The Great Recession was a global economic downturn that devastated world financial markets as well as the banking and real estate industries. 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. It’s generally considered to be the longest period of economic decline since the Great Depression of the 1930s. Although its effects were definitely global in nature, the Great Recession was most pronounced in the United States—where it originated as a result of the subprime mortgage crisis—and in Western Europe.
What Is A Recession?
A recession is a decline or stagnation in economic growth, but the economic indicators used to define the term “recession” have changed over time.
Since the Great Recession, the International Monetary Fund (IMF) has described a “global recession” as a decline in real per-capita world gross domestic product (GDP), as supported by other macroeconomic indicators such as industrial production, trade, oil consumption and unemployment, for a period of at least two consecutive quarters.
By that definition, in the United States, the Great Recession started in December 2007. From that time, until the event’s end, GDP declined by 4.3 percent, and the unemployment rate approached 10 percent.
Causes of the Recession
The Great Recession—sometimes referred to as the 2008 Recession—in the United States and Western Europe has been linked to the so-called “subprime mortgage crisis.”
Subprime mortgages are home loans granted to borrowers with poor credit histories. Their home loans are considered high-risk loans.
With the housing boom in the United States in the early to mid-2000s, mortgage lenders seeking to capitalize on rising home prices were less restrictive in terms of the types of borrowers they approved for loans. And as housing prices continued to rise in North America and Western Europe, other financial institutions acquired thousands of these risky mortgages in bulk (typically in the form of mortgage-backed securities) as an investment, in hopes of a quick profit.
These decisions, however, would soon prove catastrophic.
Subprime Crisis
Although the U.S. housing market was still fairly robust at the time, the writing was on the wall when subprime mortgage lender New Century Financial declared bankruptcy in April 2007. A couple of months earlier, in February, the Federal Home Loan Mortgage Corporation (Freddie Mac) announced that it would no longer purchase risky subprime mortgages or mortgage-related securities.
With no market for the mortgages it owned, and therefore no way to sell them to recoup their initial investment, New Century Financial collapsed. Just a few months later, in August 2007, American Home Mortgage Investment Corp. became the second major mortgage lender to crack under the pressure of the subprime crisis and the declining housing market when it entered Chapter 11 bankruptcy.
That summer, Standard and Poor’s and Moody’s credit ratings services both announced their intention to reduce the ratings on more than 100 bonds backed by second-lien subprime mortgages. Standard and Poor’s also placed more than 600 securities backed by subprime residential mortgages on “credit watch.”
By then, as the subprime crisis continued, housing prices across the country began to fall, due to a glut of new homes on the market, so millions of homeowners—and their mortgage lenders—were suddenly “underwater,” meaning their homes were valued less than their total loan amounts.
Fed Drops Interest Rates
Interestingly, on October 9, 2007, the U.S. stock market reached its all-time high, as the key Dow Jones Industrial Average exceeded 14,000 for the first time in history.
However, that would mark the last bit of good news for the U.S. economy for some time.
Over the next 18 months, the Dow would lose more than half its value, falling to 6,547 points. As a result, hundreds of thousands of Americans who had significant portions of their life saving invested in the stock market suffered catastrophic financial losses.
Indeed, over the course of the Great Recession, the net worth of American households and non-profits declined by more than 20 percent from a high of $69 trillion in the fall of 2007 to $55 trillion in the spring of 2009—a loss of some $14 trillion.
With the American economy teetering, the U.S. Federal Reserve (or “Fed”) began taking action, reducing the national target interest rate, which lenders use as a guide for setting rates on loans.
Interest rates were at 5.25 percent in September 2007. By the end of 2008, the Fed had reduced the target interest rate to zero percent for the first time in history in hopes of once again encouraging borrowing and, by extension, capital investment.
Stimulus Package
Of course, lowering the target interest rate wasn’t the only thing the Fed and the U.S. government did to combat the Great Recession and minimize its effects on the economy.
In February 2008, President George W. Bush signed the so-called Economic Stimulus Act into law. The legislation provided taxpayers with rebates ($600 to $1,200), which they were encouraged to spend; reduced taxes; and increased the loan limits for federal home loan programs (for example, Fannie Mae and Freddie Mac).
This last element was designed to, hopefully, generate new home sales and provide a boost to the economy. The so-called “Stimulus Package” also provided businesses with financial incentives for capital investment.
Too Big to Fail
However, even with these interventions, the country’s economic troubles were far from over. In March 2008, investment banking giant Bear Stearns collapsed after attributing its financial troubles to investments in subprime mortgages, and its assets were acquired by JP Morgan Chase at a cut-rate price.
A few months later, financial behemoth Lehman Brothers declared bankruptcy for similar reasons, creating the largest bankruptcy filing in U.S. history. Within days of the Lehman Brothers’ announcement, the Fed agreed to lend insurance and investment company AIG some $85 billion 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.
TARP Program
With fears that similar collapses could be sustained by other major financial companies and banks, President Bush approved the Troubled Asset Relief Program (TARP) in October 2008. TARP essentially provided the U.S. government with $700 billion in funds to purchase the assets of struggling companies in order to keep them in business. The deals would enable the government to sell these assets at a later date, hopefully at a profit.
Within a few weeks, the government spent $125 billion in TARP funds in acquiring assets from nine U.S. banks. In early 2009, TARP funds were also used to bail out automakers General Motors and Chrysler (a combined $80 billion) and banking giant Bank of America ($125 billion).
January 2009 also brought with it a new administration in the White House, that of President Barack Obama. However, many of the old financial problems remained for the new president to tackle.
In his first few weeks in office, President Obama signed a second “Stimulus Package” into law, this time earmarking $787 billion for tax cuts as well as spending on infrastructure, schools, health care and green energy.
Whether or not these initiatives brought about the end of the Great Recession is a matter of debate. However, at least officially, the National Bureau of Economic Research (NBER) determined that, based on key economic indicators (including unemployment rates and the stock market), the downturn in the United State officially ended in June 2009.
Aftermath of the Great Recession
Although the Great Recession was officially over in the United States in 2009, among many people in America and in other countries around the world, the effects of the downturn were felt for many more years.
Indeed, from 2010 through 2014, multiple European countries—including Ireland, Greece, Portugal and Cyprus—defaulted on their national debts, forcing the European Union to provide them with “bailout” loans and other cash investments.
These countries were also compelled to implement “austerity” measures—such as tax increases and cuts to social benefit programs (including healthcare and retirement programs)—to repay their debts.
Dodd-Frank Act
The Great Recession also ushered in a new period of financial regulation in the United States and elsewhere. Economists have argued that repeal in the 1990s of the Depression-era regulation known as the Glass-Steagall Act contributed to the problems that caused the recession.
While the truth is probably more complicated than that, repeal of the Glass-Steagall Act, which had been on the books since 1933, did allow many of the country’s larger financial institutions to merge, creating much larger companies. This set the stage for the “too big to fail” bailouts of many of these firms by the government.
The Dodd-Frank Act, which was signed into law by President Obama in 2010, was designed to restore at least some of the U.S. government’s regulatory power over the financial industry.
Dodd-Frank enabled the federal government to assume control of banks deemed to be on the brink of financial collapse and by implemented various consumer protections designed to safeguard investments and prevent “predatory lending”—banks who provide high-interest loans to borrowers who likely will have difficulty paying.
After he was inaugurated, President Donald Trump and some members of Congress made several efforts to gut key portions of the Dodd-Frank Act, which would remove some of the rules protecting Americans from another recession.
READ MORE: The Great Recession Timeline
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Full Timeline. Federal Reserve Bank of St. Louis.
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