Late 2000s recession

A global recession beginning in 2007 caused largely by a sudden collapse of the “housing bubble”; also known as the Great Recession

During the 2000s, low interest rates for mortgages, coupled with the expansion of credit to first-time homeowners with limited incomes, rising gas prices, and abysmal consumer confidence spurred one of the worst recessions in US history. This recession caused the collapse of several major banking institutions. The recession ended in 2009, but the economic trend continued to cost jobs, to lower incomes, and to slow growth.

The early twenty-first century was marred by a severe recession that began shortly before (and was exacerbated by) the terrorist attacks of September 11, 2001. In an effort to restart the stagnant economy, the US Federal Reserve significantly lowered interest rates, encouraging Americans to use greater access to credit to purchase real estate. This activity helped restart the economy. However, the willingness of financial institutions to expand credit to first-time homeowners (many of whom did not previously have the credit and/or the income to purchase homes) artificially inflated housing prices, creating a “housing bubble.” In 2007, this bubble collapsed, triggering a severe global recession.

A recession may be defined as a period during which economic growth declines significantly, as manifest in a fall of a nation’s gross domestic product. The Great Depression of the 1930s was the most severe recession in American history. However, the late 2000s recession was, in the minds of most observers, the worst such trend since the Depression. The late 2000s recession was evident in a wide range of areas. Unemployment rates rose significantly, especially during the 2007–8 period. The construction industry was especially hard-hit, given that new home construction was at a minimum.

The recession occurred primarily because it was not readily understood or anticipated. The signs of a coming recession were indeed manifest—monthly jobs reports were showing consistent losses and the housing market (and relevant construction) was declining rapidly. However, the government’s response was simply to lower interest rates, hoping that the reduction would stimulate growth within a few months. The focus was on inspiring consumer confidence before the sluggishness that was affecting the financial sector seeped into the lives of private citizens. However, consumer confidence was already disappearing quickly, and it became clear that the fundamental causes of the recession were more extensive and severe than previously assessed. The downturn was attributed to a number of factors.

Low Interest Rates

In many ways, interest rates are indicators of a pending recession. Some economists argue that recessions are cyclical, and that careful monitoring of interest rates can help signal the next phase of a fiscal cycle. This theory is supported by the fact that low interest rates were in place at the start of the recession. In fact, interest rates were lowered during the previous recession (which began in 2001) as a means of reinvigorating the economy. As the economic environment improved by the middle of the decade, however, the Federal Reserve opted to slowly raise interest rates again, keeping in tune with the recovery.

Policymakers, businesses, and private citizens typically welcome low interest rates. Americans are able to borrow more, allowing them to expand their businesses and purchase more goods and even homes. Then again, low interest rates, when weighed against the rates at which banks buy and sell their reserves (the “federal funds rate”), can create an imbalance. In 2006, this imbalance was evident, particularly as oil prices rose and the housing market began to decline while interest rates continued to rise. The Federal Reserve again lowered interest rates when signs of recession became manifest, but oil prices continued to rise and the real estate market contracted. Because of this imbalance, the Federal Reserve’s manipulation of interest rates created turmoil in the markets, hastening the recession’s development.

Despite the imbalances it can cause, reducing interest rates can have a positive influence on the economy. Lower interest rates can inspire more investment and purchases, from homes to groceries. They help increase consumer confidence, which fuels commerce and the economy as a whole. The problem, however, was that economists did not yet have a handle on the nature of the housing bubble’s collapse, which was at the core of the recession.

Subprime Lending

The subprime mortgage crisis was arguably the factor that worsened the recession. Ironically, this crisis was caused by market demand.

The federal government’s stated desire for Americans to purchase their own homes (a decades-long theme) helped foster the development of an industry within the financial sector, one that contributed heavily to the late 2000s recession. Lenders have long offered competitive mortgage rates to credit-worthy consumers. However, by the 2000s, lenders’ eyes turned to a sector of the population that previously could not afford to purchase homes. Subprime lenders took advantage of a lack of government oversight and a federal push for homeownership (which helped spur economic recovery after the 2001–4 recession), offering mortgages to people with credit problems and/or low incomes. The risks associated with these loans became liabilities when the real estate market began to collapse. More and more subprime-mortgage customers were unable to keep up with their payments, which meant that banks were losing great sums of money used to fund their reserves. It has been widely accepted that the practice of subprime lending contributed heavily to the financial collapse of several major banking institutions, the global markets, and clients with whom they did business.

The subprime crisis has been viewed by many as a “contagion” that would ultimately impact foreign economies as well. The impacts may be viewed in two general arenas, within the financial sector and outside the banking industry. In the former, economists at first believed many major banks outside of the United States might be able to withstand the subprime crisis. For example, the major international financial institutions of Japan (such as the Bank of Japan) appeared to have deep reserves and strong assets. Additionally, like the financial institutions of India and China, Japan’s banks were becoming increasingly decoupled (not dependent on connections with Western economies). However, the subprime crisis was so severe and sudden that it caused a sharp drop in stock markets, meaning even the Japanese banks with investments in those markets were forced to raise new capital to offset that decline. Even India and China were not entirely immune, although their state-supported and heavily insulated institutions fared far better during the recession. These economies suffered moderately because, as foreign investors lost major sums in American and other markets, they sold their holdings in Indian and Chinese companies to offset their losses.

Outside of the financial sector, the subprime crisis had a more indirect—but nonetheless significant—impact. As American consumers struggled to address the debts caused by subprime mortgages, demand for foreign imports dropped markedly. Japan, which long held a trade surplus with the United States (particularly in the automotive and information-technology manufacturing industries), saw business come to a virtual standstill.

The decline in foreign imports was particularly evident in (but by no means localized to) luxury industries. In India, for example, the major corporation Tata had purchased a number of foreign businesses, including Jaguar’s luxury sport utility vehicle the Land Rover (which had been in high demand only a few years prior), only to see those businesses underperform as the result of a lack of demand. The trend was global: Consumer demand became stagnant and trade was stifled, causing job losses and economic downturns in nations all over the world.

Credit and Debt

In the years leading up to the start of the Great Recession, available credit expanded in the United States. Mortgages were one such area in which credit was expanded. Consumers took advantage of historically low interest rates not only to purchase homes but also to pay for other products and services. The market accommodated this expansion, as the financial, insurance, and real estate sectors continued to grow to meet an enlarging customer base. Meanwhile, the rising price of homeownership, along with an economy that limited personal income growth (if income was not reduced) and the consistently increasing price of oil, meant that Americans were less able to pay down their credit debts.

There is evidence that suggests that the government’s deregulation efforts in the years prior to the mid-2000s made it possible for an expansion in credit availability. Several policy initiatives (including the Gramm-Leach-Bliley Act of 1999) relaxed regulations on the financial sector. These deregulatory acts made it possible for financial institutions to introduce new, innovative tools that could make credit more accessible for consumers. Such an environment enabled more Americans to add what could be viewed as an additional source of income to their households. Within the context of the late 2000s recession, however, this fact shrouded the severity of the situation facing the economy.

In fact, statistics on real income growth during the early to mid-2000s were misleading—most of the data included individual credit along with wages and assets. Although some citizens (namely those at the higher end of the income scale) saw actual increases in their income during the period leading up to the start of the recession, the vast majority of people experienced reductions in their incomes (a fact clouded by their credit).

Meanwhile, consumers continued to purchase goods and services using their credit. These expenditures helped charge the manufacturing and retail sectors, but only for a time. The increasing number of indebted consumers (whose disposable incomes could not compensate for their purchases) triggered a “negative credit shock” (a sudden decline in available credit). The negative credit shock brought business (which relies on credit to facilitate commerce) to a virtual standstill.

Impact

The recession of the late 2000s had a profound and extensive impact on the global economy. One of the most visible areas in which this impact was evident was in the housing market. Low-income homeowners who obtained subprime loans were increasingly unable to repay their mortgages, causing a sharp increase in foreclosures. Meanwhile, the housing crisis meant that banks lost funds used to invest in markets in the US and abroad. This issue meant that banks could not cover their own debts, causing the collapse of several financial institutions and the near-collapse of several others.

The extreme financial losses reported at some of the world’s largest banks caused a ripple effect abroad, as central banks across Europe and Asia were unable to compensate for the loss of their American banking partners. As banks struggled to keep open their doors, they could not invest in or support businesses, causing employers to lay off a high number of staff. Unemployment exacerbated the situation, as more people were unable to pay their mortgages and personal debt. Consumers’ financial situations gave way to low consumer confidence, which stymied both American and international commerce and trade.

By the end of the 2000s, several governments launched initiatives to consolidate and protect financial institutions as well as to spur economic growth. However, a number of economists predicted that the recession would last at least a few years into the next decade. While the official end of the recession was 2009, the effects of the recession lingered into the next decade: consumer confidence remained low, unemployment rates did not improve significantly, and housing sales stayed stagnant.

Bibliography

Carr, Fred M., and Jane A. Beese. “The Federal Reserve Rate Manipulations from 2000–2007 and the Housing Mortgage Crisis of 2008.” Journal of Economics and Economic Education Research 9.2 (2008): 107–15. Print. Describes the effects of the Federal Reserve’s interest-rate policies on the American economy, leading up to the 2007 recession.

Dore, Mohammed, and Rajiv Singh. “The Role of Credit in the 2007-2009 Great Recession.” Atlantic Economic Journal 40.3 (2012): 291–313. Print. Examines the role the expansion of credit played in the recession by increasing apparent rates of personal income and later triggering a negative credit shock that undermined financial institutions and markets.

Duffie, Darrell. How Big Banks Fail and What to Do about It. Princeton: Princeton UP, 2010. Print. Describes the significance of large banks with a presence in global markets. These banks, the author argues, played a major role in the global financial crisis of the late 2000s.

Hetzel, Robert L. The Great Recession: Market Failure or Policy Failure? New York: Cambridge UP, 2012. Print. Uses a macroeconomic perspective, describing the credit crisis of the latter 2000s as part of an economic cycle that has persisted since the nineteenth century.

Krugman, Paul. The Return of Depression Economics and the Crisis of 2008. New York: Norton, 2009. Print. Traces the causes of the recession of the late 2000s to issues with the US banking regulatory system.

Lambert, Thomas E. “Falling Income and Debt: Comparing Views of a Major Cause of the Great Recession.” World Review of Political Economy 2.2 (2011): 249–61. Print. Discusses how American consumers’ efforts to borrow more to pay for the rising cost of living, coupled with the practice of subprime lending and other factors, fueled consumer debt and the Great Recession as a whole.

Mishkin, Frederic S. “Over the Cliff: From Subprime to the Global Financial Crisis.” Journal of Economic Perspectives 25.1 (2011): 49–70. Print. Describes the impact of subprime lending on American financial institutions, contributing significantly to the recession.