what caused the great recession crash course

The Great Recession

, one of the worst economic declines in US history, officially lasted from December 2007 to June 2009. The collapse of the housing market — fueled by low interest rates, easy credit, insufficient regulation, and toxic subprime mortgages — led to the economic crisis.

Full Answer

What really caused the Great Recession?

The Great Recession devastated local labor markets and the national economy. Ten years later, Berkeley researchers are finding many of the same red flags blamed for the crisis: banks making subprime loans and trading risky securities.

Was the Great Recession an avoidable disaster?

According to a 2011 report by the Financial Crisis Inquiry Commission, the Great Recession was an "avoidable" disaster caused by widespread failures, including in government regulation and risky behavior by Wall Street.

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.

When did the Great Recession end?

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.

What was the main cause of the Great Recession?

The collapse of the housing market — fueled by low interest rates, easy credit, insufficient regulation, and toxic subprime mortgages — led to the economic crisis. The Great Recession's legacy includes new financial regulations and an activist Fed.

What caused the Great Recession of 2008 for dummies?

Housing prices started falling in 2007 as supply outpaced demand. That trapped homeowners who couldn't afford the payments, but couldn't sell their house. When the values of the derivatives crumbled, banks stopped lending to each other. That created the financial crisis that led to the Great Recession.

What lessons were learned from the Great Recession?

A lesson that has been re-learned often, even in times of prosperity, is that diversification is essential in managing your wealth. Extreme wealth can be created from concentrated positions, but more often than not, wealth can be destroyed in the same manner.

Who is to blame for the Great Recession of 2008?

The Biggest Culprit: The Lenders Most of the blame is on the mortgage originators or the lenders. That's because they were responsible for creating these problems. After all, the lenders were the ones who advanced loans to people with poor credit and a high risk of default. 7 Here's why that happened.

What led to 2008 financial crisis?

The collapse of the US housing bubble, which peaked in FY 2006-2007, was the primary and immediate cause of the financial crisis. But it all began after the terrorist attacks of September 11, 2001. As a result of the US economy entering a recession, the Federal Reserve System (Fed) reduced its interest rate to 1%.

What are two lessons to be learned from the 2008 financial crisis?

Stackhouse concluded with three main lessons learned from this crisis: High levels of debt, uncertain ability of borrowers to repay debt and an expectation that housing prices will always increase (among other factors) created a comfort level that was misguided.

How could the great recession have been avoided?

Two things could have prevented the crisis. The first would have been regulation of mortgage brokers, who made the bad loans, and hedge funds, which used too much leverage. The second would have been recognized early on that it was a credibility problem. The only solution was for the government to buy bad loans.

How much wealth was destroyed in the Great Recession?

According to the Federal Reserve, U.S. households lost approximately 25 percent of their aggregate wealth between the end of 2007 and the middle of 2009, when the Great Recession was officially declared at an end.

What were the effects of the Great Recession?

since the Great Depression. Catalyzed by the crisis in subprime mortgage-backed securities, the crisis spread to mutual funds, pensions, and the corporations that owned these securities, with widespread national and global impacts. Ten years after the onset of the crisis, the impacts on workers and economic inequality persist. In a series of policy briefs, IRLE will highlight work by Berkeley faculty on the causes and long-term effects of the Recession. In this brief, we review research from IRLE faculty affiliate and UC Berkeley sociologist Neil Fligstein on the root causes of the Great Recession.

Why did the housing industry collapse?

Conventional wisdom holds that the housing industry collapsed because lenders of subprime mortgages had perverse incentives to bundle and pass off risky mortgage-backed securities to other investors in order to profit from high origination fees. The logic follows that banks did not care if they loaned to borrowers who were likely to default since the banks did not intend to hold onto the mortgage or the financial products they created for very long.

What did Goldstein and Fligstein find?

They find that financial institutions actually sought out risky mortgage loans in pursuit of profits from high-yielding securities (such as an MBS or CDO), and to do so, held onto high-risk investments while engaging in multiple sectors of the mortgage securitization industry. Until the early 2000s, engaging with multiple sectors of the housing industry through a single financial institution was highly unusual; instead, a specialized firm would perform each component of the mortgage process (i.e. lending, underwriting, servicing, and securitizing). This changed when financial institutions realized that they could collect enormous fees if they engaged with all stages of the mortgage securitization process. 2

When did the mortgage market become saturated?

Using annual firm-level data for the top subprime mortgage-backed security issuers, the authors show that when the conventional mortgage market became saturated in 2003, the financial industry began to bundle lower quality mortgages—often subprime mortgage loans—in order to keep generating profits from fees.

When did fraud start?

Fraudulent activity began as early as 2003 when conventional mortgages became scarce. Several firms entered the mortgage marketplace and increased competition, while at the same time, the pool of viable mortgagors and refinancers began to decline rapidly.

Which financial institutions were more likely to hold onto high risk securities?

Financial institutions that produced risky securities were more likely to hold onto them as investments. For example, by the summer of 2007, UBS held onto $50 billion of high-risk MBS or CDO securities, Citigroup $43 billion, Merrill Lynch $32 billion, and Morgan Stanley $11 billion. Since these institutions were producing and investing in risky loans, they were thus extremely vulnerable when housing prices dropped and foreclosures increased in 2007. A final analysis shows that firms that were engaged in many phases of producing mortgage-backed securities were more likely to experience loss and bankruptcy.

Why are Lehman Brothers and Bear Stearns involved in the MBS market?

Moreover, because large firms like Lehman Brothers and Bear Stearns were engaged in multiple sectors of the MBS market, they had high incentives to misrepresent the quality of their mortgages and securities at every point along the lending process, from originating and issuing to underwriting the loan.

1. Immoderate investments and deregulation

The two decades before the Great Recession were largely prosperous, with rises in GDP, low inflation, and two relatively mild recessions.

2. Loose lending standards in the housing market

In the decade leading up to 2007, real estate and property values had been rising steadily, encouraging people to invest in property and buy homes.

3. Risky Wall Street behavior

Along with issuing mortgages, lenders found another way to make money off of the real estate industry: By packaging subprime mortgage loans and reselling them in a process called securitization.

4. Weak watchdogs

Like corporate bonds and other forms of debt, MBS and CDOs required the blessing of credit rating agencies in order to be marketed. The "Big Three" credit rating agencies include Moody's, S&P, and Fitch Group.

5. The subprime mortgage crisis

After staying low throughout the early 2000s, interest rates began to rise starting in 2004 in response to an overheating economy and fears of inflation. In mid-2004, the federal funds rate was 1.25%. By mid-2006, the interest rate was 5.25%.

6. The 2008 stock market crash

Lehman Brothers employees on the day the investment bank went bankrupt. James Leynse/Getty Images

Federal response to the Great Recession

Decisive action by the Federal Reserve, along with massive government spending, kept the US economy from total collapse.

What was the worst economic crisis since the Great Depression?

The Great Recession of 2007-2009 was the worst global economic crisis since the Great Depression in the 1930s.

What was the impact of the Lehman Brothers collapse on the US economy?

The US economy was already tipping into recession by 2007. Consumer spending was down , unemployment was up, and the financial markets were unstable. But it was the September 2008 collapse of Lehman Brothers, a major Wall Street investment firm, that ushered in the worst banking crisis the country had experienced since the Great Depression. Both the boom-and-bust dynamic associated with free-market capitalism and the monetary policies enacted by the Federal Reserve played a role in creating the crisis.

How did the Bush tax cuts affect inequality?

Critics of what became known as the “ Bush Tax Cuts ” argued that they contributed to increased income inequality by unfairly benefiting the upper class. Others have attributed rising inequality to technological advances, free trade policies, and the declining power of labor unions.

What was the role of the Federal Reserve in the economic crisis?

The Federal Reserve (the US central banking system) had implemented monetary policies aimed at increasing rates of homeownership.

What was the Federal Reserve's policy on housing?

The Federal Reserve (the US central banking system) had implemented monetary policies aimed at increasing rates of homeownership. Excessive home building, combined with the loosening of credit and the extension of high-risk mortgages, served to create a housing bubble.

What was the Bush tax cut?

Meanwhile, the Bush administration enacted some of the largest tax cuts in US history. All marginal tax rates were lowered, while certain tax credits, such as the child tax credit, became more generous. Critics of what became known as the “ Bush Tax Cuts ” argued that they contributed to increased income inequality by unfairly benefiting ...

What was the Great Recession?

Sources. 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.

Where did the Great Recession originate?

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 recession in economics?

A recession is a decline or stagnation in economic growth, but the economic indicators used to define the term “recession” have changed over time.

When did mortgages start to capitalize on the housing boom?

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.

What was the effect of the Dodd-Frank Act on the Great Recession?

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.

Why did the Fed lend AIG?

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.

Is a home loan considered high risk?

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.

What caused the stock market to go down in 1929?

Other causes included an increase in interest rates by the Federal Reserve in August 1929 and a mild recession earlier that summer, both of which contributed to gradual declines in stock prices in September and October, eventually leading investors to panic. During the mid- to late 1920s, the stock market in the United States underwent rapid ...

What was the 1929 stock market crash?

The Wall Street crash of 1929, also called the Great Crash, was a sudden and steep decline in stock prices in the United States in late October of that year.

What was the stock market like in the 1920s?

During the mid- to late 1920s, the stock market in the United States underwent rapid expansion. It continued for the first six months following President Herbert Hoover ’s inauguration in January 1929. The prices of stocks soared to fantastic heights in the great “Hoover bull market ,” and the public, from banking and industrial magnates to chauffeurs and cooks, rushed to brokers to invest their liquid assets or their savings in securities, which they could sell at a profit. Billions of dollars were drawn from the banks into Wall Street for brokers’ loans to carry margin accounts. The spectacles of the South Sea Bubble and the Mississippi Bubble had returned. People sold their Liberty Bonds and mortgaged their homes to pour their cash into the stock market. In the midsummer of 1929 some 300 million shares of stock were being carried on margin, pushing the Dow Jones Industrial Average to a peak of 381 points in September. Any warnings of the precarious foundations of this financial house of cards went unheeded.

What was the Great Depression?

Stock market crash of 1929, also called the Great Crash, a sharp decline in U.S. stock market values in 1929 that contributed to the Great Depression of the 1930s. The Great Depression lasted approximately 10 years and affected both industrialized and nonindustrialized countries in many parts of the world. Crowds gathering outside the New York ...

How many points did the Dow close down?

Still, the Dow closed down only six points after a number of major banks and investment companies bought up great blocks of stock in a successful effort to stem the panic that day. Their attempts, however, ultimately failed to shore up the market. The panic began again on Black Monday (October 28), with the market closing down 12.8 percent.

Why did people sell their Liberty bonds?

People sold their Liberty Bonds and mortgaged their homes to pour their cash into the stock market. In the midsummer of 1929 some 300 million shares of stock were being carried on margin, pushing the Dow Jones Industrial Average to a peak of 381 points in September.

Overview

See more on irle.berkeley.edu

What Caused The Banking Crisis?

What Caused Predatory Lending and Securities Fraud?

Why Didn’T The Federal Reserve Anticipate The Oncoming Crisis?

Conclusion

References