03

The Great Recession

As Federal Reserve Chairman Ben Bernanke referred, it was a global financial meltdown that
devastated world financial markets as well as the banking and real estate industries. It’s generally
considered to be the longest period of economic decline since the Great Depression of the 1930s.

The great recession also some time referred to 2008 recession started from December 2007. The
crisis led to increases in home mortgage foreclosures worldwide and caused millions of people to
lose their life savings, their jobs and their homes. Although its effects were definitely global in
nature, the Great Recession was most pronounced in the United States and in Western Europe.

Events that led to the recession

Here is just a peek into the financial devastation that occurred during the Great Recession:

 Unemployment: The national unemployment rate rose from 5% in December 2007, to

10% in October 2009.

 Mass layoffs: Mass layoffs (occurring when 50 or more claims for unemployment
insurance are filed from one employer) involved 326,392 workers in just February of
2009.

 Foreclosures: An estimated 3 million households were foreclosed on from 2005 through

2009.

 GDP: GDP declined by 4.3% from 2007 to 2009.

 Stock market: The Dow Jones Industrial Average declined by 50% in 2007, plummeting
more in the following years to a low of under 10,000 for the first time ever. The S&P 500
declined by 57.8% from 2007 to 2009.

In 2006 the signs of recession started to show but the Bush administration and the Federal
Reserve did not realize how grave those early warning signs were. After years of cheap money,
excessive spending, and negative savings rates led to the recession, but the ultimate trigger for
the recession was the uncertainty surrounding the financial industry.

By the 2007, the US economy was already tipping into recession. Consumer spending was low,
unemployment was up, and financial markets were unstable.

Federal Reserve played a role in creating the crisis. Banks made easier to get the loans through
creating adjustable rate mortgages with low early payments and accepting people with low credit
history. These less-than-ideal loans were called sub-prime mortgages. Banks pool these
mortgages together into a single bond called CDO. And then these bonds were sold to third
parties such as insurance companies or other banks. But these CDOs were risky to invest in, so
banks employed a little bit of financial trickery. Normally, if you get insurance on an asset you
use it more freely because it is protected. This is where AIG comes in.

AIG was at that time the largest insurance company in America. They have been in business
since 1919. AIG transformed these highly- risky bonds into much safer products through selling
insurance on CDOs that had poor credit rating by giving them AAA+ rating. This insurance
policy was called Credit Default Swap. People bought these bonds blindly and AIG earned in
premiums. Considering the fact, the company gave insurance solely on the statistical probability
that the housing market will not crash.

In 2007 housing market crashed leaving many Americans with a debt burden that was greater
than what their homes were worth. But banks weren’t concerned yet, because they thought that it
was secured and AIG would honor their end of bargain. AIG realized their mistake that they
have ensured far too many CDOs to possibly pay up.

On September 15, 2008 AIG ran out of the money while Lehman brothers announced
bankruptcy. Worried that this was becoming a pattern, the Fed decided to lend AIG $85 bn so
that it could remain afloat. Political leaders justified the decision, saying AIG was “too big to
fail,” and that its collapse would further destabilize the U.S. economy.

Stock market crashed in September 29 2008 which made the situation much worse. Watching
this catastrophic chain of events government intervened. Fed reduced the national target interest
rate to 0%, which lenders use as a guide for setting rates on loans. Additionally, President George
W. Bush introduced the Economic Stimulus Act, which, among many things, doled out tax rebates,
reduced taxes, provided businesses with incentives to invest capital, and increased loan limits to
encourage taking out loans and bolster the economy.

But, the package couldn't save the drowning economy, worsen the Great Recession.

Stimulation and Regulation

In October 2008, President Bush created the Troubled Asset Relief Program (TARP) in order to
prevent the total collapse of financial market, hoping to allocate some $700 billion in funds to
buying assets from struggling companies in order to keep them afloat. Funds from TARP were
used to bailout the likes of General Motors and Chrysler (together, some $80 billion), while a
hefty $125 billion was used to help out Bank of America in 2009.

Fresh into his presidency, President Barack Obama signed the American Recovery and
Reinvestment Act in February 2009, a massive stimulus package that allotted $787 billion as
foreclosure relief; tax cuts, spending on infrastructure and more.

The Dodd-Frank Act was passed in 2010. The act gave the federal government the ability to take
over banks if they were thought to be on the edge of collapse, as well as prevent so-called
"predatory lending" to under-qualified borrowers.

However, President Trump has recently made moves to alter the act.

Aftermath

In 2009 the recession was officially over but it took years to make a recognizable recovery.
Unemployment numbers took years to stabilize even after creating more employment from 2009
to 2010, wealth inequality increased dramatically, and many homeowners are still in debts
because of the mortgages.