Examples include exaggerating a borrower's income and misleading investors about the security of the MBS products offered.
Additionally, many governments and central banks needed to properly comprehend the extent to which subprime loans had been extended during the boom and the numerous ways mortgage losses spread across the financial and banking system as the crisis developed.
The Effects of the Recession of 2008
All terrible things, thankfully, eventually come to an end, and the Great Recession did as well in 2008 when the federal government initiated two major programs to aid individuals suffering from the recession:
1. The Troubled Assets Relief Program (TARP) provided aid.
Congress created the Troubled Asset Relief Program (TARP) in September 2008, allowing the U.S. Treasury to bail out failing banks by loaning them billions to acquire "preferred stock."
Under that proposal, banks would give the government a 5 percent dividend that would climb to 9 percent in 2013, incentivizing them to buy back the stock during that period.
But TARP money discovered a benefit other than banks. The Treasury used them in November 2008 to save American International Group (AIG), a big insurance company, from bankruptcy.
Following that, in December 2008, President George W. Bush used the money to save the "Big Three" car manufacturers (GM, Chrysler, and Ford), who were in danger of going bankrupt and losing a significant number of jobs.
Finally, in February 2009, TARP funds were used for the Homeowner Affordability and Stability Plan, which allowed homeowners to refinance or restructure their mortgages to stay current on their payments and fight additional foreclosures, and the Home Affordable Modification Program, which encouraged banks to reduce monthly mortgage payments for those facing foreclosure.
2. The ARRA (American Recovery and Reinvestment Act) encouraged development.
President Obama launched a $787 billion economic stimulus plan in February 2009 to boost consumer spending and confidence. Three primary sections made up the Act:
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Tax cuts
It helped both individuals and small companies. First, by lowering withholdings, the tax was decreased by $400 for individuals and $800 for families. In addition to other perks, small companies experienced a rise in their tax deduction for equipment and tax credits for employing jobless veterans and students.
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Spending on assistance programs
The ARRA increased payments to beneficiaries of Social Security, veterans' pensions, Supplemental Security Income benefits, and prolonged unemployment benefits.
Additionally, it provided a wide range of tax credits for college expenses and first-time homebuyers, enhanced access to healthcare, and increased funding for several education programs, including teacher salaries, Head Start, which helps low-income young children prepare for school, and Pell Grants for needy college students.
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Providing employment
The ARRA included funding projects to improve roads, government buildings, and water quality, update infrastructure, and create jobs.
Policy Responses in a Nutshell
Lowered Interest Rates
Increased Government Spending
Stronger Regulation of Financial Institutions
Recovery is Slow but Continuous
After over five years, the Federal Reserve finally revealed in March 2013 that family wealth had increased to $66.1 trillion at the end of 2012. That reflected a 91 percent recovery from the losses sustained and was $1.2 trillion greater than three months earlier.
When compared to an estimated low of $51.4 trillion in early 2009, private economists also claimed that stock and housing price increases had raised Americans' net worth over the pre-recession peak of $67.4 trillion. The employment gap also looked to have been resolved by April 2014.
However, the effects may still be felt today, and many people have not entirely recovered, as evidenced by the fact that they are still unemployed or that their financial condition hasn't improved much.
Economic Downturns Across Time
It's intriguing how instances like the Great Recession of 2008 differ from previous occurrences. Except for The Great Depression of 1929, there have been five further significant U.S. economic crises in the modern era, most of which were shorter and less severe:
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The Great Depression of 1929
The ten-year downturn characterized by a stock and housing market collapse, a high unemployment rate, and starvation remains the lowest point.
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Stagflation in the 1970s
The economic situation known as "stagflation" in the 1970s was marked by high unemployment, slow economic growth, and rising inflation.
The Organization of Petroleum Exporting Countries (OPEC) 's 1973 oil embargo, which reduced the amount of oil sent to the United States, has been identified as one of the major reasons for the economic weakness of the 1970s, which lasted from November 1973 to March 1975.
This economic recession was worsened by unemployment and fiscal measures such as a wage and price freeze, an import tax, and a departure from the "gold standard," which led to a decline in the dollar's value.
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1981 Recession
Between July 1981 and November 1982, the GDP (gross domestic product) was negative for six quarters, which increased unemployment to 10.8%.
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1989 Savings and Loan Crisis
From July 1990 to March 1991, the failure of more than 1,000 of the country's savings and loans and a declining real estate market caused a recession.
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The 2001 Internet Bubble and the 9/11 Attacks
The recession was primarily caused by the rise and crash of the "dot-com" economy, which was made worse by the 9/11 attacks and the following unrest.
Other, lesser recessions occurred between them, but they caused the most significant harm.
Can we prevent a recession like the one in 2008?
Recessions may start for various reasons, but it's doubtful that future ones would mirror 2008's in every way. The Dodd-Frank Act, enacted on July 21, 2010, is mostly responsible for this. The principal parts were as follows:
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Providing greater regulation to prevent any banking or insurance company from growing to a size that may endanger the financial sector.
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The Volcker Rule forbids banks from employing or holding hedge funds for their financial gain and mandates that they only do so at customers' request. In addition, since one of the main factors contributing to the Great Recession in 2008 was that investors needed to comprehend these complicated goods fully, hedge funds must register with the Securities and Exchange Commission (SEC) and submit information about their transactions and portfolios.
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The Commodity Futures Trading Commission, or the SEC, regulates risky derivatives. These financial contracts generate value from an underlying asset that a buyer commits to acquiring at a certain price and exchange through a clearinghouse similar to the stock market. (Again, hedge funds' use of derivatives exacerbated the subprime mortgage crisis.)
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Establishing more monitoring to examine future Fed emergency loans.
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Monitoring credit rating organizations that worsened the crisis by declaring some derivatives safe when they weren't.
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There are increasing regulations for all consumer financial goods, including credit cards, loans, and mortgages. Most importantly, mortgage consumers need additional information to ensure they know the hazards. Banks must also confirm the borrowers' income, credit history, and employment status to screen out riskier loans.
What benefits some people may not benefit others, and banks argued that some rules were too onerous for smaller institutions.
Because of this, the Dodd-Frank regulations for small and medium-sized banks (defined as those with less than $250 billion in assets) were repealed in 2018, leaving only the biggest banks in the country subject to the tighter regulations.
However, several consumer safeguards remain in place.
Even if many factors that contributed to the Great Recession in 2008 have been reduced, new threats can still have a devastating effect similar to the recession, as we saw with the coronavirus outbreak and the ensuing closure of companies nationwide.
A recession is difficult to forecast. However, since the reasons for a recession are mostly beyond our control, the best defense is to educate yourself.
Adopting sound financial practices, such as minimizing extravagant spending, sticking to a budget, and, where feasible, setting up a sizeable emergency fund, is the most crucial way for consumers to weather a recession.
