What Exactly Caused the 2008 Recession?

What Exactly Caused the 2008 Recession?
Point Editorial

Also called the Great Recession of the 2000s, the 2008 recession was a result of a severe decline in economic activity. Considered the worst downturn in America since the Great Depression of the 1930s, it lasted from December 2007 to June 2009. 

The recession’s immediate cause was an abrupt swing from a high economic boom to a bust in the housing market. 

Read on to learn more about the recession of 2008, what caused it, and its aftermath. 

What was the 2008 recession? 

Despite the severe hit that the U.S. economy suffered, the 2008 financial crisis did not reach Great Depression levels.  

The country's gross domestic product, or GDP, which refers to the total market value of all goods and services it produces, fell by 0.3 percent and unemployment rates rose to 10 percent.  

What caused the recession of 2008?

In 2011, the Financial Crisis Inquiry Commission published a statement declaring that the recession was indeed avoidable. The report described multiple reasons for this.

Immoderate investments and deregulation

The period before the recession was unofficially known as the Great Moderation. Despite its natural booms and busts, the economy as a whole was flourishing. 

Widespread optimism led to an excess of economic confidence and, therefore, also led to unwise spending. Investors, potential homeowners, and ordinary consumers believed the economy would continue to grow, and so they all took financial risks.

Meanwhile, the federal government practiced a hands-off approach with banks and brokerage firms, with minimal accountability. As a result, many larger firms initiated mergers among themselves, which severely decreased opportunities for smaller businesses.

The subprime mortgage crisis 

During this period, the federal government heavily advocated for homeownership. Interest rates were relatively low, so many people applied — and were approved — for mortgages.

Lenders had lax standards, often approving subprime loans and adjusting mortgages. Banks often lend subprime loans to individuals whose credit history is low and who have a poor repayment history. Adjustable mortgages refer to a loan in which the interest rate fluctuates. Both types of loans cater to borrowers who wouldn't otherwise qualify for a traditional or prime loan. 

Moneylenders were eager to take advantage of the boom and make a profit, and most borrowers assumed interest rates would remain low. Skyrocketing inflation rates, however, led to the opposite.  

The U.S. government failed to impose rules in order to reduce these behaviors.

Risky Wall Street behavior

Next, lenders sought to make even more money from the housing market explosion. Therefore, they amalgamated and resold distributed subprime loans to investment banks who, in turn, sold them to other investors around the world. These loan bundles were called mortgage-backed securities. Banks also started selling these securities as collateral for debts to cover their own significant loans. 

Just like homebuyers, institutions felt comfortable acquiring debt since the market appeared stable.

Weak watchdogs

The federal government wasn't the only "watchdog" that neglected its duties. Three main credit-rating agencies — Moody's, S&P, and the Fitch Group — are responsible for ranking investments and securities according to their stability on the market. These bodies awarded unstable securities triple-A ratings, which are typically only for the safest investments. They followed the advice of banks because banks were the ones handing out the securities.

The 2008 stock market crash

Like dominoes, prominent banking institutions began to declare bankruptcy. Lehman Brothers, the fourth-largest bank in the country, was the first to do so. They were $600 billion in debt. Witnessing this collapse, other banks panicked and stopped lending money, and both the national and global banking systems suffered from a dangerous shortage of funds.

Both foreign and domestic stocks lost their value as the bankruptcy pandemic spread its wings.

The federal response to the 2008 recession

The federal government created two programs to provide emergency assistance following the recession. 

Troubled Asset Relief Program (TARP)

This act allowed the government to buy $700 billion worth of toxic mortgages and securities to try and rebalance and cleanse the economic sector. The majority of this money was reinvested into banks to get them up and running again. 

The American Recovery and Reinvestment Act (ARRA)

In 2009, the government approved tax cuts, loan guarantees, and unemployment benefits to provide relief, as well as to encourage people to actively participate in the economy again. 

The aftermath of the 2008 recession

It wasn’t until 2011 that the nation's GDP surpassed recession levels and returned to where it was before December 2007. Unemployment rates did not improve as rapidly, however. It wasn't until 2015, eight years later, that it dropped from 10 percent back down to five percent.  

Monetary and fiscal policy

The government lowered national interest rates to zero to promote liquidity. Liquidity refers to the ease with which assets can become cash. 

The government also paid more than $7 trillion to bail out banks. 

Regarding fiscal policy, it set aside $787 billion for deficit spending to resurrect the economy. 

The Dodd-Frank Act 

Issued by President Barack Obama in 2010, the Dodd-Frank Act granted the government more power over financial organizations. They bought corporations that were close to failing and put regulations into place to prevent unhealthy loan agreements from being offered to the public. It was also mandatory for banks to set aside a certain amount of money to act as a safety net should this ever happen again. 

These actions were controversial since many people argued that government efforts to assist banks and other corporations happened at the expense of workers, whose hardships were prolonged and whose assets were lost. As a result, most Americans lost trust in all of these parties. 

Facts about the 2008 recession

Fact #1: The downturn lasted 18 months. 

Fact #2: Home foreclosures skyrocketed, with nearly three million annually in 2009 and 2010. 

Fact #3: The net worth of U.S. households declined, erasing $19.2 trillion in wealth. 

Fact #4: The GDP fell 4.3 percent, the most significant decline in 60 years. 

Fact #5: The unemployment rate reached 10 percent in October 2009. Rates were even higher among Black and Hispanic households, at about 15 percent and 12 percent, respectively. 

Fact #6: The U.S. lost more than $7 trillion in stock wealth from July 2008 to March 2009. 

Point's contributions

Highs and lows will always play a part in  economics and finances. While some recessions are preventable and others are not, there are always steps you can take to prepare. 

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