Late 2000s – early 2010s recession in the United States
Encyclopedia
After the bursting of the great Housing bubble in mid-2007, United States of America was stuck by a huge recession. The United States entered 2008 during a housing market correction
, a subprime mortgage crisis
and a declining dollar value.
In February, 63,000 jobs were lost, a 5-year record. In September, 159,000 jobs were lost, bringing the monthly average to 84,000 per month from January to September 2008.
The bottom, or trough, was reached in the second quarter of 2009 but the nation's economy continued to be described as in an "economic malaise
" during the second quarter of 2011.
had begun. The collapse of Bear Stearns
and the resulting financial market turbulence signaled that the crisis would not be mild and brief.
Alan Greenspan
, ex-Chairman of the Federal Reserve
, stated in March 2008 that the 2008 financial crisis in the United States is likely to be judged as the harshest since the end of World War II
. A chief economist at Standard & Poor's
, said in March 2008 he has a worst-case-scenario in which the country could endure a double-dip recession in which the economy would briefly recover in the summer 2008. Under this scenario, the economy's total output, as measured by the gross domestic product, would drop by 2.2 percentage points, making it the third worst recession in the post World War II period.
The former head of the National Bureau of Economic Research
said in March 2008 he believed the country was then in a recession, and it could be a severe one. A number of private economists generally predicted a mild recession ending in the summer of 2008 when the economic stimulus checks
going to 130 million households started being spent. A chief economist at Moody's
predicted in March 2008 that policymakers would act in a concerted and aggressive way to stabilize the financial markets, and that then the economy would suffer but not enter a prolonged and severe recession. It takes many months before the National Bureau of Economic Research, the unofficial arbiter of when recessions begin and end, makes its own ruling.
According to numbers published by Bureau of Economic Analysis
in May 2008, the GDP growth of the previous two quarters was positive. As one common definition of a recession is negative economic growth for at least two consecutive fiscal quarters, some analysts suggest this indicates that the U.S. economy was not in a recession at the time. However this estimate has been disputed by some analysts who argue that if inflation is taken into account, the GDP growth was negative for the past two quarters, making it a technical recession. In a May 9, 2008, report, the chief North American economist for investment bank Merrill Lynch
wrote that despite the GDP growth reported for the first quarter of 2008, "it is still reasonable to believe that the recession started some time between September and January", on the grounds that the National Bureau of Economic Research's four recession indicators all peaked during that period.
New York's budget director concluded the state of New York was officially in a recession. Governor David Paterson
called an emergency economic session of the state legislature for August 19 to push a budget cut of $600 million on top of a hiring freeze and a 7 percent reduction in spending at state agencies already implemented by the Governor. An August 1 report, issued by economists with Wachovia
, said Florida was officially in a recession.
White House budget director Jim Nussle said the U.S. avoided a recession following revised GDP numbers from the Commerce Department showing a 0.2 percent contraction in the fourth quarter of 2007 down from a 0.6 percent increase and a downward revision to 0.9 percent from 1 percent in the first quarter of 2008. The GDP for the second quarter was placed at 1.9 percent below an expected 2 percent. Martin Feldstein
, who headed the National Bureau of Economic Research until June and serves on the group's recession-dating panel, said he believed the U.S. was in a very long recession and that there was nothing the Federal Reserve could do to change it.
In a CNBC interview at the end of July 2008, Alan Greenspan said he believed the U.S. was not yet in a recession, but that it could enter one due to a global economic slowdown.
A study released by Moody's found two-thirds of the 381 largest metropolitan areas
in the United States were in a recession. The study also said 28 states were in recession with 16 at risk. The findings were based on unemployment figures and industrial production data.
In March 2008, Warren Buffett
stated in a CNBC interview that by a "common sense definition", the U.S. economy is already in a recession. Warren Buffett has also stated that the definition of recession is flawed and that it should be 3 quarters of GDP growth that is less than population growth. However, the U.S. only experienced two consecutive quarters of GDP growth less than population growth.
All the financial conglomerates, investment banks, and insurance agencies were linked together by the chain called the SECURITIZATION FOOD CHAIN.
The securitisation of food chain created a method of mortgage transfer within the economy. There are five positions, in sequential order in the chain –
The home buyers give the lender a mortgage that the lender passes to the investment banks for earning interests. The investment banks collect all mortgages to for complex derivatives called the COLLATERARISED DEBT OBLIGATION (CDO’S). The CDO’s are a mix of home loans, car loans, student loans, credit card loans. The credit rating agencies then indirectly rated these CDO’s. The highest rating was AAA, followed by AA, BBB, BB etc. The rating agencies were paid by the investment banks for their rating. The CDO’S were sold to the investors by the banks for earning interests. The insurance agencies like the AIG were selling CREDIT DEFAULT SWAPS (CDS) to the investors and earning premiums. CDS were a kind of insurance for the investors. If the rating of the CDO went down then the AIG will be paying the investors for their losses. With the introduction of derivatives the speculators were also betting against the CDO’s they didn’t own. Thus the insurance companies were earning both from premium from investors as well as from the derivatives sold to the speculators. Thus the risk was transferred to the insurance agencies.
As the investments were risk free for the investors (as the risk were borne by the insurance agencies for premium) ,the demand for the CDO’S went up. Thus the investment banks also wanted more mortgages to form CDO’S so that they could lend them to the investors and earn profits. Thus there was a massive lending and a flow of credits in the financial system. The banks started giving away riskier loans to earn more CDO’s. So the banks were making profits without having risks as the risk were borne insurance agencies.
In old mortgage system , the borrower had to pay 20% of their investment and remaining 80% he could borrow from banks. Moreover he could take loans worth of four times of his salary. But these Securitisation Food Chain created a way for the easy loans and banks started giving riskier loans.
The housing bubble nearly tripled the prices of housing and the real-estate from 1999 to 2007. This huge increase was because of the uncontrolled credit given by the American banks which increased the demand of housing sector.
On December 30, 2008 the Case-Shiller home price index reported its largest price drop in its history. Increased foreclosure rates in 2006–2007 among U.S. homeowners led to a crisis in August 2008 for the subprime, collateralized debt obligation (CDO), mortgage, credit, hedge fund, and foreign bank markets. In October 2007, the U.S. Secretary of the Treasury called the bursting housing bubble "the most significant risk to our economy."
"The
number of people not on temporary layoff surged 220,000 in August and
the level continues to reach new highs, now at 8.1 million. This
accounts for 53.9% of the unemployed — again a record high — and this is
a proxy for permanent job loss, in other words, these jobs are not
coming back. Against that backdrop, the number of people who have been
looking for a job for at least six months with no success rose a further
half-percent in August, to stand at 5 million — the long-term
unemployed now represent a record 33% of the total pool of joblessness."
The leverage ratio during the bubble also was very high as banks borrowed heavily to give away loans. The leverage ratio is the ratio between the borrowed money by banks and banks own money. The ratio was nearly 33:1 during the late 2006.
There were also faulty ratings by the rating agencies. The rating agencies had no liabilities if their ratings were wrong.
On December 1, 2008, the National Bureau of Economic Research
(NBER) declared that the United States entered a recession in December 2007, citing employment and production figures as well as the third quarter decline in GDP. The Dow Jones Industrial Average lost 679 points that same day. On January 4, 2009, Nobel
prize winning economist Paul Krugman
wrote that "This looks an awful lot like the beginning of a second Great Depression."
issued a report that its unemployment rate rose to 6.1%, the highest in five years, and the Congressional Budget Office
forecasts that the unemployment rate could reach as high as 9% during 2010. The news report cited the Department of Labor reports and interviewed Jared Bernstein, an economist:
CNN
also reported the news, quoted another economist, and placed the news in context:
As of December 2008, U1 unemployment figure was 2.8% while U6 unemployment was 13.5%. On January 26, 2009 a day dubbed "Bloody Monday" by the media, 71,400 jobs were lost in the US alone.
The unemployment rate among workers with college degrees rose to 3.8% during the first quarter of 2009. This "pinch" is also spreading worldwide.
In the summer of 2007, Countrywide Financial drew down a $11 billion line of credit and then secured an additional $12 billion bailout in September. This may be considered the start of the crisis.
In mid-December 2007, Washington Mutual bank cut more than 3,000 jobs and closed its subprime mortgage business.
In mid-March 2008, Bear Stearns was bailed out by a gift of $29 billion non-recourse treasury bill debt assets.
In early July 2008, depositors at the Los Angeles offices of IndyMac Bank frantically lined up in the street to withdraw their money. On July 11, IndyMac, a spinoff of Countrywide, was seized by federal regulators - and called for a $32 billion bailout. The mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures. That day the financial markets plunged as investors tried to gauge whether the government would attempt to save
mortgage lenders Fannie Mae and Freddie Mac. The two were placed into conservatorship
on September 7, 2008.
During the weekend of September 13–14, 2008, Lehman Brothers
declared bankruptcy
after failing to find a buyer, Bank of America
agreed to purchase Merrill Lynch
, the insurance company AIG
sought a bridge loan from the Federal Reserve, and a consortium of 10 banks created an emergency fund of at least $70 billion to deal with the effects of Lehman's closure, similar to the consortium put forth by J.P. Morgan during the stock market panic of 1907
and the crash of 1929. Stocks on "Wall Street
" tumbled on September 15.
On September 16, 2008, news emerged that the Federal Reserve may give AIG an $85 billion rescue package; on September 17, 2008, this was confirmed. The terms of the rescue package were that the Federal Reserve would receive an 80% public stake in the firm. The biggest bank failure in history occurred on September 25 when JP Morgan Chase agreed to purchase the banking assets of Washington Mutual
.
The year 2008, as of September 17, has seen 81 public corporations file for bankruptcy in the United States, already higher than the 78 in 2007. Lehman Brothers being the largest bankruptcy in U.S. history also makes 2008 a record year in terms of assets with Lehman's $691 billion in assets all past annual totals. The year also saw the ninth biggest bankruptcy with the failure of IndyMac Bank.
The Wall Street Journal states that venture capital
funding has slowed down which in the past led to unemployment and slowed new job creation.
advised Secretary of the Treasury Henry Paulson
that a large amount of public money would be needed to stabilize the financial system. Short selling on 799 financial stocks was banned on September 19. Companies were also forced to disclose large short positions.
The Secretary of the Treasury also indicated that money fund
s will create an insurance pool to cover themselves against losses and that the government will buy mortgage-backed securities from banks and investment houses. Initial estimates of the cost of the Treasury bailout proposed by the Bush Administration's draft legislation (as of September 19, 2008) were in the range of $700 billion to $1 trillion U.S. dollars
. President George W. Bush
asked Congress
on September 20, 2008 for the authority to spend as much as $700 billion to purchase troubled mortgage assets and contain the financial crisis. The crisis continued when the United States House of Representatives rejected the bill and the Dow Jones
took a 777 point plunge. A revised version of the bill was later passed by Congress, but the stock market continued to fall nevertheless.
The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. This has led some economist to argue that buying preferred stock will be far less effective than buying common stock.
As of mid-November 2008, it was estimated that the new loans, purchases, and liabilities of the Federal Reserve, the US Treasury, and FDIC, brought on by the financial crisis, totalled over $5 trillion: $1 trillion in loans by the Fed to broker-dealers through the emergency discount window
, $1.8 trillion in loans by the Fed through the Term Auction Facility
, $700 billion to be raised by the Treasury for the Troubled Assets Relief Program
, $200 billion insurance for the GSEs by the Treasury, and $1.5 trillion insurance for unsecured bank debt by FDIC. (Some portion of the Fed's emergency loans would already have been repaid.)
United States housing market correction
A United States housing market correction is a market correction or "bubble bursting" of a United States housing bubble; the most recent began following a national home price peak first identified in July 2006. Because realty trades in illiquid markets relative to financial assets such as common...
, a subprime mortgage crisis
Subprime mortgage crisis
The U.S. subprime mortgage crisis was one of the first indicators of the late-2000s financial crisis, characterized by a rise in subprime mortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages....
and a declining dollar value.
In February, 63,000 jobs were lost, a 5-year record. In September, 159,000 jobs were lost, bringing the monthly average to 84,000 per month from January to September 2008.
The bottom, or trough, was reached in the second quarter of 2009 but the nation's economy continued to be described as in an "economic malaise
Economic stagnation
Economic stagnation or economic immobilism, often called simply stagnation or immobilism, is a prolonged period of slow economic growth , usually accompanied by high unemployment. Under some definitions, "slow" means significantly slower than potential growth as estimated by experts in macroeconomics...
" during the second quarter of 2011.
Background
After the 1930 recession the American economy experienced a continuous growth from 1940 to 1980. The American enforced the The Securities Exchange Act (1934) and Chandler Act (1938) which tightly regulated the financial market and provided stability. The Securities Exchange Act of 1934 regulated the trading of the secondary securities and the Chandler act regulated the transactions in the banking sector. There were few small investment banks like JP MORGAN that grew up during the late 1970s. In the 1980s, the financial sector quantum leaped, because investment banks were going public, which brought them vast sums of stockholder capital in return. From 1978-2008, the average salary for workers outside of investment banking in the US increased from $40k to $50k – a 25 percent salary increase - and the average salary in investment banking increased from $40k to $100k – a 150 percent salary increase. The Reagan administration of the United States in the early 1980s began a thirty-year period of financial deregulation. By then end of the 1980s, many workers in the financial sector were going to jail for fraud and many people were losing their life savings. Large investment banks began merging and developing monopolies. These all led to the formation of the investment banks like Goldman Sachs.Early suggestions of recession
In the early months of 2008, many observers believed that a U.S. recessionRecession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...
had begun. The collapse of Bear Stearns
Bear Stearns
The Bear Stearns Companies, Inc. based in New York City, was a global investment bank and securities trading and brokerage, until its sale to JPMorgan Chase in 2008 during the global financial crisis and recession...
and the resulting financial market turbulence signaled that the crisis would not be mild and brief.
Alan Greenspan
Alan Greenspan
Alan Greenspan is an American economist who served as Chairman of the Federal Reserve of the United States from 1987 to 2006. He currently works as a private advisor and provides consulting for firms through his company, Greenspan Associates LLC...
, ex-Chairman of the Federal Reserve
Chairman of the Federal Reserve
The Chairman of the Board of Governors of the Federal Reserve System is the head of the central banking system of the United States. Known colloquially as "Chairman of the Fed," or in market circles "Fed Chairman" or "Fed Chief"...
, stated in March 2008 that the 2008 financial crisis in the United States is likely to be judged as the harshest since the end of World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
. A chief economist at Standard & Poor's
Standard & Poor's
Standard & Poor's is a United States-based financial services company. It is a division of The McGraw-Hill Companies that publishes financial research and analysis on stocks and bonds. It is well known for its stock-market indices, the US-based S&P 500, the Australian S&P/ASX 200, the Canadian...
, said in March 2008 he has a worst-case-scenario in which the country could endure a double-dip recession in which the economy would briefly recover in the summer 2008. Under this scenario, the economy's total output, as measured by the gross domestic product, would drop by 2.2 percentage points, making it the third worst recession in the post World War II period.
The former head of the National Bureau of Economic Research
National Bureau of Economic Research
The National Bureau of Economic Research is an American private nonprofit research organization "committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community." The NBER is well known for providing start and end...
said in March 2008 he believed the country was then in a recession, and it could be a severe one. A number of private economists generally predicted a mild recession ending in the summer of 2008 when the economic stimulus checks
Economic Stimulus Act of 2008
The Economic Stimulus Act of 2008 was an Act of Congress providing for several kinds of economic stimuli intended to boost the United States economy in 2008 and to avert a recession, or ameliorate economic conditions. The stimulus package was passed by the U.S. House of Representatives on January...
going to 130 million households started being spent. A chief economist at Moody's
Moody's
Moody's Corporation is the holding company for Moody's Analytics and Moody's Investors Service, a credit rating agency which performs international financial research and analysis on commercial and government entities. The company also ranks the credit-worthiness of borrowers using a standardized...
predicted in March 2008 that policymakers would act in a concerted and aggressive way to stabilize the financial markets, and that then the economy would suffer but not enter a prolonged and severe recession. It takes many months before the National Bureau of Economic Research, the unofficial arbiter of when recessions begin and end, makes its own ruling.
According to numbers published by Bureau of Economic Analysis
Bureau of Economic Analysis
The Bureau of Economic Analysis is an agency in the United States Department of Commerce that provides important economic statistics including the gross domestic product of the United States. Its stated mission is to "promote a better understanding of the U.S...
in May 2008, the GDP growth of the previous two quarters was positive. As one common definition of a recession is negative economic growth for at least two consecutive fiscal quarters, some analysts suggest this indicates that the U.S. economy was not in a recession at the time. However this estimate has been disputed by some analysts who argue that if inflation is taken into account, the GDP growth was negative for the past two quarters, making it a technical recession. In a May 9, 2008, report, the chief North American economist for investment bank Merrill Lynch
Merrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...
wrote that despite the GDP growth reported for the first quarter of 2008, "it is still reasonable to believe that the recession started some time between September and January", on the grounds that the National Bureau of Economic Research's four recession indicators all peaked during that period.
New York's budget director concluded the state of New York was officially in a recession. Governor David Paterson
David Paterson
David Alexander Paterson is an American politician who served as the 55th Governor of New York, from 2008 to 2010. During his tenure he was the first governor of New York of African American heritage and also the second legally blind governor of any U.S. state after Bob C. Riley, who was Acting...
called an emergency economic session of the state legislature for August 19 to push a budget cut of $600 million on top of a hiring freeze and a 7 percent reduction in spending at state agencies already implemented by the Governor. An August 1 report, issued by economists with Wachovia
Wachovia
Wachovia was a diversified financial services company based in Charlotte, North Carolina. Before its acquisition by Wells Fargo in 2008, Wachovia was the fourth-largest bank holding company in the United States based on total assets...
, said Florida was officially in a recession.
White House budget director Jim Nussle said the U.S. avoided a recession following revised GDP numbers from the Commerce Department showing a 0.2 percent contraction in the fourth quarter of 2007 down from a 0.6 percent increase and a downward revision to 0.9 percent from 1 percent in the first quarter of 2008. The GDP for the second quarter was placed at 1.9 percent below an expected 2 percent. Martin Feldstein
Martin Feldstein
Martin Stuart "Marty" Feldstein is an economist. He is currently the George F. Baker Professor of Economics at Harvard University, and the president emeritus of the National Bureau of Economic Research . He served as President and Chief Executive Officer of the NBER from 1978 through 2008...
, who headed the National Bureau of Economic Research until June and serves on the group's recession-dating panel, said he believed the U.S. was in a very long recession and that there was nothing the Federal Reserve could do to change it.
In a CNBC interview at the end of July 2008, Alan Greenspan said he believed the U.S. was not yet in a recession, but that it could enter one due to a global economic slowdown.
A study released by Moody's found two-thirds of the 381 largest metropolitan areas
United States metropolitan area
In the United States a metropolitan statistical area is a geographical region with a relatively high population density at its core and close economic ties throughout the area. Such regions are not legally incorporated as a city or town would be, nor are they legal administrative divisions like...
in the United States were in a recession. The study also said 28 states were in recession with 16 at risk. The findings were based on unemployment figures and industrial production data.
In March 2008, Warren Buffett
Warren Buffett
Warren Edward Buffett is an American business magnate, investor, and philanthropist. He is widely regarded as one of the most successful investors in the world. Often introduced as "legendary investor, Warren Buffett", he is the primary shareholder, chairman and CEO of Berkshire Hathaway. He is...
stated in a CNBC interview that by a "common sense definition", the U.S. economy is already in a recession. Warren Buffett has also stated that the definition of recession is flawed and that it should be 3 quarters of GDP growth that is less than population growth. However, the U.S. only experienced two consecutive quarters of GDP growth less than population growth.
Causes
With the advent of internet trading of stocks and development of the concepts of derivatives the investment banking started to flourish rapidly.All the financial conglomerates, investment banks, and insurance agencies were linked together by the chain called the SECURITIZATION FOOD CHAIN.
The securitisation of food chain created a method of mortgage transfer within the economy. There are five positions, in sequential order in the chain –
- home buyers,
- lenders,
- investment banks,
- investors,
- insurance companies.
The home buyers give the lender a mortgage that the lender passes to the investment banks for earning interests. The investment banks collect all mortgages to for complex derivatives called the COLLATERARISED DEBT OBLIGATION (CDO’S). The CDO’s are a mix of home loans, car loans, student loans, credit card loans. The credit rating agencies then indirectly rated these CDO’s. The highest rating was AAA, followed by AA, BBB, BB etc. The rating agencies were paid by the investment banks for their rating. The CDO’S were sold to the investors by the banks for earning interests. The insurance agencies like the AIG were selling CREDIT DEFAULT SWAPS (CDS) to the investors and earning premiums. CDS were a kind of insurance for the investors. If the rating of the CDO went down then the AIG will be paying the investors for their losses. With the introduction of derivatives the speculators were also betting against the CDO’s they didn’t own. Thus the insurance companies were earning both from premium from investors as well as from the derivatives sold to the speculators. Thus the risk was transferred to the insurance agencies.
As the investments were risk free for the investors (as the risk were borne by the insurance agencies for premium) ,the demand for the CDO’S went up. Thus the investment banks also wanted more mortgages to form CDO’S so that they could lend them to the investors and earn profits. Thus there was a massive lending and a flow of credits in the financial system. The banks started giving away riskier loans to earn more CDO’s. So the banks were making profits without having risks as the risk were borne insurance agencies.
In old mortgage system , the borrower had to pay 20% of their investment and remaining 80% he could borrow from banks. Moreover he could take loans worth of four times of his salary. But these Securitisation Food Chain created a way for the easy loans and banks started giving riskier loans.
The housing bubble nearly tripled the prices of housing and the real-estate from 1999 to 2007. This huge increase was because of the uncontrolled credit given by the American banks which increased the demand of housing sector.
On December 30, 2008 the Case-Shiller home price index reported its largest price drop in its history. Increased foreclosure rates in 2006–2007 among U.S. homeowners led to a crisis in August 2008 for the subprime, collateralized debt obligation (CDO), mortgage, credit, hedge fund, and foreign bank markets. In October 2007, the U.S. Secretary of the Treasury called the bursting housing bubble "the most significant risk to our economy."
Government policies
The government policies were responsible to a large extent for the recession in the united states and large unemployment.- Off-shoring of American Jobs for the past few years: The US government has always encouraged the outsourcing of American jobs with the investment in its own country. President Kennedy gave tax relaxation to those industries which had outsourced the jobs to developing countries.
- Encouraging Mergers: The US government had always encouraged mergers which has reduced the government revenue and has killed the market competition. The mergers always reduce employment. US Treasury Department has allowed the banks and other financial institutions to use the bailout money to buy their competitors.
- Allowed the unemployment to grow to control inflation: the US government allowed the unemployment to grow in order to achieve the long run growth by reducing inflation. According to Merrill Lynch chief economist David Rosenberg:
"The
number of people not on temporary layoff surged 220,000 in August and
the level continues to reach new highs, now at 8.1 million. This
accounts for 53.9% of the unemployed — again a record high — and this is
a proxy for permanent job loss, in other words, these jobs are not
coming back. Against that backdrop, the number of people who have been
looking for a job for at least six months with no success rose a further
half-percent in August, to stand at 5 million — the long-term
unemployed now represent a record 33% of the total pool of joblessness."
Role of Allan Greenspan
He was the Chairman of the Federal Reserve of the United States from 1987 to 2006.He was appointed Federal Reserve chairman by President Ronald Reagan in August 1987 and was again reappointed as chairman 2006. He was the person responsible for the housing bubble in the US. Though he said that "I really didn't get it until very late in 2005 and 2006." . Greenspan stated that the housing bubble was "fundamentally engendered by the decline in real long-term interest rates", though he also claims that long-term interest rates are beyond the control of central banks because "the market value of global long-term securities is approaching $100 trillion" and thus these and other asset markets are large enough that they "now swamp the resources of central banks".Formation of bubble
There was a sharp increase in the SUB-PRIME LOANS in 2006. Now the borrowers could borrow even 99% of their investments. The investment banks preferred the subprime loans as it earned a high revenue due to high risks. More the poor ratings more are the interest rate. There was massive credit flow and thus the demand for the housing sector increased and the housing bubble formed. Mortgage regulations were relaxed and there were huge profits in the financial sector. The stock profits sky-rocketed.The leverage ratio during the bubble also was very high as banks borrowed heavily to give away loans. The leverage ratio is the ratio between the borrowed money by banks and banks own money. The ratio was nearly 33:1 during the late 2006.
There were also faulty ratings by the rating agencies. The rating agencies had no liabilities if their ratings were wrong.
Recession declared by economists
National Bureau of Economic Research
The National Bureau of Economic Research is an American private nonprofit research organization "committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community." The NBER is well known for providing start and end...
(NBER) declared that the United States entered a recession in December 2007, citing employment and production figures as well as the third quarter decline in GDP. The Dow Jones Industrial Average lost 679 points that same day. On January 4, 2009, Nobel
Nobel Memorial Prize in Economic Sciences
The Nobel Memorial Prize in Economic Sciences, commonly referred to as the Nobel Prize in Economics, but officially the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel , is an award for outstanding contributions to the field of economics, generally regarded as one of the...
prize winning economist Paul Krugman
Paul Krugman
Paul Robin Krugman is an American economist, professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics, and an op-ed columnist for The New York Times...
wrote that "This looks an awful lot like the beginning of a second Great Depression."
Rise in unemployment
On September 5, 2008, the United States Department of LaborUnited States Department of Labor
The United States Department of Labor is a Cabinet department of the United States government responsible for occupational safety, wage and hour standards, unemployment insurance benefits, re-employment services, and some economic statistics. Many U.S. states also have such departments. The...
issued a report that its unemployment rate rose to 6.1%, the highest in five years, and the Congressional Budget Office
Congressional Budget Office
The Congressional Budget Office is a federal agency within the legislative branch of the United States government that provides economic data to Congress....
forecasts that the unemployment rate could reach as high as 9% during 2010. The news report cited the Department of Labor reports and interviewed Jared Bernstein, an economist:
CNN
CNN
Cable News Network is a U.S. cable news channel founded in 1980 by Ted Turner. Upon its launch, CNN was the first channel to provide 24-hour television news coverage, and the first all-news television channel in the United States...
also reported the news, quoted another economist, and placed the news in context:
As of December 2008, U1 unemployment figure was 2.8% while U6 unemployment was 13.5%. On January 26, 2009 a day dubbed "Bloody Monday" by the media, 71,400 jobs were lost in the US alone.
The unemployment rate among workers with college degrees rose to 3.8% during the first quarter of 2009. This "pinch" is also spreading worldwide.
Liquidity crisis
From late 2007 through September 2008, before the official October 3 bailout, there was a series of smaller bank rescues that occurred which totalled almost $800 billion.In the summer of 2007, Countrywide Financial drew down a $11 billion line of credit and then secured an additional $12 billion bailout in September. This may be considered the start of the crisis.
In mid-December 2007, Washington Mutual bank cut more than 3,000 jobs and closed its subprime mortgage business.
In mid-March 2008, Bear Stearns was bailed out by a gift of $29 billion non-recourse treasury bill debt assets.
In early July 2008, depositors at the Los Angeles offices of IndyMac Bank frantically lined up in the street to withdraw their money. On July 11, IndyMac, a spinoff of Countrywide, was seized by federal regulators - and called for a $32 billion bailout. The mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures. That day the financial markets plunged as investors tried to gauge whether the government would attempt to save
Federal takeover of Fannie Mae and Freddie Mac
The federal takeover of Fannie Mae and Freddie Mac refers to the placing into conservatorship of government sponsored enterprises Fannie Mae and Freddie Mac by the U.S. Treasury in September 2008. It was one financial event among many in the ongoing subprime mortgage crisis.On September 6, 2008,...
mortgage lenders Fannie Mae and Freddie Mac. The two were placed into conservatorship
Conservatorship
Conservatorship is a legal concept in the United States of America, where an entity or organization is subjected to the legal control of an external entity or organization, known as a conservator. Conservatorship is established either by court order or via a statutory or regulatory authority...
on September 7, 2008.
During the weekend of September 13–14, 2008, Lehman Brothers
Lehman Brothers
Lehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...
declared bankruptcy
Bankruptcy of Lehman Brothers
Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. The bankruptcy of Lehman Brothers remains the largest bankruptcy filing in U.S...
after failing to find a buyer, Bank of America
Bank of America
Bank of America Corporation, an American multinational banking and financial services corporation, is the second largest bank holding company in the United States by assets, and the fourth largest bank in the U.S. by market capitalization. The bank is headquartered in Charlotte, North Carolina...
agreed to purchase Merrill Lynch
Merrill Lynch
Merrill Lynch is the wealth management division of Bank of America. With over 15,000 financial advisors and $2.2 trillion in client assets it is the world's largest brokerage. Formerly known as Merrill Lynch & Co., Inc., prior to 2009 the firm was publicly owned and traded on the New York...
, the insurance company AIG
AIG
AIG is American International Group, a major American insurance corporation.AIG may also refer to:* And-inverter graph, a concept in computer theory* Answers in Genesis, a creationist organization in the U.S.* Arta Industrial Group in Iran...
sought a bridge loan from the Federal Reserve, and a consortium of 10 banks created an emergency fund of at least $70 billion to deal with the effects of Lehman's closure, similar to the consortium put forth by J.P. Morgan during the stock market panic of 1907
Panic of 1907
The Panic of 1907, also known as the 1907 Bankers' Panic, was a financial crisis that occurred in the United States when the New York Stock Exchange fell almost 50% from its peak the previous year. Panic occurred, as this was during a time of economic recession, and there were numerous runs on...
and the crash of 1929. Stocks on "Wall Street
Wall Street
Wall Street refers to the financial district of New York City, named after and centered on the eight-block-long street running from Broadway to South Street on the East River in Lower Manhattan. Over time, the term has become a metonym for the financial markets of the United States as a whole, or...
" tumbled on September 15.
On September 16, 2008, news emerged that the Federal Reserve may give AIG an $85 billion rescue package; on September 17, 2008, this was confirmed. The terms of the rescue package were that the Federal Reserve would receive an 80% public stake in the firm. The biggest bank failure in history occurred on September 25 when JP Morgan Chase agreed to purchase the banking assets of Washington Mutual
Washington Mutual
Washington Mutual, Inc. , abbreviated to WaMu, was a savings bank holding company and the former owner of Washington Mutual Bank, which was the United States' largest savings and loan association until its collapse in 2008....
.
The year 2008, as of September 17, has seen 81 public corporations file for bankruptcy in the United States, already higher than the 78 in 2007. Lehman Brothers being the largest bankruptcy in U.S. history also makes 2008 a record year in terms of assets with Lehman's $691 billion in assets all past annual totals. The year also saw the ninth biggest bankruptcy with the failure of IndyMac Bank.
The Wall Street Journal states that venture capital
Venture capital
Venture capital is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as...
funding has slowed down which in the past led to unemployment and slowed new job creation.
| Federal reserve rates changes | |||||
| Date Calendar date A date in a calendar is a reference to a particular day represented within a calendar system. The calendar date allows the specific day to be identified. The number of days between two dates may be calculated. For example, "24 " is ten days after "14 " in the Gregorian calendar. The date of a... | Discount rate Discount rate The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window.... | Discount rate Discount rate The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window.... | Discount rate Discount rate The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window.... | Fed funds | Fed funds rate |
|---|---|---|---|---|---|
| Primary | Secondary | ||||
| rate change | new interest rate | new interest rate | rate change | new interest rate | |
| Apr 30, 2008 | -.25% | 2.25% | 2.75% | -.25% | 2.00% |
| Mar 18, 2008 | -.75% | 2.50% | 3.00% | -.75% | 2.25% |
| Mar 16, 2008 | -.25% | 3.25% | 3.75% | ||
| Jan 30, 2008 | -.50% | 3.50% | 4.00% | -.50% | 3.00% |
| Jan 22, 2008 | -.75% | 4.00% | 4.50% | -.75% | 3.50% |
Bailout of U.S. financial system
On September 17, 2008, Federal Reserve chairman Ben BernankeBen Bernanke
Ben Shalom Bernanke is an American economist, and the current Chairman of the Federal Reserve, the central bank of the United States. During his tenure as Chairman, Bernanke has overseen the response of the Federal Reserve to late-2000s financial crisis....
advised Secretary of the Treasury Henry Paulson
Henry Paulson
Henry Merritt "Hank" Paulson, Jr. is an American banker who served as the 74th United States Secretary of the Treasury. He previously served as the Chairman and Chief Executive Officer of Goldman Sachs.-Early life and family:...
that a large amount of public money would be needed to stabilize the financial system. Short selling on 799 financial stocks was banned on September 19. Companies were also forced to disclose large short positions.
The Secretary of the Treasury also indicated that money fund
Money fund
A money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely regarded as being as safe as bank deposits yet providing a higher yield...
s will create an insurance pool to cover themselves against losses and that the government will buy mortgage-backed securities from banks and investment houses. Initial estimates of the cost of the Treasury bailout proposed by the Bush Administration's draft legislation (as of September 19, 2008) were in the range of $700 billion to $1 trillion U.S. dollars
United States dollar
The United States dollar , also referred to as the American dollar, is the official currency of the United States of America. It is divided into 100 smaller units called cents or pennies....
. President George W. Bush
George W. Bush
George Walker Bush is an American politician who served as the 43rd President of the United States, from 2001 to 2009. Before that, he was the 46th Governor of Texas, having served from 1995 to 2000....
asked Congress
United States Congress
The United States Congress is the bicameral legislature of the federal government of the United States, consisting of the Senate and the House of Representatives. The Congress meets in the United States Capitol in Washington, D.C....
on September 20, 2008 for the authority to spend as much as $700 billion to purchase troubled mortgage assets and contain the financial crisis. The crisis continued when the United States House of Representatives rejected the bill and the Dow Jones
Dow Jones Industrial Average
The Dow Jones Industrial Average , also called the Industrial Average, the Dow Jones, the Dow 30, or simply the Dow, is a stock market index, and one of several indices created by Wall Street Journal editor and Dow Jones & Company co-founder Charles Dow...
took a 777 point plunge. A revised version of the bill was later passed by Congress, but the stock market continued to fall nevertheless.
The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. This has led some economist to argue that buying preferred stock will be far less effective than buying common stock.
As of mid-November 2008, it was estimated that the new loans, purchases, and liabilities of the Federal Reserve, the US Treasury, and FDIC, brought on by the financial crisis, totalled over $5 trillion: $1 trillion in loans by the Fed to broker-dealers through the emergency discount window
Discount window
The discount window is an instrument of monetary policy that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions...
, $1.8 trillion in loans by the Fed through the Term Auction Facility
Term auction facility
The Term Auction Facility is a temporary program managed by the United States Federal Reserve designed to "address elevated pressures in short-term funding markets." Under the program the Fed auctions collateralized loans with terms of 28 and 84 days to depository institutions that are "in...
, $700 billion to be raised by the Treasury for the Troubled Assets Relief Program
Troubled Assets Relief Program
The Troubled Asset Relief Program is a program of the United States government to purchase assets and equity from financial institutions to strengthen its financial sector that was signed into law by U.S. President George W. Bush on October 3, 2008...
, $200 billion insurance for the GSEs by the Treasury, and $1.5 trillion insurance for unsecured bank debt by FDIC. (Some portion of the Fed's emergency loans would already have been repaid.)