the great recession of 2008 essay

The Great Recession

December 2007–june 2009.

The Great Recession began in December 2007 and ended in June 2009, which makes it the longest recession since World War II. Beyond its duration, the Great Recession was notably severe in several respects. Real gross domestic product (GDP) fell 4.3 percent from its peak in 2007Q4 to its trough in 2009Q2, the largest decline in the postwar era (based on data as of October 2013). The unemployment rate, which was 5 percent in December 2007, rose to 9.5 percent in June 2009, and peaked at 10 percent in October 2009.

The financial effects of the Great Recession were similarly outsized: Home prices fell approximately 30 percent, on average, from their mid-2006 peak to mid-2009, while the S&P 500 index fell 57 percent from its October 2007 peak to its trough in March 2009. The net worth of US households and nonprofit organizations fell from a peak of approximately $69 trillion in 2007 to a trough of $55 trillion in 2009.

As the financial crisis and recession deepened, measures intended to revive economic growth were implemented on a global basis. The United States, like many other nations, enacted fiscal stimulus programs that used different combinations of government spending and tax cuts. These programs included the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009.

The Federal Reserve’s response to the crisis evolved over time and took a number of nontraditional avenues. Initially, the Fed employed “traditional” policy actions by reducing the federal funds rate from 5.25 percent in September 2007 to a range of 0-0.25 percent in December 2008, with much of the reduction occurring in January to March 2008 and in September to December 2008. The sharp reduction in those periods reflected a marked downgrade in the economic outlook and the increased downside risks to both output and inflation (including the risk of deflation).

With the federal funds rate at its effective lower bound by December 2008, the FOMC began to use its policy statement to provide forward guidance for the federal funds rate. The language made reference to keeping the rate at exceptionally low levels “for some time” (Board of Governors 2008) and then “for an extended period” (Board of Governors 2009a). This guidance was intended to provide monetary stimulus through lowering the term structure of interest rates, increasing inflation expectations (or decreasing prospects of deflation), and reducing real interest rates. With the recovery from the Great Recession slow and tenuous, the forward guidance was strengthened by providing more explicit conditionality on specific economic conditions such as “low rates of resource utilization, subdued inflation trends, and stable inflation expectations” (Board of Governors 2009b). This was followed by the explicit calendar guidance in August 2011 of “exceptionally low levels for the federal funds rate at least through mid-2013” and eventually by economic-threshold-based guidance for raising the funds rate from its zero lower bound, with the thresholds based on the unemployment rate and inflationary conditions (Board of Governors 2012). This forward guidance can be seen as an extension of the Federal Reserve’s traditional policy of affecting the current and future path of the funds rate.

In addition to its forward guidance, the Fed pursued two other types of “nontraditional” policy actions during the Great Recession. One set of nontraditional policies can be characterized as credit easing programs that sought to facilitate credit flows and reduce the cost of credit, as discussed in more detail in “ Federal Reserve Credit Programs during the Meltdown ."

Another set of non-traditional policies consisted of the large scale asset purchase (LSAP) programs. With the federal funds rate near zero, the asset purchases were implemented to help push down longer-term public and private borrowing rates. In November 2008, the Fed announced that it would purchase US agency mortgage-backed securities (MBS) and the debt of housing related US government agencies (Fannie Mae, Freddie Mac, and the Federal Home Loan banks). 1   The choice of assets was partly aimed at reducing the cost and increasing the availability of credit for home purchases. These purchases provided support for the housing market, which was the epicenter of the crisis and recession, and also helped improve broader financial conditions. The initial plan had the Fed buying up to $500 billion in agency MBS and up to $100 billion in agency debt; this particular program was expanded in March 2009 and completed in 2010. In March 2009, the FOMC also announced a program to purchase $300 billion of longer-term Treasury securities, which was completed in October 2009, just after the end of the Great Recession as dated by the National Bureau of Economic Research. Together, under these programs and their expansions (commonly called QE1), the Federal Reserve purchased approximately $1.75 trillion of longer-term assets, with the size of the Federal Reserve’s balance sheet increasing by slightly less because some securities on the balance sheet were maturing at the same time.

As of this writing in 2013, however, real GDP is only a little over 4.5 percent above its previous peak and the unemployment rate remains at 7.3 percent. With the federal funds rate at the zero bound and the current recovery slow and grudging, the Fed’s monetary policy strategy has continued to evolve in an attempt to stimulate the economy and fulfill its statutory mandate. Since the end of the Great Recession, the Fed has continued to make changes to its communication policies and to implement additional LSAP programs: a Treasuries-only purchase program of $600 billion in 2010-11 (commonly called QE2) and an outcome-based purchase program that began in September 2012 (in addition, there was a maturity extension program in 2011-12 where the Fed sold shorter-maturity Treasury securities and purchased longer-term Treasuries). Moreover, the increased focus on financial stability and regulatory reform, the economic side effects of the European sovereign debt crisis, and the limited prospects for global growth in 2013 and 2014 speak to how the aftermath of the Great Recession continues to be felt today.

• 1  About $12 billion of short-term agency debt was purchased starting in September 2008 to provide liquidity to markets.

Bibliography

Board of Governors of the Federal Reserve System. “Federal Reserve Issues FOMC Statement.” December 12, 2012, http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm .

Board of Governors of the Federal Reserve System. “FOMC Statement.” December 16, 2008, http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm .

Board of Governors of the Federal Reserve System. “FOMC Statement.” March 18, 2009a, http://www.federalreserve.gov/newsevents/press/monetary/20090318a.htm .

Board of Governors of the Federal Reserve System. “FOMC Statement.” November 4, 2009b, http://www.federalreserve.gov/newsevents/press/monetary/20091104a.htm .

Written as of November 22, 2013. See disclaimer .

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The Great Recession of 2008: A Timeline and Its Effects

All the Key Events of the 2008 Recession

Erika Rasure is globally-recognized as a leading consumer economics subject matter expert, researcher, and educator. She is a financial therapist and transformational coach, with a special interest in helping women learn how to invest.

How the Subprime Mortgage Crisis Caused the Recession

The recession underway, efforts towards recovery, the role of the banks in a sluggish recovery, why not let the banks go bankrupt.

• Why Didn't Obama Do More?

The Dangers of Derivatives

How the bailout affects you, frequently asked questions (faqs).

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The Great Recession began well before 2008. The first signs came in 2006 when housing prices began falling. By August 2007, the Federal Reserve responded to the  subprime mortgage crisis  by adding $24 billion in liquidity to the banking system. By October 2008, Congress approved a $700 billion bank bailout, now known as the Troubled Asset Relief Program. By February 2009, Obama proposed the $787 billion economic stimulus package , which helped avert a global depression.  Here is an overview of the significant moments of the Great Recession of 2008.

• The Great Recession began with the subprime mortgage crisis in 2006, when banks invested in mortgages in the form of derivatives.
• Subprime borrowers started defaulting when the housing bubble burst at the same time the Fed raised rates.
• “Too big to fail” banks, hedge funds, and insurance firms found themselves holding worthless investments.
• The stock market crashed in 2008, as the Dow registered one of the largest point drops in history.
• Congress passed multiple acts and enacted economic stimulus plans to prevent the Great Recession from becoming the second Great Depression.

In November 2006, the Department of Housing and Urban Development warned that new home building permits were 26% lower than the year before.  At this point, the mortgage crisis could have been prevented.  But the Bush administration and the Federal Reserve did not realize how grave those early warning signs were. They ignored declines in the inverted yield curve. Instead, they thought the strong money supply and low interest rates would restrict any problems faced by the real estate industry.

They didn't realize how reliant banks had become on derivatives, or contracts whose value is derived from another asset. Banks and hedge funds sold assets like  mortgage-backed securities  (MBS) to each other as investments. But they were backed by questionable mortgages. 

These interest-only loans were offered to subprime, high-risk borrowers who were most likely to default on a loan. The banks offered them low interest rates. But these “too-good-to-be-true” loans reset to a much higher rate after a certain period. Home prices fell at the same time interest rates reset. Defaults on these loans caused the subprime mortgage crisis. When home prices started falling in 2007, it signaled a real estate crisis that was already in motion.

Essentially, banks had sold more mortgage-backed securities than what could be supported by good mortgages. But they felt safe because they also bought  credit default swaps (CDS), which insured against the risk of defaults. But when the MBS market caved in, insurers did not have the capital to cover the CDS holders. As a result, insurance giant American International Group almost went belly-up before the federal government saved it.

The bottom line? Banks relied too much on derivatives. They sold too many bad mortgages to keep the supply of derivatives flowing. That was the underlying cause of the recession.

This financial catastrophe quickly spilled out of the confines of the housing scene and spread throughout the banking industry, bringing down financial behemoths with it. Among those deemed “too big to fail” were Lehman Brothers and Merrill Lynch. Because of this, the crisis spread globally.

2007: The Fed Didn't Do Enough to Prevent the Recession

On April 17, 2007, the Federal Reserve announced that the federal financial regulatory agencies that oversee lenders would encourage them to work with lenders to work out loan arrangements rather than foreclose. Alternatives to foreclosure included converting the loan to a fixed-rate mortgage and receiving credit counseling through the Center for Foreclosure Solutions. Banks that worked with borrowers in low-income areas could also receive Community Reinvestment Act benefits.

In September, the Fed began lowering interest rates. By the end of the year, the Fed funds rate was 4.25%. But the Fed didn't drop rates far enough, or fast enough, to calm markets. 

July 2008: The Recession Began

The subprime crisis reached the entire economy by the third quarter of 2008 when GDP fell by 2.1% .

But for early observers, the first clue was in October 2006. Orders for durable goods were lower than they had been in 2005, foreshadowing a decline in housing production. Those orders also measure the health of manufacturing orders, a key indicator in the direction of national GDP.

August 2008: Fannie and Freddie Spiraled Downward

Mortgage giants  Fannie Mae and Freddie Mac were fully succumbing to the subprime crisis in the summer of 2008. The failure of the government-backed companies that insured mortgages signaled that the bottom was dropping out. The Bush administration announced plans to take over Freddie and Fannie in order to prevent a full collapse.

Many in Congress then blamed Fannie and Freddie for causing the crisis. They said the two semi-private companies took too many risks in their drive for profits. But, in reality, the companies were trying to remain competitive in an industry that had already become too risky.

September 2008: The Stock Market Crashed

On Sept. 29, 2008, the stock market crashed . The Dow Jones Industrial Average fell 777.68 points in intra-day trading. Until 2018, it was the largest point drop in history. It plummeted because Congress rejected the bank bailout bill.

Although a stock market crash can cause a recession, in this case, it had already begun. But the crash of 2008 made a bad situation much, much worse. 

October 2008: $700 Billion Bank Bailout Bill

On Oct. 3, 2008, Congress established the Troubled Asset Relief Program, which allowed the U.S. Treasury to bail out troubled banks . The Treasury Secretary lent $115 billion to banks by purchasing preferred stock.

It also increased the Federal Deposit Insurance Corporation limit for bank deposits to $250,000 per account and allowed the FDIC to tap federal funds as needed through 2009. That allayed any fears that the agency itself might go bankrupt.

February 2009: The $787 Billion Stimulus Package

On Feb. 17, 2009, Congress passed the  American Recovery and Reinvestment Act . The $787 billion economic stimulus plan ended the recession. It granted $212 billion in tax cuts and $575 billion in outlays, including $311 billion for new projects such as health care, education, and infrastructure initiatives.

On Feb. 18, 2009, Obama announced a $75 billion plan to help stop foreclosures. The Homeowner Stability Initiative was designed to help 7 to 9 million homeowners before they got behind in their payments (most banks won't allow a loan modification until the borrower misses three payments). It subsidized banks that restructured or refinanced their mortgage. However, it wasn't enough to convince banks to change their policies.

Efforts aside, the downward momentum of the economy was too strong. On March 9, 2009, the Dow hit its recession bottom. It dropped to 6,547.05, a total decline of 53.8% from its peak close of 14,164.53 on Oct. 9, 2007. This was worse than any other bear market since the Great Depression of 1929.

March 2009: Making Home Affordable Launched

Making Home Affordable was an initiative launched by the Obama Administration to help homeowners avoid foreclosure. The program generated more than 1.7 million loan modifications in its lifespan.

The Homeowner Affordable Refinance Program (HARP) was one of its programs. It was designed to stimulate the housing market by allowing up to two million credit-worthy homeowners who were upside-down in their homes to refinance and take advantage of lower mortgage rates. But banks only selected the best applicants.

August 2009: Obama Asked Banks to Modify Loans

By August, foreclosures kept mounting, dimming hopes of an economic recovery. Banks could have, but didn't, prevent foreclosures by modifying loans. That's because it would further hurt their bottom line. But record foreclosures (360,149 in July) only made things worse for them as well as American families. July's foreclosure rate was the highest since RealtyTrac, a real estate information firm, began keeping records in 2005. It was 32% higher than in 2008.

Foreclosures continued rising as more adjustable-rate mortgages came due at higher rates. More than half of foreclosures were from just four states: Arizona, California, Florida, and Illinois. California banks beefed up their foreclosure departments, expecting higher home losses.

The Obama administration asked banks to double loan modifications voluntarily by November 1.

October 2009: Banks Weren't Lending

In October 2009,  unemployment peaked at 10% , the worst level since the 1982 recession. Almost 6 million jobs were lost in the 12 months prior to that. Employers were adding temporary workers as they grew too wary of the economy to add full-time employees. But the fields of health care and education continued to expand.

One reason the recovery was sluggish was that banks were not lending. Lending was down 15% from the nation's four biggest banks: Bank of America, JPMorgan Chase, Citigroup, and Wells Fargo, according to The Huffington Post's analysis of federal data. Between April and October of 2009, these banks cut their commercial and industrial lending by $100 billion. Loans to small businesses fell sharply during the same period as well.  

Lending from all banks surveyed showed the number of loans made was down 9% from October 2008. But the outstanding balance of all loans made went up 5%. This meant banks made larger loans to fewer recipients.

The banks said there were fewer qualified borrowers thanks to the recession. Businesses said the banks tightened their lending standards. But if you looked at the 18 months of potential foreclosures in the pipeline, it looked like banks were hoarding cash to prepare for future write-offs. In other words, banks were sitting on $1.1 trillion in government subsidies.

In December of 2009, Bank of America pledged to President Obama that it would increase lending to small and medium-sized businesses by $5 billion in 2010. But that was only after drastically slashing lending in 2009.

People are still angry about the $350 billion in taxpayer dollars that were used to bail out the banks . Many people feel that there was no oversight and that the banks just used the money for executive bonuses. In this case, people thought banks should not have been rescued for making bad decisions based on greed. The argument goes that, if we had just let the banks go bankrupt, the worthless assets would be written off. Other companies would purchase the good assets and the economy would be much stronger as a result. In other words, let laissez-faire capitalism do its thing.

In fact, that is what Former Treasury Secretary Hank Paulson attempted to do with Lehman Brothers in September. The result was a market panic. It created a run on the ultra-safe money market funds, which threatened to shut down cash flow to all businesses, large and small. In other words, the free market couldn't solve the problem without government help.

In fact, most of the government funds were used to create the assets that allowed the banks to write down about $1 trillion in losses. The other problem is that there were no "new companies," i.e. other banks that had the funds to purchase these banks. Even Citigroup—one of the banks that the government had hoped would bail out the other banks—required a bailout to keep going.

Letting the major banks go bankrupt would have left the American economy with no financial system at all. It might have led to the next Great Depression.

Why Didn't Obama Do More To End the Recession?

President Obama was dealing with more than just the recession as he looked toward the midterm elections.

He launched sorely needed but sharply criticized healthcare reform. He also supported the Dodd-Frank Wall Street Reform Act . That and new Federal Reserve regulations were designed to prevent another banking collapse. They also made banking much more conservative. As a result, many banks didn't lend as much, because they were conserving capital to conform to regulations and write down bad debt. But bank lending was needed to spur the small business growth needed to create new jobs. 

The cause of the meltdown was the deregulation of derivatives that was so complicated that even their originators didn't understand them. Banks became so quick to resell mortgages on the secondary market that they felt immune to the dangers of taking riskier and riskier mortgages. Other aggressive moves by banks to sell more collateralized debt obligations (CDOs) and corporations to sell more asset-backed commercial paper helped to push the economy toward a bubble. These derivatives were designed to increase liquidity in the economy, but that liquidity drove housing prices and debt to unmanageable levels.

The Dodd-Frank Act stopped the bank credit panic, allowed LIBOR interest rates to return to normal, and made it possible for everyone to get loans. Without the credit market functioning, businesses were not able to get the capital they need to run their day-to-day business.

Without the bill, it would have been impossible for people to get credit applications approved for home mortgages and even car loans. In a few weeks, the lack of capital would have led to a shutdown of small businesses, which couldn't afford the high interest rates. Also, those whose mortgage rates reset would have seen their loan payments jump. This would have caused even more foreclosures. The Great Recession would have become a depression.

That gives us hope because we learned more about how the economy works and became smarter about managing it. Without that knowledge, we would be in much worse shape today.

How long did the Great Recession last?

The Great Recession lasted 18 months. That's the longest recession since 1960. Before the Great Recession, the average recession lasted 11 months.

How did the amount of bank reserves change in the wake of the Great Recession?

Bank reserves are the amount of cash that banks keep on hand. After the Great Recession, the Federal Reserve increased its reserve requirements for banks, especially larger "systemically important" banks. By requiring banks to keep more capital sitting in reserves, the Federal Reserve sought to improve the stability of the banking system.

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The Great Recession of 2008-2009: Causes, Consequences and Policy Responses

IZA Discussion Paper No. 4934

62 Pages Posted: 29 Jun 2010

Sher Verick

International Labour Organization (ILO); IZA Institute of Labor Economics

Iyanatul Islam

Griffith University - Griffith Asia Institute

Starting in mid-2007, the global financial crisis quickly metamorphosed from the bursting of the housing bubble in the US to the worst recession the world has witnessed for over six decades. Through an in-depth review of the crisis in terms of the causes, consequences and policy responses, this paper identifies four key messages. Firstly, contrary to widely-held perceptions during the boom years before the crisis, the paper underscores that the global economy was by no means as stable as suggested, while at the same time the majority of the world's poor had benefited insufficiently from stronger economic growth. Secondly, there were complex and interlinked factors behind the emergence of the crisis in 2007, namely loose monetary policy, global imbalances, misperception of risk and lax financial regulation. Thirdly, beyond the aggregate picture of economic collapse and rising unemployment, this paper stresses that the impact of the crisis is rather diverse, reflecting differences in initial conditions, transmission channels and vulnerabilities of economies, along with the role of government policy in mitigating the downturn. Fourthly, while the recovery phase has commenced, a number of risks remain that could derail improvements in economies and hinder efforts to ensure that the recovery is accompanied by job creation. These risks pertain in particular to the challenges of dealing with public debt and continuing global imbalances.

Keywords: global financial crisis, unemployment, macroeconomic policy, labour market policy

JEL Classification: E24, E60, G01, J08, J60

Suggested Citation: Suggested Citation

Sher Verick (Contact Author)

International labour organization (ilo) ( email ).

Route des Morillons 4 Geneva, 1211 Switzerland

IZA Institute of Labor Economics ( email )

P.O. Box 7240 Bonn, D-53072 Germany

Griffith University - Griffith Asia Institute ( email )

Queensland, 4111 Australia

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Policy Brief

What Really Caused the Great Recession?

By Erin Coghlan , Lisa McCorkell and Sara Hinkley • September 19, 2018

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. Congress just voted to scale back many Dodd-Frank provisions. Does another recession lie around the corner?

The Great Recession that began in 2008 led to some of the highest recorded rates of unemployment and home foreclosures in the U.S. 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.

What caused the banking crisis?

Fligstein and Adam Goldstein (Assistant Professor at Princeton University) 1 examine the history of bank action leading up to the market collapse, paying particular attention to why banks created and purchased risky mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) in the first place, and why they ignored early warnings of market failure in 2006-07.

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.

Goldstein and Fligstein challenge this understanding. 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

Large financial conglomerates including Bear Stearns, Lehman Brothers, Merrill Lynch, and Morgan Stanley became lenders of mortgages, creators of mortgage-backed securities and collateralized debt obligations (rather than outside investors), underwriters of securities, and mortgage servicers. They all also invested these securities on their own accounts, frequently using borrowed money to do this. This means that as financial institutions entered the market to lend money to homeowners and became the servicers of those loans, they were also able to create new markets for securities (such as an MBS or CDO), and profited at every step of the process by collecting fees for each transaction.

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. By 2006, more than half of the largest financial firms in the country were involved in the nonconventional MBS market. About 45 percent of the largest firms had a large market share in three or four nonconventional loan market functions (originating, underwriting, MBS issuance, and servicing). As shown in Figure 1, by 2007, nearly all originated mortgages (both conventional and subprime) were securitized.

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.

What caused predatory lending and securities fraud?

In a 2015 working paper, Fligstein and co-author Alexander Roehrkasse (doctoral candidate at UC Berkeley) 3 examine the causes of fraud in the mortgage securitization industry during the financial crisis. Fraudulent activity leading up to the market crash was widespread: mortgage originators commonly deceived borrowers about loan terms and eligibility requirements, in some cases concealing information about the loan like add-ons or balloon payments. Banks gave risky loans, such as “NINJA” loans (a loan given to a borrower with no income, no job, and no assets) and Jumbo loans (large loans usually intended for luxury homes), to individuals who could not afford them, knowing that the loans were likely to default. Banks that created mortgage-backed securities often misrepresented the quality of loans. For example, a 2013 suit by the Justice Department and the U.S. Securities and Exchange Commission found that 40 percent of the underlying mortgages originated and packaged into a security by Bank of America did not meet the bank’s own underwriting standards. 4

The authors look at predatory lending in mortgage originating markets and securities fraud in the mortgage-backed security issuance and underwriting markets. After constructing an original dataset from the 60 largest firms in these markets, they document the regulatory settlements from alleged instances of predatory lending and mortgage-backed securities fraud from 2008 until 2014. The authors show that over half of the financial institutions analyzed were engaged in widespread securities fraud and predatory lending: 32 of the 60 firms—which include mortgage lenders, commercial and investment banks, and savings and loan associations—have settled 43 predatory lending suits and 204 securities fraud suits, totaling nearly $80 billion in penalties and reparations.

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. To increase the pool, the authors argue that large firms encouraged their originators to engage in predatory lending, often finding borrowers who would take on risky nonconventional loans with high interest rates that would benefit the banks. In other words, banks pursued a new market of mortgages—in the form of nonconventional loans—by finding borrowers who would take on riskier loans. This allowed financial institutions to continue increasing profits at a time when conventional mortgages were scarce. Firms with MBS issuers and underwriters were then compelled to misrepresent the quality of nonconventional mortgages, often cutting them up into different slices or “tranches” that they could then pool into securities. 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. Fligstein and Roehrkasse make the case that the integrated structure of financial firms into multiple sectors of the MBS industry, alongside the marketplace dynamics of increased scarcity and competition for new mortgages, led firms to engage in fraud.

Key terms defined Collateralized debt obligations (CDO) – multiple pools of mortgage-backed securities (often low-rated by credit agencies); subject to ratings from credit rating agencies to indicate risk 10 Conventional mortgage – a type of loan that is not part of a specific government program (FHA, VA, or USDA) but guaranteed by a private lender or by Fannie Mae and Freddie Mac; typically fixed in its terms and rates for 15 or 30 years; usually conform to Fannie Mae and Freddie Mac’s underwriting requirements and loan limits, such as 20% down and a credit score of 660 or above 11 Mortgage-backed security (MBS) – a bond backed by a pool of mortgages that entitles the bondholder to part of the monthly payments made by the borrowers; may include conventional or nonconventional mortgages; subject to ratings from credit rating agencies to indicate risk 12 Nonconventional mortgage – government backed loans (FHA, VA, or USDA), Alt-A mortgages, subprime mortgages, jumbo mortgages, or home equity loans; not bought or protected by Fannie Mae, Freddie Mac, or the Federal Housing Finance Agency 13 Predatory lending – imposing unfair and abusive loan terms on borrowers, often through aggressive sales tactics; taking advantage of borrowers’ lack of understanding of complicated transactions; outright deception 14 Securities fraud – actors misrepresent or withhold information about mortgage-backed securities used by investors to make decisions 15 Subprime mortgage – a mortgage with a B/C rating from credit agencies. Common reasons to issue include: if the borrower has been delinquent two or more times in the last 12 months, has a low credit rating (below 660), or has filed for bankruptcy in the past 5 years 16

Why didn’t the Federal Reserve anticipate the oncoming crisis?

In a 2014 IRLE working paper by Fligstein with Jonah Stuart Brundage and Michael Schultz (both doctoral candidates at UC Berkeley), 5 the authors analyze 72 meeting transcripts from the Federal Reserve’s decision-making body, the Federal Open Market Committee (FOMC), from 2000 until the 2008 market crash. FOMC members set monetary policy and have partial authority to regulate the U.S. banking system. Fligstein and his colleagues find that FOMC members were prevented from seeing the oncoming crisis by their own assumptions about how the economy works using the framework of macroeconomics.

Their analysis of meeting transcripts reveal that as housing prices were quickly rising, FOMC members repeatedly downplayed the seriousness of the housing bubble. Even after Lehman Brothers collapsed in September 2008, the committee showed little recognition that a serious economic downturn was underway. The authors argue that the committee relied on the framework of macroeconomics to mitigate the seriousness of the oncoming crisis, and to justify that markets were working rationally. They note that most of the committee members had PhDs in Economics, and therefore shared a set of assumptions about how the economy works and relied on common tools to monitor and regulate market anomalies. The meeting transcripts show that the FOMC tried to explain the rise and fall of housing prices in terms of fundamental issues of supply and demand, which was an inadequate frame to recognize the complexity of the changes taking place throughout the entire economy. “The fact that the group of experts whose job it is to make sense of the direction of the economy were more or less blinded by their assumptions about how that reality works, is a sobering result” (Fligstein et al., 2014, p.46). FOMC members saw the price fluctuations in the housing market as separate from what was happening in the financial market, and assumed that the overall economic impact of the housing bubble would be limited in scope, even after Lehman Brothers filed for bankruptcy. In fact, Fligstein and colleagues argue that it was FOMC members’ inability to see the connection between the house-price bubble, the subprime mortgage market, and the financial instruments used to package mortgages into securities that led the FOMC to downplay the seriousness of the oncoming crisis. These topics were often discussed separately in FOMC meetings rather than connected in a coherent narrative. This made it nearly impossible for FOMC members to anticipate how a downturn in housing prices would impact the entire national and global economy.

When the mortgage industry collapsed, it shocked the U.S. and global economy. Had it not been for strong government intervention, U.S. workers and homeowners would have experienced even greater losses.

Observers are raising the alarm that many of the practices prevalent in 2006-2007 are making a comeback. Banks are once again financing subprime loans, particularly in auto loans and small business loans. 6 And banks are once again bundling nonconventional loans into mortgage-backed securities. 7

More recently, President Trump rolled back many of the regulatory and reporting provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act for small and medium-sized banks with less than $250 billion in assets. 8 Legislators—Republicans and Democrats alike—argued that many of the Dodd-Frank provisions were too constraining on smaller banks and were limiting economic growth. 9

This new deregulatory action, coupled with the rise in risky lending and investment practices, could create the economic conditions all too familiar in the time period leading up to the market crash. Fligstein and his co-authors suggest several options to avoid another disaster:

• Regulators should work to have a variety of perspectives in the room to help avoid another large-scale crises: e.g. include other backgrounds on the FOMC
• Restructure employee compensation at financial institutions to avoid incentivizing risky behavior, and increase regulation of new financial instruments
• Task regulators with understanding and monitoring the competitive conditions and structural changes in the financial marketplace, particularly under circumstances when firms may be pushed towards fraud in order to maintain profits.

How bad was the Great Recession? The U.S. unemployment rate peaked at 10 percent in October 2009; rates were higher for African Americans (roughly 15 percent) and Hispanics (roughly 12 percent) 17 Of those unemployed, nearly half were unemployed for 27 weeks or more 18 The construction and manufacturing industries experienced double-digit losses in employment from December 2007 to June 2009 19 Between the onset of the crisis in December 2009 through its end in June 2009, real GDP fell roughly 4.3 percent 20 During the first quarter of 2009—the lowest point of the Recession—over 230,000 U.S. businesses closed 21 From 2007 to 2012, more than 450 banks failed across the country 22 Between 2006 and 2014, over 16 million homes foreclosed in the U.S., with nearly 3 million foreclosures each year at the peak of the crisis in 2009 and 2010 23

Next In The Series

This is the first of a series of policy briefs featuring IRLE faculty research on the Great Recession. The second brief will explore the effects the downturn had on family life and well-being, the third will review employment and wage trends during and since the Great Recession, and the fourth will look at strategies for regulating the recovery.

Featured Research

Fligstein, N., Brundage, J. S., & Schultz, M. (2014). Why the Federal Reserve failed to see the financial crisis of 2008: The role of “macroeconomics” as sense-making and cultural frame. IRLE working paper #111-14. http://www.irle.berkeley.edu/files/2014/Why-the-Federal-Reserve-Failed-to-See-the-Financial-Crisis-of-2008.pdf (Subsequently published as “Seeing like the Fed: Culture, Cognition, and Framing and the Failure to Anticipate the Financial Crisis of 2008 [with Jonah Stuart Brundage and Michael Schultz]. American Sociological Review, 82: 879 – 909, 2017.)

Fligstein, N. & Goldstein, A. (2014). The transformation of mortgage finance and the industrial roots of the mortgage meltdown. IRLE working paper #133-12. http://www.irle.berkeley.edu/files/2012/The-Transformation-of-Mortgage-Finance-and-the-Industrial-Roots-of-the-Mortgage-Meltdown.pdf (Subsequently published as “Financial markets as production markets: the industrial roots of the mortgage meltdown” (with Adam Goldstein). Socio-Economic Review, 15: 483–510, 2017.)

Fligstein, N. & Roehrkasse (2015). The causes of fraud in the financial crises: Evidence from the mortgage-backed securities industry. IRLE working paper #122-15. http://www.irle.berkeley.edu/files/2015/The-Causes-of-Fraud-in-Financial-Crises.pdf (Subsequently published as “The Causes of Fraud in Financial Crises: Evidence from the Mortgage-Backed Securities Industry” (With Alex Roehrkasse). American Sociological Review, 81: 617 – 643, 2016.)

About IRLE’s Policy Brief Series

IRLE’s mission is to support rigorous scholarship on labor and employment at UC Berkeley by conducting and disseminating policy-relevant and socially-engaged research. Our Policy Brief series translates academic research by UC Berkeley faculty and affiliated scholars for policymakers, journalists, and the public. To view this brief and others in the series, visit irle.berkeley.edu/policy-briefs/

Series editor: Sara Hinkley, Associate Director of IRLE

• Fligstein, N. & Goldstein, A. (2014). The transformation of mortgage finance and the industrial roots of the mortgage meltdown. IRLE working paper #133-12. http://www.irle.berkeley.edu/files/2012/The-Transformation-of-Mortgage-Finance-and-the-Industrial-Roots-of-the-Mortgage-Meltdown.pdf
• Fees can be charged when loans are disbursed to a homebuyer, when the mortgage is sold to a wholesaler or issuer, and when the loan is turned into a mortgage-backed security (MBS). Fees may also be collected when underwriting the MBS deal, selling the MBS to an investor, and servicing loans part of the MBS. For more information, see: Fligstein, N. & Goldstein, A. (2014).
• Fligstein, N. & Roehrkasse (2015). The causes of fraud in the financial crises: Evidence from the mortgage-backed securities industry. IRLE working paper #122-15. http://www.irle.berkeley.edu/files/2015/The-Causes-of-Fraud-in-Financial-Crises.pdf
• Ingram, D, & Rudegeair, P. (2013). “U.S. accuses Bank of America of mortgage-backed securities fraud.” Reuters. Cited in Fligstein, N. & Roehrkasse (2015)
• Fligstein, N., Brundage, J. S., & Schultz, M. (2014). Why the federal reserve failed to see the financial crisis of 2008: The role of “Macroeconomics” as sense-making and cultural frame. IRLE working paper #111-14. Berkeley, CA: Institute for Research on Labor and Employment. http://www.irle.berkeley.edu/files/2014/Why-the-Federal-Reserve-Failed-to-See-the-Financial-Crisis-of-2008.pdf
• Campbell, D., & Surane, J. (2018 January 2). Subprime loans return with economic risk and rewards: Quicktake. The Washington Post. Retrieved March 20, 2018 from https://www.washingtonpost.com/business/subprime-loans-return-with-economic-risk-and-rewards-quicktake/2018/01/02/47ca5854-f003-11e7-95e3-eff284e71c8d_story.html?utm_term=.94e75b54b7e9
• Lane, B. (2017 April 6). S&P: Mortgage-backed security market making a comeback in 2017. Housingwire. Retrieved March 20, 2018 from https://www.housingwire.com/articles/39794-sp-mortgage-backed-security-market-making-a-comeback-in-2017
• Dexheimer, E. (2018 May 24). Trump signs biggest rollback of bank rules since Dodd-Frank Act. Bloomberg. Retrieved from https://www.bloomberg.com/news/articles/2018-05-24/trump-signs-biggest-rollback-of-bank-rules-since-dodd-frank-act
• Rappeport, A., & Flitter, E. (2018 May 22). Congress approves first big Dodd-Frank rollback. New York Times. Retrieved from https://www.nytimes.com/2018/05/22/business/congress-passes-dodd-frank-rollback-for-smaller-banks.html
• Fligstein, N. & Goldstein, A. (2014).
• Fligstein, N. & Roehrkasse (2015).
• U.S. Bureau of Labor Statistics (2012). The recession of 2007-2009. Washington, DC: U.S. Bureau of Labor Statistics. Retrieved February 28, 2018, from https://www.bls.gov/spotlight/2012/recession/pdf/recession_bls_spotlight.pdf
• Center on Budget and Policy Priorities (2018). Chart book: The legacy of the Great Recession. Washington, DC: Center on Budget and Policy Priorities. Retrieved February 28, 2018, from https://www.cbpp.org/research/economy/chart-book-the-legacy-of-the-great-recession
• Rich, R. (2013). The Great Recession: December 2007 – June 2009. Richmond, VA: Federal Reserve Bank of Richmond, Federal Reserve History. Retrieved February 28, 2018, from https://www.federalreservehistory.org/essays/great_recession_of_200709
• Federal Deposit Insurance Corporation (2016). Bank failures in brief. FDIC. Retrieved March 15, 2018 from https://www.fdic.gov/bank/historical/bank/2012/index.html
• Carlyle, E. (2015). 2014 foreclosure filings hit lowest level since 2006, RealtyTrac says. Forbes. Retrieved February 15, 2018 from, https://www.forbes.com/sites/erincarlyle/2015/01/15/foreclosure-filings-drop-by-18-in-2014-hit-lowest-level-since-2006-realtytrac-says/#18d6d7d448e5

Related Publications

A review of Money and Finance after the Crisis

March 18, 2019

Read More Right Arrow

The Causes of Fraud in Financial Crises

October 1, 2015

Why the Federal Reserve Failed to See the Financial Crisis of 2008

September 1, 2014

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The great recession: a macroeconomic earthquake.

February 7, 2017

Economic Policy Papers are based on policy-oriented research produced by Minneapolis Fed staff and consultants. The papers are an occasional series for a general audience. The views expressed here are those of the authors, not necessarily those of others in the Federal Reserve System.

Executive Summary

The Great Recession was particularly severe and has endured far longer than most recessions. Economists now believe it was caused by a perfect storm of declining home prices, a financial system heavily invested in house-related assets and a shadow banking system highly vulnerable to bank runs or rollover risk. It has lasted longer than most recessions because economically damaged households were unwilling or unable to increase spending, thus perpetuating the recession by a mechanism known as the paradox of thrift. Economists believe the Great Recession wasn’t foreseen because the size and fragility of the shadow banking system had gone unnoticed.

The recession has had an inordinate impact on macroeconomics as a discipline, leading economists to reconsider two largely discarded theories: IS-LM and the paradox of thrift. It has also forced theorists to better understand and incorporate the financial sector into their models, the most promising of which focus on mismatch between the maturity periods of assets and liabilities held by banks.

Introduction

The Great Recession struck individuals, the aggregate economy and the economics profession like an earthquake, and its aftershocks are still being felt. Job losses and housing foreclosures devastated many families. National economies were deeply damaged and have yet to fully recover. And economists—​who failed to predict either the crisis or the recession—​have been struggling to understand why they didn’t grasp the fragility of the financial system and the duration of the recession.

This essay briefly discusses why the Great Recession is considered both “Great” and a “Recession.” It then turns to the emerging consensus about its cause, its duration and the reasons so few predicted it. Finally, it explores the impact of the Great Recession on how academic economists now think about the economy.

“Great Recession”

The economic downturn the United States suffered from late 2007 to the third quarter of 2009 was particularly damaging. Output, consumption, investment, employment and total hours worked dropped far more during the recent recession than the comparable average figures for all other recessions since 1945. Employment, for example, dropped 6.7 percent during the 2007-09 recession compared with an average of 3.8 percent for postwar recessions. Analogous figures for output: 7.2 percent and 4.4 percent; for consumption: 5.4 percent and 2.1 percent. That higher level of severity across the board is why this recession has earned the adjective “Great.”

By the same token, however, this recession was definitely not the worst U.S. downturn on record. Conditions were far worse during the Great Depression. Employment fell 27 percent from 1929 to 1933 (compared with 6.7 percent from 2007 to 2009), output fell 36 percent (7.2 percent) and consumption fell 23 percent (5.4 percent). For that reason, the recent slump, though severe, is rightly considered a recession rather than a full-bore depression.

Another reason to consider this recession “Great” is how uncommonly long the economy has been taking to recover. The accompanying figure displays labor productivity (output per working-age person, adjusted for inflation) from 1977 through 2014. 1 The vertical pink bars in the figure indicate the starting and ending dates for recessions, as determined by the National Bureau of Economic Research (NBER).

The U.S. economy did not return to the 2007 level of output per capita until a little over five years later, in first quarter 2013. 2 The productivity trend lines for the previous four recessions show that the economy usually snaps back more quickly. Even now, the U.S. economy is still about 10 percent below normal (that is, trend growth in 2007). 3

What caused the Great Recession?

Conventional wisdom is now converging on a particular narrative about the cause of the Great Recession. In effect, the Great Recession was a “perfect storm” created by the concurrence of three factors. 4 Taken by itself, none of these factors would have caused a major recession, but in combination, they were explosive.

The first was the decline in housing prices that began in the summer of 2007. Whether this was the end of a “bubble” or just an ordinary fluctuation does not matter for the narrative. The second factor was that the financial system was heavily invested in housing-related assets, mortgage-backed securities. 5 The third factor was that the shadow banking system was invested in housing assets and highly vulnerable to bank runs. 6

These three factors are the essential elements in the following narrative about the Great Recession.

The fall in housing prices damaged the assets of the shadow banking system and thereby created the conditions in which a run on the shadow banking system could occur. Alas, a run did occur in the summer of 2007, forcing the shadow banking system to sell its assets at fire sale prices.

This asset decline damaged the whole banking system and hindered its ability to intermediate not just house purchases, but investment more generally. With reduced credit, purchases of houses declined and the fall in house prices was reinforced.

By reducing household wealth, the fall in house prices induced households to cut back on spending. Faced with declining sales, firms pulled back on investment and hiring. All of these factors reinforced each other, sending the economy into the tailspin documented above.

Why has it lasted so long?

The conventional view on why the recession lasted so long is that the events described in the previous paragraph reinforced the desire to save, relative to the desire to invest. If markets worked efficiently, then the interest rate would have fallen to balance the demand and supply of savings, without a significant fall in employment. According to the conventional view, this required that interest rates be substantially negative, something that could not be achieved because the nominal interest rate cannot be much below zero. Because interest rates could not fall enough to clear lending markets, something else had to bring the demand and supply of saving into equality. That something else was the fall in aggregate output and income, which allowed lending markets to clear by reducing saving as people tried to avoid reducing their consumption too much. This is essentially the logic of the “paradox of thrift” analyzed in undergraduate textbooks in macroeconomics. 7 Consistent with those textbooks, the fall in output arising from this paradox-of-thrift reasoning could in principle last for a long time.

Why didn’t policymakers or economists see it coming?

The emerging consensus is that no one, neither policymakers nor academic economists, was aware of the third factor underlying the Great Recession, the size and fragility of the shadow banking sector (see, for example, Bernanke 2010). 8 The reason is simple. Much of what policymakers and economists know about financial markets comes about as a side effect of regulation, and the shadow banking system existed mostly outside the normal regulatory framework.

Impact on macroeconomics

The Great Recession is having an enormous impact on macroeconomics as a discipline, in two ways. First, it is leading economists to reconsider two theories that had largely been discredited or neglected. Second, it has led the profession to find ways to incorporate the financial sector into macroeconomic theory.

Neglected paradigms

At its heart, the narrative described above characterizes the Great Recession as the response of the economy to a negative shock to the demand for goods all across the board. This is very much in the spirit of the traditional macroeconomic paradigm captured by the famous IS-LM (or Hicks-Hansen) model, 9 which places demand shocks like this at the heart of its theory of business cycle fluctuations. Similarly, the paradox-of-thrift argument 10 is also expressed naturally in the IS-LM model.

The IS-LM paradigm, together with the paradox of thrift and the notion that a decision by a group of people 11 could give rise to a welfare-reducing drop in output, had been largely discredited among professional macroeconomists since the 1980s. But the Great Recession seems impossible to understand without invoking paradox-of-thrift logic and appealing to shocks in aggregate demand. As a consequence, the modern equivalent of the IS-LM model—the New Keynesian model—has returned to center stage. 12 (To be fair, the return of the IS-LM model began in the late 1990s, but the Great Recession dramatically accelerated the process.)

The return of the dynamic version of the IS-LM model is revolutionary because that model is closely allied with the view that the economic system can sometimes become dysfunctional, necessitating some form of government intervention. This is a big shift from the dominant view in the macroeconomics profession in the wake of the costly high inflation of the 1970s. Because that inflation was viewed as a failure of policy, many economists in the 1980s were comfortable with models that imply markets work well by themselves and government intervention is typically unproductive.

Accounting for the financial sector

The Great Recession has had a second important effect on the practice of macroeconomics. Before the Great Recession, there was a consensus among professional macroeconomists that dysfunction in the financial sector could safely be ignored by macroeconomic theory. The idea was that what happens on Wall Street stays on Wall Street—that is, it has as little impact on the economy as what happens in Las Vegas casinos. This idea received support from the U.S. experiences in 1987 and the early 2000s, when the economy seemed unfazed by substantial stock market volatility. But the idea that financial markets could be ignored in macroeconomics died with the Great Recession.

Now macroeconomists are actively thinking about the financial system, how it interacts with the broader economy and how it should be regulated. This has necessitated the construction of new models that incorporate finance, and the models that are empirically successful have generally integrated financial factors into a version of the New Keynesian model, for the reasons discussed above. (See, for example, Christiano, Motto and Rostagno 2014.)

Economists have made much progress in this direction, too much to summarize in this brief essay. One particularly notable set of advances is seen in recent research by Mark Gertler, Nobuhiro Kiyotaki and Andrea Prestipino. (See Gertler and Kiyotaki 2015 and Gertler, Kiyotaki and Prestipino 2016.) In their models, banks finance long-term assets with short-term liabilities. This liquidity mismatch between assets and liabilities captures the essential reason that real world financial institutions are vulnerable to runs. As such, the model enables economists to think precisely about the narrative described above (and advocated by Bernanke 2010 and others) about what launched the Great Recession in 2007. Refining models of this kind is essential for understanding the root causes of severe economic downturns and for designing regulatory and other policies that can prevent a recurrence of disasters like the Great Recession.

1 The output and population data were obtained from FRED, the online database maintained by the Federal Reserve Bank of St. Louis. The FRED label for the output measure is GDPC1, and the label for the working-age population is LFWA64TTUSQ647S.

2 The exact amount of time required for per capita output to return to its prerecession peak depends somewhat on the population measure used. If instead the civilian non-institutional population measure (FRED label CNP16OV) were used, then the amount of time would have been longer, roughly seven years. The difference from the results in the figure reflects demographic factors that cause the working-age population to grow less rapidly than the population as a whole.

3 For additional discussion about the trend of U.S. economic output in 2007, see Christiano, Eichenbaum and Trabandt (2015). The 10 percent number in the text was rounded after doing the following calculations. I fit a linear time trend to the natural logarithm of the output measure in the figure, using data from the beginning of the sample to the fourth quarter of 2007, the quarter before the Great Recession began according to the NBER. I extended the trend to the end of the sample. The difference between the trend at the end of the sample and the (log of the) last data point is 0.136, which I rounded to 0.10. The 10 percent number reported in the text is the last number, multiplied by 100.

4 An early, subsequently discarded, view was the so-called labor mismatch hypothesis. It held that the low level of employment was not due to a lack of jobs, but to the lack of workers with the right skills to fill them. Workforce and firms were “ mismatched .”

This view lost its appeal as it became apparent just how broad-based the recession was. Employment and hours worked fell in virtually all sectors. The unemployment rate jumped for virtually every type of worker, by level of education and occupation. According to the mismatch hypothesis, wage growth should have been especially high and unemployment low for the highly sought-after types of workers. But jobs were scarce virtually everywhere, for everyone.

Why did employers hire so few workers? Since the early 1970s, the National Federation of Independent Business has surveyed its members to find out what their top problem is. They are asked to select from among 10 possibilities, including taxes, inflation, poor sales and quality of labor. Under the mismatch hypothesis, a large fraction of firms should have selected “quality of labor” as their top problem. They didn’t. Instead, “poor sales” surged beyond all other options as their top problem. Firms were not hiring simply because people were not buying their goods and services.

5 It is an interesting story, beyond the scope of this analysis, how so much money came to be invested in mortgages. Under the conventional view, the source of the money was what Bernanke (2005) called the “savings glut”: Money poured in from high-saving countries in Asia and oil-producing regions. Under what Shin (2012) called the “banking glut,” a lot of that incoming money went to Europe and then came right back to the United States. The European institutions that managed this back-and-forth flow had a strong preference for mortgages.

Evidence in favor of the notion that the large current account deficit reflected an increase in the supply of funds by foreigners is the sharp drop in interest rates since 2000. The evidence that a lot of the extra money went into mortgages is that mortgage rates and lending conditions became particularly loose. For further discussion of this view, see Justiniano, Primiceri and Tambalotti (2015). Evidence consistent with the notion that the U.S. current account deficit played an important role in housing markets can also be seen in the substantial covariation between U.S. housing prices and the current account (see Figure 1.1 in Justiano, Primiceri and Tambalotti 2015).

6 Technically, what happened was a rollover crisis, not a traditional bank run like those familiar from movies and photographs from the Great Depression. For a careful discussion of a rollover crisis, see Gertler and Kiyotaki (2015).

7 The paradox-of-thrift argument described in the text lies at the heart of the analysis of the interest rate lower bound in Eggertsson and Woodford (2003).

8 That shadow banking system was of a similar order of magnitude as the traditional banking system discussed in Geithner (2008).

9 The IS-LM model—often depicted graphically and thought to encapsulate traditional Keynesian theory—describes the relationship between real output (GDP) and nominal interest rates. On a graph with real interest rates on the vertical axis and real GDP on the horizontal, IS-LM is seen as a downward-sloping IS curve (investment and savings, or the market for economic goods) and an upward-sloping LM curve (liquidity preference and money supply). The intersection of these curves indicates an economy’s equilibrium interest rate and GDP.

10 This is the idea that if people feel poor because the economy is not prospering, they’ll cut back on spending; that cutback will, in turn, encourage businesses to retrench on investment and hiring, leading to a self-fulfilling prophecy of economic downturn. The “paradox” is that while thrift at the individual level may be wise, it can have a harmful impact on the broader economy and ultimately on individuals as well. See, for example, “Paradox” Redux in the June 2013 Region .

11 Businesses reducing investment when they experience lower sales, for instance, or households cutting back because they feel poor with the fall in house prices.

12 For another model that may also be able to come to terms with the data on the Great Recession, see Buera and Nicolini (2016).

Bernanke, Ben S. 2005. “The Global Saving Glut and the U.S. Current Account Deficit.” Sandridge Lecture. Virginia Association of Economists, April 14.

Bernanke, Ben S. 2010. Statement before the Financial Crisis Inquiry Commission. Washington, D.C., Sept. 2. https://www.federalreserve.gov/newsevents/testimony/bernanke20100902a.pdf

Buera, Francisco and Juan Pablo Nicolini. 2016. “Liquidity Traps and Monetary Policy: Managing a Credit Crunch.” Unpublished manuscript, Federal Reserve Bank of Chicago.

Christiano, Lawrence J., Martin S. Eichenbaum and Mathias Trabandt. 2015. “Understanding the Great Recession.” American Economic Journal: Macroeconomics 7 (1): 110-67.

Christiano, Lawrence J., Roberto Motto and Massimo Rostagno. 2014. “Risk Shocks.” American Economic Review 104 (1): 27-65.

Eggertsson, Gauti, and Michael Woodford. 2003. “The Zero Bound on Interest Rates and Optimal Monetary Policy.” Brookings Papers on Economic Activity 34 (1): 139-235.

Geithner, Timothy F. 2008. “Reducing Systemic Risk in a Dynamic Financial System.” Remarks at The Economic Club of New York. New York City, June 9. https://www.newyorkfed.org/newsevents/speeches/2008/tfg080609.html

Gertler, Mark, and Nobuhiro Kiyotaki. 2015. “Banking, Liquidity, and Bank Runs in an Infinite Horizon Economy.” American Economic Review 105 (7): 2011-43.

Gertler, Mark, Nobuhiro Kiyotaki and Andrea Prestipino. 2016. “Wholesale Banking and Bank Runs in Macroeconomic Modelling of Financial Crises.” Working Paper 21892, National Bureau of Economic Research.

Justiniano, Alejandro, Giorgio Primiceri and Andrea Tambalotti. 2015. “The Effects of the Saving and Banking Glut on the U.S. Economy.” Working Paper 19635, National Bureau of Economic Research.

Shin, Hyun Song. 2011. “Global Banking Glut and Loan Risk Premium.” Draft. 2011 Mundell-Fleming Lecture.

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Great Recession Timeline

By: History.com Editors

Updated: April 3, 2020 | Original: December 4, 2017

What were the key moments in the Great Recession , the most significant economic downturn since the Great Depression of the 1920s and 1930s? Here are some of the most important milestones in a Great Recession timeline of the financial crisis—also known as the 2008 recession—which lasted in the United States from mid-2007 to June of 2009.

Bankruptcies Begin

April 2, 2007: New Century Financial declares Chapter 11 bankruptcy. The company specialized in so-called “subprime” mortgages, or home loans to borrowers with poor credit histories, making $60 billion in such loans in 2006 alone. It attributes its financial troubles to an increasing number of borrowers who defaulted on their mortgages in a slumping housing market. Earlier in the year, the Federal Home Loan Mortgage Corporation (or “ Freddie Mac ”) announces that it will no longer purchase risky subprime mortgages and mortgage-related securities.

Dow Jones Soars

October 9, 2007: The U.S. stock market hits an all-time high, as the Dow Jones Industrial Average reaches 14,164 points.

December, 2007: The National Bureau of Economic Research (NBER) retrospectively declares that the economic downturn, which was later dubbed the “ Great Recession ,” began at the end of 2007, after two consecutive quarters of declining economic growth. At the beginning of the downturn, the U.S. unemployment rate is 5 percent and the net worth of American households stands at $69 trillion. The latter figure falls to $55 trillion over the course of the recession.

January 30, 2008: The U.S. Federal Reserve drops short-term interest rates to 3 percent, marking the fourth time the “Fed” opts to reduce interest rates since September 2007, when rates were 5.25 percent.

February 13, 2008: President George W. Bush signs the Economic Stimulus Act of 2008 into law. The legislation provides many Americans with income tax rebates and gives tax breaks for businesses purchasing new equipment.

Bear Stearns Collapses

March 16, 2008: After losing billions in subprime mortgage investments, 85-year-old brokerage firm Bear Stearns collapses and is purchased by JPMorgan Chase at the cut-rate price of $2 per share. Bear Stearns stock had been valued at $30 per share just days before the sale. The shocking news of the sale sends global stock markets tumbling.

July 11, 2008: IndyMac, a mortgage lender that includes Countrywide Financial, collapses, and its assets are seized by the U.S. government. Although the “Mac” in the company’s name is similar to the nickname for the federal mortgage program Freddie Mac, IndyMac is a private company that specialized in subprime mortgages and other high-risk loans. In addition to financial consequences for investors, its closure resulted in more than 4,000 people losing their jobs.

September 7, 2008: The U.S. Treasury takes over management of Freddie Mac and the Federal National Mortgage Association (“ Fannie Mae ”). The two companies had guaranteed 80 percent of U.S. home mortgages, 30 percent of which are “underwater”—valued at less than the total mortgage loan—at the time of the takeover.

Lehman Brothers Bankruptcy

September 15, 2008: Venerable brokerage firm Lehman Brothers declares bankruptcy. It’s the largest bankruptcy case in U.S. history, involving $619 billion in debts.

September 16, 2008: The U.S. government announces plans to bail out insurance company AIG, paying $85 billion for 80 percent of the company’s assets. AIG had been considered one of the companies that was “too big to fail”—meaning its collapse would pose a threat to American financial stability.

Troubled Asset Relief Program

October 3, 2008: The Troubled Asset Relief Program (TARP) is signed into law by President Bush. The legislation commits $700 billion in federal taxpayer funds toward the purchase of mortgage-backed securities and other assets from struggling financial institutions in an effort to restore confidence in the credit markets.

October 6-10, 2008: The Dow suffers its largest-ever weekly loss: 1,874 points. The value of U.S. stocks plunges, causing many Americans to lose savings invested in financial markets.

November, 2008: The U.S. government announces its plan to bail out Citigroup , in response to concerns that the bank lacked sufficient funds to cover its mortgage-related losses. The government essentially purchases $45 billion worth of preferred and common stock in the company, which is sold a few years later at a net gain of $12 billion.

December, 2008: Struggling automakers General Motors and Chrysler receive a combined $80.7 billion TARP funds to remain afloat and keep workers employed.

December 16, 2008: The Federal Reserve reduces short-term interest rates to 0 percent for the first time in American history. The Fed had been reducing the target interest rate incrementally (usually by a quarter- or a half-percent) since the start of the Great Recession in an attempt to boost loans for real estate sales and capital investment.

Bank Bailouts

January 16, 2009: The U.S. government bails out another bank—this time, Bank of America , to the tune of $20 billion in federal funds and $100 billion in guarantees in subprime mortgages and other toxic assets. It’s the second largest bank bailout of the recession.

February 18, 2009: Within weeks of taking office, President Barack Obama approves a $787 billion stimulus package, which includes tax cuts ($400 for individuals and $800 for couples) and money for infrastructure, schools, health care and green energy.

Dow Plunges

March 9, 2009: The “Dow” falls to its Great Recession low of 6,547 points, a drop of more than 50 percent from its all-time high set in October 2007.

June 2009: The NBER officially declares the Great Recession over, at least in the United States. However, the effects of the downturn are still being felt at home and abroad.

GM Bankruptcy

June 1, 2009: GM files for bankruptcy, announcing plans to close 14 factories, despite having received TARP funds.

October 2009: The U.S. unemployment rate hits 10 percent for the first time in a quarter century.

December 2009: Housing foreclosures in the United States reach record levels, with 2.9 million in 2009 alone.

Dodd-Frank Act

July 21, 2010: President Obama signs into law the Dodd–Frank Wall Street Reform and Consumer Protection Act. The legislation is designed to restore at least some of the U.S. government’s regulatory power over the financial industry by enabling the government to assume control of banks deemed to be on the brink of financial collapse, among other provisions.

August 5, 2010: Bond rating firm Standard and Poor’s lowers the U.S. government’s credit rating from AAA to AA+ for the first time in history.

August 2, 2012: The Dow Jones Industrial Average reaches a new record high of 15,658 points, indicating that investor confidence has finally recovered, more than three years after the official end of the Great Recession.

2010-2013: Several countries—Cyprus, Greece, Ireland and Spain, among others—receive billions in bailouts from the European Union after their respective national debts reached crisis levels.

Rich, Robert. “The Great Recession.” Federalreservehistory.org . “New Century files for Chapter 11 bankruptcy.” Reuters.com . “3 Years After the Stock Market Peak: Here are the Lessons.” CBSNews .com . Rich, Robert. “The Great Recession.” Federalreservehistory.com . Full Timeline. Federal Reserve Bank of St. Louis . “Bush signs stimulus bill; rebate checks expected in May.” CNN.com . “JPMorgan scoops up troubled Bear.” CNN.com . Devcic, John. “Too Good To Be True: The Fall Of IndyMac.” Investopedia.com . “Why the U.S. Treasury Really Took Over Fannie Mae and Freddie Mac.” Economyandmarkets.com . “Case Study: the Collapse of Lehman Brothers.” Investopedia.com . Gethard, Gregory. “Falling Giant: a Case Study of AIG.” Investopedia.com . Glass, Andrew. “Bush signs bank bailout, Oct. 3, 2008.” Politico.com . Amadeo, Kimberly. “Auto Industry Bailout (GM, Chrysler, Ford).” thebalance.com . Associated Press. “GM files for bankruptcy protection; will close 14 plants.” TheDailyGazette.com . Gandel, Stephen. “Government banks $15 billion on Citigroup bailout.” Fortune.com . “Bank of America gets big government bailout. Reuters.com . “Obama Signs Stimulus Plan Into Law.” CBSNews.com . Isidore, Chris. “Recession officially ended in June 2009.” CNN.com . The Christian Science Monitor. “Timeline on the Great Recession.” CSMonitor.com . “European Debt Crisis Fast Facts.” CNN.com .

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Sowing the Seeds of the Crisis

Signs of trouble.

• Aug. 2007: The Beginning
• March 2008: Bear Stearns
• Sept. 2008: Lehman Brothers

The Aftermath

About dodd-frank.

• Financial Crisis FAQs

The Bottom Line

The 2007–2008 financial crisis in review.

Thomas J Catalano is a CFP and Registered Investment Adviser with the state of South Carolina, where he launched his own financial advisory firm in 2018. Thomas' experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.

Pete Rathburn is a copy editor and fact-checker with expertise in economics and personal finance and over twenty years of experience in the classroom.

• Guide to Stock Market Crashes
• October: The Month of Market Crashes?
• How Do Investors Lose Money When the Stock Market Crashes?
• Timeline of U.S. Stock Market Crashes
• October Effect
• Financial Crisis
• Circuit Breaker
• Plunge Protection Team
• Dutch Tulip Bulb Market Bubble
• Black Friday
• Bank Panic of 1907
• Stock Market Crash of 1929
• What Caused the Stock Market Crash of 1929
• Black Tuesday
• Black Thursday
• Stock Market Crash of 1987
• Black Monday
• What Caused Black Monday: The Stock Market Crash of 1987
• The 2007-2008 Financial Crisis in Review CURRENT ARTICLE
• The Fall of the Market in the Fall of 2008
• Components of the 2008 Bubble
• Financial Regulations: Glass-Steagall to Dodd-Frank
• Consequences of the Glass-Steagall Act Repeal
• Lessons from the 2008 Financial Crisis
• Major Players in the 2008 Financial Crisis: Where Are They Now?
• Too Big to Fail Banks: Where Are They Now?

The financial crisis of 2007–2008 was years in the making. Financial markets around the world were showing signs by the summer of 2007 that the reckoning was overdue for a years-long binge on cheap credit. Two Bear Stearns hedge funds had collapsed, BNP Paribas was warning investors that they might not be able to withdraw money from three of its funds, and the British bank Northern Rock was about to seek emergency funding from the Bank of England.

Few investors suspected that the worst crisis in nearly eight decades was about to engulf the global financial system despite the warning signs, bringing Wall Street's giants to their knees and triggering the Great Recession.

It was an epic financial and economic collapse that cost many ordinary people their jobs, their life savings, their homes, or all three.

Key Takeaways

• The 2007–2008 financial crisis developed gradually. Home prices began to fall in early 2006.
• Subprime lenders began to file for bankruptcy in early 2007.
• Two big hedge funds failed in June 2007, weighed down by investments in subprime loans.
• Losses from subprime loan investments caused a panic that froze the global lending system in August 2007.
• In September 2008 Lehman Brothers collapsed in the biggest U.S. bankruptcy ever in September 2008.

The seeds of the financial crisis were planted during years of rock-bottom interest rates and loose lending standards that fueled a housing price bubble in the U.S. and elsewhere. It began, as usual, with good intentions. Faced with the bursting of the dot-com bubble, a series of corporate accounting scandals, and the September 11 terrorist attacks , the Federal Reserve lowered the federal funds rate from 6.5% in May 2000 to 1% in June 2003.

The aim was to boost the economy by making money available to businesses and consumers at bargain rates. The result was an upward spiral in home prices as borrowers took advantage of the low mortgage rates. Even subprime borrowers with poor or no credit history were able to realize the dream of buying a home.

The 2008 financial crisis began with cheap credit and lax lending standards that fueled a housing bubble. Banks were left holding trillions of dollars of worthless investments in subprime mortgages when the bubble burst. The Great Recession that followed cost many their jobs, their savings, and their homes.

The banks then sold these loans on to Wall Street banks that packaged them into what were billed as low-risk financial instruments such as mortgage-backed securities and collateralized debt obligations (CDOs). A big secondary market for originating and distributing subprime loans soon developed.

The Securities and Exchange Commission (SEC) in October 2004 relaxed the net capital requirements for five investment banks in 2004: Goldman Sachs (NYSE: GS), Merrill Lynch (NYSE: MER), Lehman Brothers, Bear Stearns, and Morgan Stanley (NYSE: MS). This fueled greater risk-taking among banks and freed them to leverage their initial investments by up to 30 times or even 40 times.

Interest rates eventually started to rise and homeownership reached a saturation point. The Fed started raising rates in June 2004 and the Federal funds rate reached 5.25% two years later, where it remained until August 2007.

There were early signs of distress. U.S. homeownership had peaked at 69.2% by 2004. Then home prices started to fall in early 2006.

This caused real hardship to many Americans. Their homes were worth less than what they had paid for them. They couldn't sell their houses without owing money to their lenders. Their costs were going up as their homes' values were going down if they had adjustable-rate mortgages. The most vulnerable subprime borrowers were stuck with mortgages they couldn't afford in the first place.

Subprime mortgage company New Century Financial made nearly $60 billion in loans in 2006, according to the Reuters news service. It filed for bankruptcy protection in 2007.

One subprime lender after another filed for bankruptcy as 2007 got underway. More than 25 subprime lenders went under during February and March. New Century Financial which specialized in sub-prime lending filed for bankruptcy and laid off half of its workforce in April.

Bear Stearns stopped redemptions in two of its hedge funds by June, prompting Merrill Lynch to seize $800 million in assets from the funds.

But even these were small matters compared to what was to happen in the months ahead.

August 2007: The Dominoes Start to Fall

It became apparent by August 2007 that the financial markets couldn't solve the subprime crisis and that the problems were reverberating well beyond the U.S. borders.

The interbank market that keeps money moving around the globe froze completely, largely due to fear of the unknown. Northern Rock had to approach the Bank of England for emergency funding due to a liquidity problem. In October 2007, Swiss bank UBS became the first major bank to announce losses $3.4 billion from subprime-related investments.

The Federal Reserve and other central banks would take coordinated action to provide billions of dollars in loans to the global credit markets in the coming months. The markets were grinding to a halt as asset prices fell. Financial institutions meanwhile struggled to assess the value of the trillions of dollars worth of now-toxic mortgage-backed securities that were sitting on their books.

March 2008: The Demise of Bear Stearns

The U.S. economy was in a full-blown recession by the winter of 2008. Stock markets around the world were tumbling more than they had since the September 11 terrorist attacks as financial institutions' liquidity struggles continued.

The Fed cut its benchmark rate by three-quarters of a percentage point in January 2008. This was its biggest cut in a quarter-century as it sought to slow the economic slide.

The bad news continued to pour in from all sides. The British government was forced to nationalize Northern Rock in February. Global investment bank Bear Stearns, a pillar of Wall Street that dated to 1923, collapsed and was acquired by JPMorgan Chase for pennies on the dollar in March.

September 2008: The Fall of Lehman Brothers

The carnage was spreading across the financial sector by the summer of 2008. IndyMac Bank became one of the largest banks ever to fail in the U.S. The country's two biggest home lenders, Fannie Mae and Freddie Mac, had been seized by the U.S. government.

Yet the collapse of the venerable Wall Street bank Lehman Brothers in September marked the largest bankruptcy in U.S. history and it became for many a symbol of the devastation caused by the global financial crisis.

Financial markets were in free fall in September with the major U.S. indexes suffering some of their worst losses on record. The Fed, the Treasury Department, the White House, and Congress struggled to put forward a comprehensive plan to stop the bleeding and restore confidence in the economy.

The Wall Street bailout package was approved in the first week of October 2008.

The package included many measures , such as a huge government purchase of "toxic assets," an enormous investment in bank stock shares, and financial lifelines thrown to Fannie Mae and Freddie Mac.

Public indignation was widespread. It appeared that bankers were being rewarded for recklessly tanking the economy but it got the economy moving again. The investments in the banks were fully recouped by the government, with interest.

The passage of the bailout package stabilized the stock markets, which hit bottom in March 2009 and then embarked on the longest bull market in its history.

The government spent $440 billion through the Troubled Asset Relief Program (TARP). It got $442.6 billion back after assets bought in the crisis were resold at a profit.

The economic damage and human suffering were nonetheless immense. Unemployment reached 10%. About 3.8 million Americans lost their homes to foreclosures.

The most ambitious and controversial attempt to prevent such an event from happening again was the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. The act restricted some of the riskier activities of the biggest banks, increased government oversight of their activities, and forced them to maintain larger cash reserves. It attempted to reduce predatory lending.

Some portions of the act had been rolled back by the Trump Administration by 2018 although an attempt at a more wholesale dismantling of the new regulations failed in the U.S. Senate.

Those regulations are intended to prevent a crisis similar to the 2007–2008 event from happening again but this doesn't mean that there won't be another financial crisis in the future. Bubbles have occurred periodically since the 1630s Dutch Tulip Bubble .

The 2007–2008 financial crisis was a global event. It wasn't restricted to the U.S. Ireland 's vibrant economy fell off a cliff and Greece defaulted on its international debts. Portugal and Spain suffered from extreme levels of unemployment. Every nation's experience was different and complex.

What Is a Mortgage-Backed Security?

A mortgage-backed security is similar to a bond. It consists of home loans that are bundled together and sold by banks that lend the money to Wall Street investors. The point is to profit from the loan interest paid by the mortgage holders.

Loan originators encouraged millions to borrow beyond their means to buy homes they couldn't afford in the early 2000s. These loans were then sent on to investors in the form of mortgage-backed securities. The homeowners who had borrowed beyond their means began to default. Housing prices fell and millions walked away from mortgages that cost more than their houses were worth.

Who Is to Blame for the Great Recession?

Many economists place the greatest part of the blame on lax mortgage lending policies that allowed many consumers to borrow far more than they could afford. There's plenty of blame to go around, however, including:

• The predatory lenders who marketed homeownership to people who couldn't possibly pay back the mortgages they were offered
• The investment gurus who bought those bad mortgages and rolled them into bundles for resale to investors
• The agencies who gave those mortgage bundles top investment ratings, making them appear to be safe
• The investors who failed to check the ratings or who simply took care to unload the bundles to other investors before they blew up

Which Banks Failed in 2008?

The total number of bank failures linked to the financial crisis can't be revealed without reporting that no depositor in an American bank lost a penny to a bank failure. That said, more than 500 banks failed between 2008 and 2015, compared to a total of 25 in the preceding seven years, according to the Federal Reserve of Cleveland.

Most were small regional banks and all were acquired by other banks, along with their depositors' accounts. The biggest failures weren't banks in the traditional Main Street sense but investment banks that catered to institutional investors. These notably included Lehman Brothers and Bear Stearns . Lehman Brothers was denied a government bailout and shut its doors. JPMorgan Chase bought the ruins of Bear Stearns on the cheap.

As for JPMorgan Chase, Goldman Sachs, Bank of America, and Morgan Stanley, they were all famously " too big to fail ." They took the bailout money, repaid it to the government, and emerged bigger than ever after the recession.

Who Made Money in the 2008 Financial Crisis?

Several smart investors made money from the crisis, mostly by picking up pieces from the wreckage.

• Warren Buffett invested billions in companies including Goldman Sachs and General Electric out of a mix of motives that combined patriotism and profit.
• Hedge fund manager John Paulson made a lot of money betting against the U.S. housing market when the bubble formed and then made a lot more money betting on its recovery after it hit bottom.
• Investor Carl Icahn proved his market-timing talent by selling and buying casino properties before, during, and after the crisis.

Bubbles occur all the time in the financial world. The price of a stock or any other commodity can become inflated beyond its intrinsic value. The damage is usually limited to losses for a few over-enthusiastic buyers. The financial crisis of 2007–2008 was a different kind of bubble, however.

Like only a few others in history, it grew big enough that it damaged entire economies and hurt millions of people when it burst, including many who weren't speculating in mortgage-backed securities.

U.S. Securities and Exchange Commission. " SEC Charges Two Former Bear Stearns Hedge Fund Managers with Fraud ."

Bank for International Settlements. " Reflections on Northern Rock: The Bank Run that Heralded the Global Financial Crisis ." Page 101.

Federal Reserve. " Open Market Operations Archive ."

Federal Reserve. " Open Market Operations ."

Federal Reserve Bank of St. Louis. " All-Transactions House Price Index for the United States ."

Brookings. " The Origins of the Financial Crisis ." Pages 7–8.

Federal Reserve Bank of St. Louis. " Homeownership Rate for the United States ."

Huduser.gov. " U.S. Housing Market Conditions - 4th Quarter 2006 ." Page 1 of PDF.

Reuters. " New Century Files for Chapter 11 Bankruptcy ."

U.S. Securities and Exchange Commission. " New Century Financial Corporation Files for Chapter 11; Announces Agreement to Sell Servicing Operations ."

Hill, Michael C. "Cannibal Capitalism." John Wiley & Sons, 2012, page 44.

Hanson, Lindsey K. and Essenburg, Timothy J. "The New Faces of American Poverty: A Reference Guide to the Great Recession." ABC-CLIO, 2014, page 18.

UK Parliament. " The Nationalisation of Northern Rock ." Page 3.

U.S. Securities and Exchange Commission. " Bear Stearns: Merger Proposed—Your Vote Is Very Important ."

FDIC. " Failed Bank Information: Information for IndyMac Bank, F.S.B., and IndyMac Federal Bank, F.S.B., Pasadena, CA ."

Federal Housing Finance Agency. " History of Fannie Mae and Freddie Mac Conservatorships ."

U.S. Securities and Exchange Commission. " The Causes and Effects of the Lehman Brothers Bankruptcy ."

GovTrack. " Emergency Economic Stabilization Act of 2008 ."

U.S. Department of the Treasury. " Monthly Report to Congress - August 2018 ." Page 5.

Federal Reserve Bank of Chicago. " Have Borrowers Recovered from Foreclosures During the Great Recession? "

Govinfo.gov. " Dodd-Frank Wall Street Reform and Consumer Protection Act ."

Govinfo.gov. " Executive Order 14036 of July 9, 2021 ." Pages 3, 12.

Federal Reserve Bank of Cleveland. " Cleveland Fed Marks 10 Years Since the Start of the Great Recession By Outlining Some Lessons Learned ."

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The Great Recession and Government Failure

When comparing the performance of markets to government, markets look pretty darn good...

The origins of the financial crisis and the Great Recession are widely attributed to "market failure." This refers primarily to the bad loans and excessive risks taken on by banks in the quest to expand their profits. The "Chicago School of Economics" came under sustained attacks from the media and the academy for its analysis of the efficacy of competitive markets. Capitalism itself as a way to organize an economy was widely criticized and said to be in need of radical alteration.

Although many banks did perform poorly, government behavior also contributed to and prolonged the crisis. The Federal Reserve kept interest rates artificially low in the years leading up to the crisis. Fannie Mae and Freddie Mac, two quasi-government institutions, used strong backing from influential members of Congress to encourage irresponsible mortgages that required little down payment, as well as low interest rates for households with poor credit and low and erratic incomes. Regulators who could have reined in banks instead became cheerleaders for the banks.

This recession might well have been a deep one even with good government policies, but "government failure" added greatly to its length and severity, including its continuation to the present. In the U.S., these government actions include an almost $1 trillion in federal spending that was supposed to stimulate the economy. Leading government economists, backed up by essentially no evidence, argued that this spending would stimulate the economy by enough to reduce unemployment rates to under 8%.

Such predictions have been so far off the mark as to be embarrassing. Although definitive studies are not yet available about the stimulus package's overall effects on the American economy, most everyone agrees that it was badly designed and executed. What the stimulus did produce is a sizable expansion of the federal deficit and debt.

The misdiagnosis of widespread market failure led congressional leaders, after the 2008 election, to propose radical changes in financial institutions and, more generally, much wider regulation and government control of companies and consumer behavior. They proposed higher taxes on upper-income families and businesses, and extensive controls over executive pay, as they bashed "billionaire" businessmen with private planes and expensive lifestyles. These political leaders wanted to reformulate antitrust policies away from efficiency, slow the movement by the U.S. toward freer trade, add many additional regulations in the medical-care sector, levy big taxes on energy emissions, and cut opportunities to drill for oil and other fossil fuels.

Congress did manage to pass badly designed laws concerning financial markets, consumer protection and medical care. Although regulatory discretion failed leading up to the crisis, Congress nevertheless added to the number and diversity of federal regulations as well as to the discretion of regulators. These laws and the continuing calls for additional regulations and taxes have broadened the uncertainty about the economic environment facing businesses and consumers. This uncertainty decreased the incentives to invest in long-lived producer and consumer goods. Particularly discouraged was the creation of small businesses, which are a major source of new hires.

The expansion of government resulting from the stimulus and other government programs contributed to rising deficits and growing public debt just when the U.S. faced the prospect of big increases in future debt due to built-in commitments to raise government spending on entitlements. Social Security, Medicaid and Medicare already account for about 40% of total federal government spending, and this share will grow rapidly during the next couple of decades unless major reforms are adopted.

A reasonably well-functioning government would try to sharply curtail the expected growth in entitlements, but such reform is not part of the budget deal between Congress and President Obama that led to a higher debt ceiling. Nor, given the looming 2012 elections, is such reform likely to be addressed seriously by the congressional panel set up to produce further reductions in federal spending.

It is a commentary on the extent of government failure that despite the improvements during the past few decades in the mental and physical health of older men and women, no political agreement seems possible on delaying access to Medicare beyond age 65. No means testing (as in Rep. Paul Ryan's budget roadmap) will be introduced to determine eligibility for full Medicare benefits, and most Social Security benefits will continue to start for individuals at age 65 or younger.

In a nutshell, there is little political will to reduce spending on entitlements by limiting them mainly to persons in need.

State and local governments also greatly increased their spending as tax revenues rolled in during the good economic times that preceded the collapse in 2008. This spending included extensive commitments to deferred benefits that could not be easily reduced after the recession hit, especially pensions and health-care benefits to retired government workers.

Unless states like California and Illinois, and cities like Chicago, take drastic steps to reduce their deferred spending, their problems will multiply as this spending grows over time. A few newly elected governors, such as Scott Walker in Wisconsin, have pushed through reforms to curtail the power of unionized state employees. But most other governors have been afraid to take on the unions and their political supporters.

Numerous examples illustrate government failure in other countries as well. Highly publicized are the troubles facing Greece, Portugal, Ireland, Italy and Spain that are mainly due to the growth in spending and debt of their governments prior to the 2008 crisis. Perhaps the governments of these countries, and the banks that bought their debt, expected Germany and other rich members of the European Union to bail them out if they got into trouble. Whatever the explanation, the reckless behavior by these governments will greatly harm businesses and consumers in their countries along with taxpayers of countries coming to their rescue.

The traditional case for private competitive markets goes back to Adam Smith (and even earlier writers). It is mainly based on abundant evidence that most of the time competitive markets work quite well, usually much better than government alternatives. The main reason is not that individuals in the private sector are intrinsically better than government bureaucrats and politicians, but rather that competitive pressures discipline market behavior much more effectively than government actions.

The lesson is that it is crucial to consider whether government regulations and laws are likely to improve rather than worsen the performance of private markets. In an article "Competition and Democracy" published more than 50 years ago, I said "monopoly and other imperfections are at least as important, and perhaps substantially more so, in the political sector as in the marketplace. . . . Does the existence of market imperfections justify government intervention? The answer would be no, if the imperfections in government behavior were greater than those in the market."

The widespread demand after the financial crisis for radical modifications to capitalism typically paid little attention to whether in fact proposed government substitutes would do better, rather than worse, than markets.

Government regulations and laws are obviously essential to any well-functioning economy. Still, when the performance of markets is compared systematically to government alternatives, markets usually come out looking pretty darn good.

Mr. Becker, the 1992 Nobel economics laureate, is professor of economics at the University of Chicago and senior fellow at the Hoover Institution.

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The Stock Market Crash of 2008 Caused the Great Recession: Theory and Evidence

This paper argues that the stock market crash of 2008, triggered by a collapse in house prices, caused the Great Recession. The paper has three parts. First, it provides evidence of a high correlation between the value of the stock market and the unemployment rate in U.S. data since 1929. Second, it compares a new model of the economy developed in recent papers and books by Farmer, with a classical model and with a textbook Keynesian approach. Third, it provides evidence that fiscal stimulus will not permanently restore full employment. In Farmer's model, as in the Keynesian model, employment is demand determined. But aggregate demand depends on wealth, not on income.

This paper was prepared as a Plenary Address to the 17th International Conference in Economics and Finance, held at the Federal Reserve Bank of San Francisco, June 29th-July 1st 2011. I would like to thank the Society for Computational Economics and the Federal Reserve Bank of San Francisco for supporting this event and the organizers, Richard Dennis and Kevin Lansing, for inviting me to present my work. I would also like to thank Dmitry Plotnikov of UCLA for his invaluable research assistance and to acknowledge the input of seminar participants at Academia Sinica, the Federal Reserve Banks of Atlanta and Dallas, Georgetown University, Taiwan National University, UCLA and the University of California San Diego. I would also like to thank Cars Hommes and an associate editor of this journal for their comments on the paper. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.

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Economic Policies During the 2008 Great Recession Essay

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A recession is a concept in macroeconomics, indicating abrupt slump of the rate of production over a long period (half a year or more). The process is characterized by zero or negative dynamics of the GDP (gross domestic product). Recession leads to a decline in business activity and the slowdown in economic development. Reduction of GDP means the decrease in production volumes and consumption. Recession inevitably follows the rise (manufacturing boom), due to the cyclical nature of any economic system.

In general, this cycle consists of four phases – the growth (rise), stagnation (stabilization, the absence of any dynamics), recession (slump) and the crisis (depression). The main impact of the recession in the economy includes the decline in production, the collapse of the financial markets, decrease in lending activity, the increase in interest rates on credits, growing unemployment, decline in real income of the population, the fall in GDP. The most powerful and critical consequence of the recession is the crisis of the economy.

Fiscal policy is one of the main methods of government intervention in the economy to reduce fluctuations in the business cycles and provide a stable economic system in a short term. Fiscal policy today is a tool that defines the main directions of state’s financial expenditures, financing methods and the primary sources of replenishment of the budget. The main instruments of fiscal policy are the revenues and expenses of the state budget, taxes, transfers, etc.

Fiscal policy in the country is held by the government. As a tool of public administration, it has several objectives. The first goal is the stabilization of gross domestic product and thus, of aggregate demand. Fiscal policy is an instrument used exclusively in the period of instability and manifestations of the crisis symptoms in the economy. Since the Great Depression, fiscal policy is very often used by the US government and other countries to save the economy.

The effect of such policy is often minimal over the long term. The mortgage crisis, which was followed by the financial crisis of the US economy in the second half of 2007, created a situation of growing uncertainty not only in the medium and long term, but even in short-term forecasting system of Federal Finance, and the American economy as a whole (Hetzel, 2012). This circumstance has created the effect of the shock to the top political leadership of the USA, which continued to evaluate the status of the main parameters of the Federal budget, mainly based on pre-crisis mechanisms of budget deficits, at which the peak value in one particular financial year presupposed their sequential decline over subsequent years.

Before the Great Recession, fiscal policy has not been considered as effective anti-crisis measures, its instruments were regarded as remnants of the Keynesian model. The Great Recession, however, revived the Keynesian approach in the US and almost all other countries (Lavoie, 2014). The sharp rise in public spending was to support the demand of the private sector. The expansionary fiscal policy promotes the growth of the money supply and does not allow the economy to slip into deflation and recession (Cristini, 2014).

Traditional monetary policy presupposes that central banks tend to maintain market rates for interbank lending certain limited target level, raising or lowering the interest rate. Also, the central bank can achieve its target interest rate by conducting banking operations in loan capital market by buying or selling government bonds to banks and other financial institutions. Buying or selling bonds, the central banks alter the amount of money in circulation and the rate of return on government bonds, thereby affecting short-term credit interest rate.

During the financial crisis of 2008-2009, a number of central banks in developed economies have resorted to a policy of zero interest rates. According to this policy, central banks had no opportunity anymore to influence the increase of money supply and encourage borrowing setting the zero nominal interest rate. In autumn 2008, in the midst of the global financial crisis, the US Federal Reserve begins to lower the interest on Federal Funds Rate (Hetzel, 2012).

In December of the same year followed the decision to reduce rates of central banks of European countries-leaders. The decision to adopt such measures meant a change of strategy, and it subsequently became a program that was called “Quantitative easing” (Hausken & Ncube, 2013). Quantitative easing or QE is not the conventional view of policy used by central banks to stimulate the economy in times when conventional monetary policy does not have the desired effect. It took place in three rounds under the names of QE1, QE2, and QE3 (Hausken & Ncube, 2013). The result of this program was the delay of the decline in GDP growth rates.

Increasing the monetary base during the program of “Quantitative easing” did not only keep the US money supply from falling but also ensured its growth almost in half. The result of such demand-side policies is the resumption of economic growth. This skillful US policy allowed them to return to economic recovery ahead of other developed countries. It should be noted that the enormous increase in the monetary base did not lead to inflation. Moreover, throughout almost the entire period of monetary easing the Federal Reserve System has struggled with deflation.

Reference List

Cristini, A. (2014). The Great Recession, housing wealth and consumption in the European countries. In Cristini, A., Fazzari, S., Greenberg, E., & Leoni, R. (Eds.), Cycles, Growth, and the Great Recession (pp. 157-182). New York, NY: Routledge.

Hausken, K., & Ncube, M. (2013). Quantitative easing and its impact in the US, Japan, the UK and Europe. New York, NY: Springer Science & Business Media.

Hetzel, R. (2012). The great recession . Cambridge: Cambridge University Press.

Lavoie, M. (2014). Post-Keynesian economics . Northampton, MA: Edward Elgar Publishing Ltd.

• The New York Stock Exchange: Opportunity Inequality
• Great Recessions of 1930s and 2007-2008
• Food and Drug Administration Easing Restrictions
• UK Banking Sector Recovery Plan
• Fiscal and Monetary Policies
• Market Failures and Impact of Human Activities
• Financial Crisis and Great Recession Causality
• Scarcity, Decision-Making, and Macroeconomics
• Spain and Its Unemployment Problems
• Euro Area Debt Crisis, Its Causes and Challenges
• Chicago (A-D)
• Chicago (N-B)

IvyPanda. (2020, September 12). Economic Policies During the 2008 Great Recession. https://ivypanda.com/essays/economic-policies-during-the-2008-great-recession/

"Economic Policies During the 2008 Great Recession." IvyPanda , 12 Sept. 2020, ivypanda.com/essays/economic-policies-during-the-2008-great-recession/.

IvyPanda . (2020) 'Economic Policies During the 2008 Great Recession'. 12 September.

IvyPanda . 2020. "Economic Policies During the 2008 Great Recession." September 12, 2020. https://ivypanda.com/essays/economic-policies-during-the-2008-great-recession/.

1. IvyPanda . "Economic Policies During the 2008 Great Recession." September 12, 2020. https://ivypanda.com/essays/economic-policies-during-the-2008-great-recession/.

Bibliography

IvyPanda . "Economic Policies During the 2008 Great Recession." September 12, 2020. https://ivypanda.com/essays/economic-policies-during-the-2008-great-recession/.

What did Tim Walz do in Congress? How he staked out the middle before shifting left as governor

WASHINGTON – There aren’t many things progressive Rep. Alexandria Ocasio-Cortez and now-independent Sen. Joe Manchin, who left the Democratic Party earlier this year, see eye-to-eye on.

But one is Minnesota Gov. Tim Walz. 

That’s in part because Vice President Kamala Harris’ new running mate had a moderate track record over a dozen years in the House before he carved out a different path as a progressive governor. It's a shift the Harris campaign will likely leverage to fold in a frustrated left wing and reassure centrist voters as Democrats try to hold onto the White House.

Walz as a teenager joined the National Guard and later became a high school teacher and football coach in Mankato, Minnesota. In 2006, he beat out a six-term Republican to represent Minnesota’s rural 1st Congressional District in the U.S. House – one of the biggest upsets in the country that year.

He spent 12 years in the lower chamber, holding on to his seat amid nationwide waves of Republican wins, including former President Donald Trump's 2016 victory. But after Walz replaced retiring Minnesota Gov. Mark Dayton in 2019, he took the state down a more progressive path. 

As Walz takes up the Democratic Party’s VP mantle, strategists are hopeful he can help Harris appeal to Midwestern voters, including in the “Blue Wall” states of Wisconsin and Michigan.

Meanwhile, Republicans have been quick to paint him as an extreme and out-of-touch liberal. 

“From proposing his own carbon-free agenda, to suggesting stricter emissions standards for gas-powered cars, and embracing policies to allow convicted felons to vote, Walz is obsessed with spreading California’s dangerously liberal agenda far and wide,” Trump campaign national press secretary Karoline Leavitt said in a statement shortly after the pick was announced.

Here’s what to know about Walz’s credentials in the House and the governor's mansion – and how it might translate to his vice presidential candidacy.

Staking out the middle in the House

House Veterans Affairs Ranking Member Mark Takano, D-Calif., served with Walz when the Midwesterner was the top Democrat on the committee. Takano noted that Walz was easily reelected, even in the 2010 election that brought a wave of conservatives to Capitol Hill with the Tea Party movement.

“How did Tim prevail in that tsunami?” Takano asked. “It’s because of the trust that Tim engenders, by his character and his personality and by his actions.”

Here's what those actions looked like: As a representative of a rural, conservative-leaning district, Walz staked out a position among House Democrats as a moderate member and was dubbed the 7th-most bipartisan lawmaker in the 114th Congress by the Lugar Center.

He voted against the 2008 law to bail out banks in the wake of the Great Recession and for continued funding for the wars in Iraq and Afghanistan in 2010. He voted to approve the landmark health care bill the Affordable Care Act , which would become a major attack point from Republicans for years afterward.  

In 2012, he voted to extend tax cuts enacted under former President George W. Bush but later voted against the 2017 Trump-era tax bill, the Tax Cuts and Jobs Act.

An avid hunter, Walz was a favorite of the National Rifle Association when he served in Congress, picking up endorsements and donations from the powerful guns rights group. (He became a supporter of stricter gun control laws after the 2018 Parkland shooting.)

Walz was among only a few dozen Democrats to support building the Keystone XL pipeline, an oil pipeline running from Canada through the western United States. 

And he was one of just 17 Democrats to vote to hold former Attorney General Eric Holder in contempt of Congress for disregarding a congressional subpoena. Nevertheless, Holder would go on to lead the vice presidential vetting process for Harris in which Walz emerged as the pick.

Progressive push as governor

Walz became governor in Minnesota in 2019, leading a state that voted for Democrats in every presidential election since 1976. The new job also brought a shift left in his policy positions.

His first term was marked by the COVID-19 pandemic and the police murder of George Floyd that kicked off massive protests in the state’s major cities. Images of those protests – which at times veered into burning and looting buildings – are likely to be a major focus for Republicans attacks. Prominent GOP officials have already said he did not move quickly enough to contain them.

He also instituted an indoor mask mandate and a hotline to report violations of the state’s COVID-19 rules, which state Republicans railed against in court.

Democrats took back full control of the statehouse at the beginning of 2023, and over the past year and a half, Walz has focused on broad progressive policies he's sure to tout on the campaign trail.

He signed a law to codify the right to abortion ; expanded voting rights for Minnesotans who are on felony supervision or probation , approved labor-backed policies such as outlawing non-compete agreements ; legalized recreational marijuana ; and passed a 20-week paid leave program that was vehemently opposed by the state’s business community. 

He also signed a tax law that created a state-level child tax credit , approved free breakfast and lunch for all Minnesota kids, approved background checks for all private gun sales and signed off on a mandate that Minnesotans use all carbon-free electricity sources by 2040.

Those policies, celebrated by prominent progressives, also brought about the largest budget in the state’s history. It's something allies have dubbed “ transformational ” and GOP opponents called “ unsustainable and unaffordable ” as his critics zero in on his pivot to the left from his time in Congress.

Will Walz help or hurt the Democratic ticket?

Republicans are already hopeful that Walz’s record will be easier to frame as too far to the left, especially compared with other top VP contenders like Pennsylvania Gov. Josh Shapiro and Arizona Gov. Mark Kelly.

Republican vice presidential candidate JD Vance on Tuesday bashed Walz's selection, calling it “more instructive for what it says about Kamala Harris that she doesn’t care about the border, she doesn’t care about crime, she doesn’t care about American energy, and most importantly she doesn’t care about the Americans who have been made to suffer under those policies.”

Democrats, meanwhile, say that Walz’s policy positions – and track records in the House and as governor – will appeal to both their base voters and independent-minded voters.

Those who critique Walz as vice president argue that she missed an opportunity to choose a candidate from a state that is on the table in the election, rather than Minnesota, which was already safely in hand for Democrats. 

But “I don’t think that was the primary consideration of Kamala Harris,” Larry Jacobs, director of the Center for the Study of Politics and Governance at the University of Minnesota said. “I think she was looking at someone who could be a partner in running this overwhelming executive branch.”

Others hope he can be an effective communicator to rural and Midwestern voters with a straight-talking style. 

Walz went from relative obscurity on the national scene to a top vice presidential contender in a matter of weeks, thanks in part to his approach to defending Harris on television. He was the first to focus on attacking Trump and Vance as being “weird” rather than a threat to democracy – as President Joe Biden had been. Walz's comments became a strategy quickly adopted by Harris and other Democrats. 

Democratic strategist Maria Cardona predicted that Walz could help Harris hold onto “A lot of the same voters that Joe Biden was able to reach out to" when he was elected in 2020.

“He has something about him that really speaks to a lot of the voters, frankly, that the Democratic Party lost to Trump in 2016.”