| Late-2000s recession around the world |
After the bursting of the great Housing bubble in mid-2007, United States of America was stuck by a huge recession. The United States entered 2008 during a housing market correction, a subprime mortgage crisis and a declining dollar value.[1]
In February, 63,000 jobs were lost,[2] a 5-year record.[3] In September, 159,000 jobs were lost, bringing the monthly average to 84,000 per month from January to September 2008.[4]
The bottom, or trough, was reached in the second quarter of 2009[5] but the nation's economy continued to be described as in an "economic malaise" during the second quarter of 2011.[6]
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After the 1930 recession the American economy experienced a continuous growth from 1940 to 1980. The American enforced the The Securities Exchange Act (1934)[7] and Chandler Act (1938)[8] which tightly regulated the financial market and provided stability. The Securities Exchange Act of 1934 regulated the trading of the secondary securities and the Chandler act regulated the transactions in the banking sector. There were few small investment banks like JP MORGAN that grew up during the late 1970s. In the 1980s, the financial sector quantum leaped, because investment banks were going public, which brought them vast sums of stockholder capital in return. From 1978-2008, the average salary for workers outside of investment banking in the US increased from $40k to $50k [9] – a 25 percent salary increase - and the average salary in investment banking increased from $40k to $100k – a 150 percent salary increase. The Reagan administration of the United States in the early 1980s began a thirty-year period of financial deregulation.[10] By then end of the 1980s, many workers in the financial sector were going to jail for fraud and many people were losing their life savings. Large investment banks began merging and developing monopolies. These all led to the formation of the investment banks like Goldman Sachs.
In the early months of 2008, many observers believed that a U.S. recession had begun.[11][12][13] The collapse of Bear Stearns and the resulting financial market turbulence signaled that the crisis would not be mild and brief.
Alan Greenspan, ex-Chairman of the Federal Reserve, stated in March 2008 that the 2008 financial crisis in the United States is likely to be judged as the harshest since the end of World War II.[14] A chief economist at Standard & Poor's, said in March 2008 he has a worst-case-scenario in which the country could endure a double-dip recession in which the economy would briefly recover in the summer 2008. Under this scenario, the economy's total output, as measured by the gross domestic product, would drop by 2.2 percentage points, making it the third worst recession in the post World War II period.
The former head of the National Bureau of Economic Research said in March 2008 he believed the country was then in a recession, and it could be a severe one. A number of private economists generally predicted a mild recession ending in the summer of 2008 when the economic stimulus checks going to 130 million households started being spent. A chief economist at Moody's predicted in March 2008 that policymakers would act in a concerted and aggressive way to stabilize the financial markets, and that then the economy would suffer but not enter a prolonged and severe recession. It takes many months before the National Bureau of Economic Research, the unofficial arbiter of when recessions begin and end, makes its own ruling.[15]
According to numbers published by Bureau of Economic Analysis in May 2008, the GDP growth of the previous two quarters was positive. As one common definition of a recession is negative economic growth for at least two consecutive fiscal quarters, some analysts suggest this indicates that the U.S. economy was not in a recession at the time.[16] However this estimate has been disputed by some analysts who argue that if inflation is taken into account, the GDP growth was negative for the past two quarters, making it a technical recession.[17] In a May 9, 2008, report, the chief North American economist for investment bank Merrill Lynch wrote that despite the GDP growth reported for the first quarter of 2008, "it is still reasonable to believe that the recession started some time between September and January", on the grounds that the National Bureau of Economic Research's four recession indicators all peaked during that period.[18]
New York's budget director concluded the state of New York was officially in a recession. Governor David Paterson called an emergency economic session of the state legislature for August 19 to push a budget cut of $600 million on top of a hiring freeze and a 7 percent reduction in spending at state agencies already implemented by the Governor.[19] An August 1 report, issued by economists with Wachovia, said Florida was officially in a recession.[20]
White House budget director Jim Nussle said the U.S. avoided a recession following revised GDP numbers from the Commerce Department showing a 0.2 percent contraction in the fourth quarter of 2007 down from a 0.6 percent increase and a downward revision to 0.9 percent from 1 percent in the first quarter of 2008. The GDP for the second quarter was placed at 1.9 percent below an expected 2 percent.[21] Martin Feldstein, who headed the National Bureau of Economic Research until June and serves on the group's recession-dating panel, said he believed the U.S. was in a very long recession and that there was nothing the Federal Reserve could do to change it.[22]
In a CNBC interview at the end of July 2008, Alan Greenspan said he believed the U.S. was not yet in a recession, but that it could enter one due to a global economic slowdown.[23]
A study released by Moody's found two-thirds of the 381 largest metropolitan areas in the United States were in a recession. The study also said 28 states were in recession with 16 at risk. The findings were based on unemployment figures and industrial production data.[24]
In March 2008, Warren Buffett stated in a CNBC interview that by a "common sense definition", the U.S. economy is already in a recession. Warren Buffett has also stated that the definition of recession is flawed and that it should be 3 quarters of GDP growth that is less than population growth. However, the U.S. only experienced two consecutive quarters of GDP growth less than population growth.[25][26]
With the advent of internet trading of stocks and development of the concepts of derivatives the investment banking started to flourish rapidly.
All the financial conglomerates, investment banks, and insurance agencies were linked together by the chain called the SECURITIZATION FOOD CHAIN.[27]
The securitisation of food chain created a method of mortgage transfer within the economy. There are five positions, in sequential order in the chain –
The home buyers give the lender a mortgage that the lender passes to the investment banks for earning interests. The investment banks collect all mortgages to for complex derivatives called the COLLATERARISED DEBT OBLIGATION (CDO’S).[28] The CDO’s are a mix of home loans, car loans, student loans, credit card loans. The credit rating agencies then indirectly rated these CDO’s. The highest rating was AAA, followed by AA, BBB, BB etc. The rating agencies were paid by the investment banks for their rating. The CDO’S were sold to the investors by the banks for earning interests. The insurance agencies like the AIG were selling CREDIT DEFAULT SWAPS (CDS) to the investors and earning premiums. CDS were a kind of insurance for the investors. If the rating of the CDO went down then the AIG will be paying the investors for their losses. With the introduction of derivatives the speculators were also betting against the CDO’s they didn’t own. Thus the insurance companies were earning both from premium from investors as well as from the derivatives sold to the speculators. Thus the risk was transferred to the insurance agencies.
As the investments were risk free for the investors (as the risk were borne by the insurance agencies for premium) ,the demand for the CDO’S went up. Thus the investment banks also wanted more mortgages to form CDO’S so that they could lend them to the investors and earn profits. Thus there was a massive lending and a flow of credits in the financial system. The banks started giving away riskier loans to earn more CDO’s. So the banks were making profits without having risks as the risk were borne insurance agencies. In old mortgage system , the borrower had to pay 20% of their investment and remaining 80% he could borrow from banks. Moreover he could take loans worth of four times of his salary. But these Securitisation Food Chain created a way for the easy loans and banks started giving riskier loans.
The housing bubble nearly tripled the prices of housing and the real-estate from 1999 to 2007. This huge increase was because of the uncontrolled credit given by the American banks which increased the demand of housing sector. On December 30, 2008 the Case-Shiller home price index[29] reported its largest price drop in its history. Increased foreclosure rates in 2006–2007 among U.S. homeowners led to a crisis in August 2008 for the subprime, collateralized debt obligation (CDO), mortgage, credit, hedge fund, and foreign bank markets. In October 2007, the U.S. Secretary of the Treasury called the bursting housing bubble "the most significant risk to our economy."
The government policies were responsible to a large extent for the recession in the united states and large unemployment.
"The number of people not on temporary layoff surged 220,000 in August and the level continues to reach new highs, now at 8.1 million. This accounts for 53.9% of the unemployed — again a record high — and this is a proxy for permanent job loss, in other words, these jobs are not coming back. Against that backdrop, the number of people who have been looking for a job for at least six months with no success rose a further half-percent in August, to stand at 5 million — the long-term unemployed now represent a record 33% of the total pool of joblessness."
He was the Chairman of the Federal Reserve of the United States from 1987 to 2006.He was appointed Federal Reserve chairman by President Ronald Reagan in August 1987 and was again reappointed as chairman 2006. He was the person responsible for the housing bubble in the US. Though he said that "I really didn't get it until very late in 2005 and 2006."[31] . Greenspan stated that the housing bubble was "fundamentally engendered by the decline in real long-term interest rates",[32] though he also claims that long-term interest rates are beyond the control of central banks because "the market value of global long-term securities is approaching $100 trillion" and thus these and other asset markets are large enough that they "now swamp the resources of central banks".[33]
There was a sharp increase in the SUB-PRIME LOANS in 2006. Now the borrowers could borrow even 99% of their investments. The investment banks preferred the subprime loans as it earned a high revenue due to high risks. More the poor ratings more are the interest rate. There was massive credit flow and thus the demand for the housing sector increased and the housing bubble formed. Mortgage regulations were relaxed and there were huge profits in the financial sector. The stock profits sky-rocketed. The leverage ratio during the bubble also was very high as banks borrowed heavily to give away loans. The leverage ratio is the ratio between the borrowed money by banks and banks own money. The ratio was nearly 33:1 during the late 2006. There were also faulty ratings by the rating agencies. The rating agencies had no liabilities if their ratings were wrong.
On December 1, 2008, the National Bureau of Economic Research (NBER) declared that the United States entered a recession in December 2007, citing employment and production figures as well as the third quarter decline in GDP.[34][35] The Dow Jones Industrial Average lost 679 points that same day.[36] On January 4, 2009, Nobel prize winning economist Paul Krugman wrote that "This looks an awful lot like the beginning of a second Great Depression."[37]
On September 5, 2008, the United States Department of Labor issued a report that its unemployment rate rose to 6.1%, the highest in five years,[38][6] and the Congressional Budget Office forecasts that the unemployment rate could reach as high as 9% during 2010.[39] The news report cited the Department of Labor reports and interviewed Jared Bernstein, an economist:
| “ | The unemployment rate jumped to 6.1 percent in August, its highest level in five years, as the erosion of the job market accelerated over the summer. Employers cut 84,000 jobs last month, more than economists had expected, and the Labor Department said that more jobs were lost in June and July than previously thought. So far, 605,000 jobs have disappeared since January. The unemployment rate, which rose from 5.7 percent in July, is now at its highest level since September 2003. Jared Bernstein, economist at the Economics Policy Institute in Washington, said eight months of consecutive job losses had historically signaled that the economy was in a recession. "If anyone is still scratching their head over that one, they can stop," Mr. Bernstein said. Stocks fell after the release of the report, with the Dow Jones industrials down about 100 points after about 40 minutes of trading. | ” |
CNN also reported the news,[40] quoted another economist, and placed the news in context:
| “ | Job losses are still mild by recession standards, but the losses are relentless and they are accumulating. If job growth had paced with population growth during this year, it would have meant 1.3 million new jobs would have been created. Instead 605,000 were lost. That means about 2 million fewer people are working than if the economy were on a steady path. And that's a big number." But while economists generally study the payroll numbers most closely, it's the unemployment rate that registers with most Americans when they think about the labor market.[40] -- Bob Brusca of FAO Economics |
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As of December 2008, U1 unemployment figure was 2.8% while U6 unemployment was 13.5%.[41] On January 26, 2009 a day dubbed "Bloody Monday" by the media, 71,400 jobs were lost in the US alone.[42]
The unemployment rate among workers with college degrees rose to 3.8% during the first quarter of 2009.[43] This "pinch" is also spreading worldwide.[44]
From late 2007 through September 2008, before the official October 3 bailout, there was a series of smaller bank rescues that occurred which totalled almost $800 billion.
In the summer of 2007, Countrywide Financial drew down a $11 billion line of credit and then secured an additional $12 billion bailout in September. This may be considered the start of the crisis.
In mid-December 2007, Washington Mutual bank cut more than 3,000 jobs and closed its subprime mortgage business.
In mid-March 2008, Bear Stearns was bailed out by a gift of $29 billion non-recourse treasury bill debt assets.
In early July 2008, depositors at the Los Angeles offices of IndyMac Bank frantically lined up in the street to withdraw their money. On July 11, IndyMac, a spinoff of Countrywide, was seized by federal regulators - and called for a $32 billion bailout. The mortgage lender succumbed to the pressures of tighter credit, tumbling home prices and rising foreclosures. That day the financial markets plunged as investors tried to gauge whether the government would attempt to save mortgage lenders Fannie Mae and Freddie Mac. The two were placed into conservatorship on September 7, 2008.
During the weekend of September 13–14, 2008, Lehman Brothers declared bankruptcy after failing to find a buyer, Bank of America agreed to purchase Merrill Lynch, the insurance company AIG sought a bridge loan from the Federal Reserve, and a consortium of 10 banks created an emergency fund of at least $70 billion to deal with the effects of Lehman's closure,[45] similar to the consortium put forth by J.P. Morgan during the stock market panic of 1907 and the crash of 1929. Stocks on "Wall Street" tumbled on September 15.[46]
On September 16, 2008, news emerged that the Federal Reserve may give AIG an $85 billion rescue package; on September 17, 2008, this was confirmed. The terms of the rescue package were that the Federal Reserve would receive an 80% public stake in the firm. The biggest bank failure in history occurred on September 25 when JP Morgan Chase agreed to purchase the banking assets of Washington Mutual.[47]
The year 2008, as of September 17, has seen 81 public corporations file for bankruptcy in the United States, already higher than the 78 in 2007. Lehman Brothers being the largest bankruptcy in U.S. history also makes 2008 a record year in terms of assets with Lehman's $691 billion in assets all past annual totals.[48] The year also saw the ninth biggest bankruptcy with the failure of IndyMac Bank.[49]
The Wall Street Journal states that venture capital funding has slowed down which in the past led to unemployment and slowed new job creation.[50]
| Federal reserve rates changes[51] | |||||
| Date | Discount rate | Discount rate | Discount rate | Fed funds | Fed funds rate |
|---|---|---|---|---|---|
| Primary | Secondary | ||||
| rate change | new interest rate | new interest rate | rate change | new interest rate | |
| Apr 30, 2008 | -.25% | 2.25% | 2.75% | -.25% | 2.00% |
| Mar 18, 2008 | -.75% | 2.50% | 3.00% | -.75% | 2.25% |
| Mar 16, 2008 | -.25% | 3.25% | 3.75% | ||
| Jan 30, 2008 | -.50% | 3.50% | 4.00% | -.50% | 3.00% |
| Jan 22, 2008 | -.75% | 4.00% | 4.50% | -.75% | 3.50% |
On September 17, 2008, Federal Reserve chairman Ben Bernanke advised Secretary of the Treasury Henry Paulson that a large amount of public money would be needed to stabilize the financial system.[52] Short selling on 799 financial stocks was banned on September 19. Companies were also forced to disclose large short positions.[53] The Secretary of the Treasury also indicated that money funds will create an insurance pool to cover themselves against losses and that the government will buy mortgage-backed securities from banks and investment houses.[53] Initial estimates of the cost of the Treasury bailout proposed by the Bush Administration's draft legislation (as of September 19, 2008) were in the range of $700 billion[54] to $1 trillion U.S. dollars.[55] President George W. Bush asked Congress on September 20, 2008 for the authority to spend as much as $700 billion to purchase troubled mortgage assets and contain the financial crisis.[56][57] The crisis continued when the United States House of Representatives rejected the bill and the Dow Jones took a 777 point plunge.[58] A revised version of the bill was later passed by Congress, but the stock market continued to fall nevertheless.[59] [60] The first half of the bailout money was primarily used to buy preferred stock in banks instead of troubled mortgage assets. This has led some economist to argue that buying preferred stock will be far less effective than buying common stock.[61]
As of mid-November 2008, it was estimated that the new loans, purchases, and liabilities of the Federal Reserve, the US Treasury, and FDIC, brought on by the financial crisis, totalled over $5 trillion: $1 trillion in loans by the Fed to broker-dealers through the emergency discount window, $1.8 trillion in loans by the Fed through the Term Auction Facility, $700 billion to be raised by the Treasury for the Troubled Assets Relief Program, $200 billion insurance for the GSEs by the Treasury, and $1.5 trillion insurance for unsecured bank debt by FDIC.[62] (Some portion of the Fed's emergency loans would already have been repaid.)
The Federal Reserve, Treasury, and Securities and Exchange Commission took several steps on September 19 to intervene in the crisis. To stop the potential run on money market mutual funds, the Treasury also announced on September 19 a new $50 billion program to insure the investments, similar to the Federal Deposit Insurance Corporation (FDIC) program.[63] Part of the announcements included temporary exceptions to section 23A and 23B (Regulation W), allowing financial groups to more easily share funds within their group. The exceptions would expire on January 30, 2009, unless extended by the Federal Reserve Board.[64] The Securities and Exchange Commission announced termination of short-selling of 799 financial stocks, as well as action against naked short selling, as part of its reaction to the mortgage crisis.[65]
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