The U.S. Recession and the Housing Crisis of 2007 and 2008
The global financial crisis rapidly transformed starting in mid 2007. During this crisis, there was a burst of the housing bubble in the United States that caused the worst recession witnessed in the world for nearly six decades. It was a sharp decline in the economic activity during the 2007 and 2008. During this time, housing market dropped significantly where derivatives and mortgages-backed securities amounting to billions of dollars lost significant value. The collapse of these securities jeopardized the solvency of financial institutions and over-leveraged banks in Europe and the U.S. This paper aims at identifying four key messages using a thorough review of the crisis in regard to consequences, causes, and policy responses. In addition, this paper will identify the causes, remedies and discourses of the Great Recession.
Background and Introduction
The 2007 global financial crisis laid its long shadow on many countries’ economic fortunes that was referred to as the ‘Great Recession’. Initially, it started as an isolated turmoil in the sub-prime segment of the housing market in the US that was transformed into a whole blown recession towards the end of 2007. Largely, the crisis came as a big surprise to various multilateral agencies, policy makers, investors, and academics. Subsequently, this financial crisis was the worst that ever happened since the great depression. As a result, a significant increase in the federal budget deficit was caused. It had a significant consequence on the American and worldwide banking systems. Though this recession originated from America, the entire world experienced the financial crisis. Economic globalization suggested that a great deal of non-American investors were quite exposed to the American financial markets. Consequently, the decline of those markets had a negative impact on the individuals and institutions abroad (Hetzel, 2012, p. 17). In addition, the financial crisis was the cause of the growing fears on levels of the public debt that contributed to the sovereign debt crisis that emerged in Ireland and Greece sometimes in 2010.
The causes of the Great Recession basically lie in government policies that are rather misguided, but not what many believe to be the underlying workings of the market. Ideally, these polices caused a boom that did not have capacity to create sustainable growth. Subsequently, it was bound to end in a bust, and this was the case.
Causes of the Great Recession
Primarily, the great recession was as a result of many indirect and direct factors that started in 2007. The major cause of the crisis was lax lending standards that led to high levels of first world countries real-estate bubbles and household debt and International trade, limited regulation of non-depository financial institutions, limited regulation of non-depository financial institution and American housing policies. When the recession started, certain responses were tried with various degrees of success. These were monetary policies of central banks, fiscal policies of governments, inconsistent approaches that were used by countries to bail out private bondholders and banking industries, imagining socializing losses and private debt burdens.
There is another theory illustrating the cause of the crisis, which starts with the considerable increase in putting aside savings for investments in the year 2000 to 2007. During this time, there was an increase in the global pool of fixed-income securities from nearly $38 trillion in 2001 to $80 in 2007. The crisis and recession resulted to a long period of expansion in US home prices, housing construction, and housing credit. Markedly, this expansion started sometimes in 1993 and progressed through the 2001 recession and later hastened towards mid-2000s (Hsu, 2013, p. 70). Between 19998 and 2006, US home prices more than doubled as the biggest increase in the US history was recorded. During this period, home ownership rose from 65% in 1995 to 68% in 2005. Similarly, residential investments increased considerably from 4.6% of US GDP to approximately 41% of job creation in the private sector between 2001 and 2005.
As the housing sector expanded, home mortgage borrowing by households in America expanded. As a result, the US household’s mortgage debt increased from 63% of GDP in 1998 to 98% in 2006. Indeed, various factors could have contributed to the increase in home mortgage debt. After the 2001 recession, FOMC Federal Open Market Committee sustain a low federal funds rate. However, some analysts claim that the fall in asset prices including mortgage backed securities in 2007 and 2008 had a huge impact on economy particularly on the bank run on the shadow banking system in the US, which include non-depository financial entities and investment banks.
Markedly, the system had experienced a tremendous growth to challenge the depository financial organizations in scale. However, it was not the focus of the same regulatory safeguards. Subsequently, banks that were struggling to build their reputation in Europe and America cut back lending and this caused a credit crisis. Some governments and consumers were unable to spend and borrow at pre-crisis level. Similarly, businesses restrained their investments as demand reduced and faltered their workforces. As a result of the recession, higher levels of unemployment made it quite difficult for countries and consumers to honor all their responsibilities and commitments (In Bellofiore, 2014). This resulted to deepening the credit crunch, and losses to surge of financial institutions thereby developing an adverse feedback loop.
The proximate and immediate cause of the 2008 crisis was caused by the risk of failure or failure at key financial institutions internationally, in March 2008 starting with the rescue of Bear Stearns an investment bank. The majority of these financial institutions had major investments in risky securities that mislaid all their worth after European and U.S housing bubbles started deflating on during the 2007-2009 era. In addition, various institutions were entirely dependent on short-term funding markets that were believed to be prone to disruption.
Markedly, the cause of these housing bubbles entailed two key factors considerable growth in savings that were available from growing countries as a result of ongoing trade imbalances, and low interest rates in Europe and U.S following the 2000 – 2001 recession in America. Subsequently, all these factors caused a huge increase in demand for investments that were believed to be high-yield. The majority of institutions considered lowering their credit standards so as to go on with feeding the international demand for housing securities, hence creating more profits that were shared by its investors. Additionally, they shared the risk. Household debts increased sharply as bubbles developed after 2000 (Roberts, 2010, p. 18).
The Beginning of the End
All this trouble began when home ownership reached a point of saturation and the interest rates stated rising. The Fed began increasing rates to an extent that by June 2006, the rates of the Federal funds had reached 6% and until August 2007, this percentage remained unchanged. As the decline started, people started experiencing early signs of distress in 2004. Home ownership in America had reached 70% to an extent that people were no longer interested in eating or buying more candy. However, home prices showed signs of falling in 2005 and this led to a 40% decline in the Home Constructions in America. Subsequently, the majority of supreme borrowers started defaulting on their loans after they were unable to withstand the higher interest rates. It was a bad year for investors and in particular, subprime lenders who constantly filed for bankruptcy.
The 2007 news reports said that hedge and financial firms owned over $1 trillion in securities backed by the supreme mortgages that were constantly failing. If more and more subprime borrowers continued defaulting, it would be enough to begin a global financial tsunami. In August 2007, it became clear that none of the financial markets could resolve the subprime crisis without external assistance and the issues increased to all borders in the U.S. Consequently, bodies such as the interbank market were completely frozen, mainly due to the fear of the unknown. One of the British banks, Northern Rock requested emergency funding from the Bank of England to solve a liquidity issue. At this time, governments and central banks around the world had begun liaising in so as to prevent more financial catastrophe.
Remedies and Discourses of the Great Recession
The Great Recession ended in mid 2009 when President Obama came into office. It was after a thorough research and intervention that Obama clearly understood that the Recession was an all-out crisis that required an all-out remedy trough policy response. Obama’s administration worked the FDIC and the Federal Reserve to assist in repairing the financial system. One of the biggest interventions by these bodies in fixing the financial system was working jointly to stem stabilize the housing market. The Federal Reserve and the treasury worked help reduce interest rates in mortgages, which resulted to lower payments for the many Americans who refinanced their homes. In addition, programs were started to assist responsible homeowners who were facing foreclosure to receive mortgage payments that were more manageable.
Actions of this policy complemented actions of the Federal Reserve. Subsequently, the policy interest rate was quickly reduced to about zero by the monetary policy makers. The policy makers also took on large-scale purchases of mortgage backed securities and government bonds to continue reducing longer-term interest rates. Markedly, this made a huge difference. For the third quarter in a row, great steps were significant in fixing the financial system. However, full recovery happened when spending began rebounding. In addition, Obama held talks with the Congress to jump-start the makeover to what is considers as clean energy that helped firms establish themselves as producers of solar panels, wind turbines and other energy products (Sperry, 2011, p. 9). As a result, more jobs were created.
To conclude, the Great Recession did not result from market failure. Instead, it was a typical example of the unintended repercussions of interventions by the government both through misguided attempts and expansionary monetary policy to boost housing market in America. The crisis and recession resulted to a long period of expansion in US home prices, housing construction, and housing credit. Markedly, this expansion started sometimes in 1993 and progressed through the 2001 recession and later hastened towards mid-2000s. Markedly, this amalgamation brought forth an unsustainable boom in years that followed the 9/11 attack (Rosenberg, 2012, p. 55). However, this boom was policy-induced. Economic globalization suggested that a great deal of non-American investors were quite exposed to the financial markets. As a result, the decline of those markets had a negative impact on the individuals and institutions abroad. However, programs were started to assist responsible homeowners who were facing foreclosure to receive mortgage payments that were more manageable.
The financial crisis caused the growing fears on levels of the public debt that contributed to the sovereign debt crisis that emerged in Ireland and Greece sometimes in 2010. Home ownership in America had reached 70% to an extent that people were no longer interested in eating or buying more candy. However, home prices showed signs of falling in 2005 and this led to a 40% decline in the Home Constructions in America. Ideally, Obama’s tenure from 2009 was the ultimate solution of this crisis. In collaboration with the Congress, he managed to come up with coherent ideas that fixed the financial system. Specifically, there was an initiative to stem the rising tide of foreclosures and stabilize the housing market. To add on to that, the treasury and the Federal Reserve worked jointly to help reduce interest rates in mortgages. Markedly, this intervention resulted to lower payments for the many Americans who refinanced their homes.
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