The Great Recession
Seth Armstrong
American Economic History
Professor Emma Davis
April 18th, 2021
The Great Recession of 2007 to 2009
The financial meltdown of 2007 affected the economic development of many countries globally, causing the Great Recession. This recession that ended in June 2009 was the longest and the most severe in many aspects since the Second World War. According to European and American economists, the crisis was caused by failures in financial regulation and excess borrowing (Zingales, 2017). It started in the US housing department, where housing loans were given indiscriminately to many borrowers having poor histories in loan repayments. At that time, there was a continual rise in housing prices with the increased demand for houses. Many of these subprime mortgages, considered high-risk loans, were given in bulk by financial institutions as an investment to increase profits. On the contrary, the interest rates increased, and housing demand declined, resulting in the fall of prices of homes. Many subprime borrowers then lacked the capacity to repay their loans, and the number of foreclosures escalated. These banks halted giving loans to subprime clients and even businesses qualified for loans which further brought down the prices and demands, landing the banks in severe financial problems (Verick & Islam, 2010). Businesses collapsed, unemployment rates increased, some companies looked for government bailouts and mergers from stable firms. All these factors combined prolonged and worsened the economic stagnation in the United States of America. In this essay, the Federal Reserve Bank’s measures to respond to the crisis, the lessons learnt from the Great Recession, and why the great recession caused unemployment will be discussed.
Why Did the Great Recession Cause Unemployment?
Recession and unemployment have complex relationships. A recession is capable of causing unemployment in certain sections of the economy, and this unemployment can cause another financial recession in another section of the economy. Once people lose their jobs, there is a decrease in income which then impairs their ability to buy goods and services. A rise in the unemployment rate catalyses the depth and length of a recession (United Nations, 2011). People who have low income are severely affected by the economic stagnation since these employees are the first ones to be laid off. Most of the time, these people at the bottom of the income ladder are low skilled, making it difficult for them to find other sources of employment. The Great Recession affected the banking sector, the real estate industry, the automotive industry, and other industries that depended heavily on banking for their daily business operations. These companies and organisations had several employees, but as a result of the economic stagnation, the rate of lay-offs in these companies escalated since businesses were making losses and unable to support their workforce fully. This volume of unemployment associated with loss of jobs and delay of the unemployed population in securing new jobs due to an economic recession is called cyclical unemployment.
How has the Federal Reserve Bank responded to the Great Recession?
The Federal Reserve Bank is an institution in charge of policymaking to fight economic recessions. It also regulates banks and ensures financial stability in the country. During the Great Recession and after, the reserve bank assisted a lot in combating the consequences of the crisis in the financial and economic systems. With the steady increment of unemployment in the US, the bank responded by employing the monetary policy of cutting the interest rates in the banking system. These low tariffs assisted organisations in starting fresh investments, propelled individuals to purchase new homes, finance renovations, and helped purchase goods like vehicles (Rich, 2013). When there is a depressed economy with many available resources, extra spending increases economic outturn and employment. In a normal functioning economy, additional spending increases the inflation rate. When it becomes uncontrollable, the federal bank elevates the federal fund rate, resulting in a greater interest rate and reduced spending in the economy. During the economic recession, the Federal Bank Reserve reduced the interest rates to zero percent by December 2008, which greatly assisted financial institutions in receiving cheap loans to prevent more bankruptcies.
Since the interest rates could not go below zero percent during the Great Recession, the bank used another measure called quantitative easing. This quantitative easing is a government policy that involves money supply increment domestically to boost economic development in a country by buying large government bonds and other financial assets. The Federal Reserve applied this method during the Great Recession in three rounds, the first one focused on purchases of mortgages, the second round concentrated on treasury securities, while the last round combined treasury security and mortgage purchases (Yglesias, 2014). During this time, quantitative easing enabled businesses to borrow loans and fostered economic recovery. The other method that the bank used was Forward Guidance. This tool was used to inform the public on future monetary policies. This guidance helped individuals and businesses during the recession period to make informed decisions on investments and spending of money.
What lessons did we learn from the Great Recession?
The Great Recession taught the world several lessons that should help in averting devastating recessions in future. The first lesson is that a recession can happen anywhere. Initially, the Great Recession emanated from the housing market, and it was viewed as a minor economic glitch in a section of the economy, but it proliferated and caused severe negative impacts in other sectors of economic development. Financial crises were assumed to only happen in developing nations that suffer inadequate regulation and have feeble financial institutions. However, the Great Recession paralysed most businesses in the US, despite being a superpower country believed to have the capacity to prevent these situations from happening in the first place (Blinder, 2015). This proves that economic turmoil can happen to any country and at any time. Another lesson is that regulators must carry out their job of regulation and not delegate. Poor regulation of finances in a country can cause negative impacts on the economy, causing a recession.
The third lesson that people learnt was how financial illiteracy could be devastating. Individuals who lack the proper understanding of mortgages, compound interest, and amortisation can be lured into receiving loans that can be hard for them to repay. As a result, they get hurt in the long run when financial institutions seize their assets due to failure to pay the loans. Financial institutions also learnt to avoid issuing subprime mortgages to individuals because if asset pricing like housing drops, the banks suffer significant losses (Menand, 2020). Additionally, banks learnt that limiting issuing of loans to qualified borrowers as it happened in the Great Recession leads to businesses failure and lay-offs increase, causing ultimate deterioration in the economy. These financial institutions also learnt that diversification of investments was helpful. In the last recession, banks heavily invested in risky mortgages and failed terribly. Therefore it was essential to invest in other projects that could bring profits instead of relying on one side.
Another lesson businesses learnt was that government assistance was essential during a financial crisis. Companies, in most cases, like to depend on their efforts to succeed in the market, but during a crisis, a helping hand is essential to alleviate problems. During the Great Recession, the Federal Bank assisted most bankrupt companies by giving loans with low interest and cash infusions. The government greatly assisted the financial institutions, real estate companies, and the automotive industry to survive.
Innovating to survive in an unprecedented crisis, acting faster and decisively was another lesson. Companies learnt that they should always have back up plans if their main plans fail since disasters can occur at any time. Proper preparation for these uncertainties is critical to protect the businesses until the economic situations return to normal. During the last recession, businesses that were not overly leveraged survived. This means that those companies that reduced their debt quantities survived during the Great Recession (Blinder, 2015). The lesson learnt through this is that preserving cash and finding ways to reduce the debt load is a solution to maintain business operations.
Conclusion
The great recession was a rough time for businesses. Nonetheless, it yielded many important lessons that can assist in fighting other economic uncertainties that could happen in future. Upcoming companies can draw important lessons from the survival strategies of companies that survived during the recession and depression eras. The Great Recession was 18 months, but its aftermaths have lasted for years. Many developing and developed countries have learnt through what happened in the crisis in the US. Their governments have learnt how to fight different crises that affect them by implementing monetary policies that worked during the recession. Beyond that, they have laid down measures to ensure economic downtowns are never repeated in their own countries, and if they occur, they can act decisively based on a workable model.
References
Blinder, A. S. (2015). What Did We Learn from the Financial Crisis, the Great Recession, and the Pathetic Recovery? The Journal of Economic Education, 46(2), 135–149. https://doi.org/10.1080/00220485.2015.1015190
Menand, G. S., Lev. (2020, March 21). Unsanitized: Seven Lessons from the Great Recession. The American Prospect. https://prospect.org/coronavirus/unsanitized-seven-lessons-from-great-recession/
Pascus, B. (2018, September 16). GM, Ford, and Chrysler almost died a decade ago during the financial crisis — here’s how the auto giants have changed since. Business Insider. https://www.businessinsider.com/gm-ford-chrysler-almost-died-during-financial-crisis-changes-since-2018-9?IR=T
Rich, R. (2013, November 22). The Great Recession | Federal Reserve History. Www.federalreservehistory.org. https://www.federalreservehistory.org/essays/great-recession-of-200709
United Nations. (2011). The Great Recession and the jobs crisis. https://www.un.org/esa/socdev/rwss/docs/2011/chapter2.pdf
Verick, S., & Islam, I. (2010). The Great Recession of 2008-2009: Causes, Consequences and Policy Responses. http://ftp.iza.org/dp4934.pdf
Yglesias, M. (2014, June 21). The Fed and the 2008 financial crisis. Vox; Vox. https://www.vox.com/2014/6/20/18079946/fed-vs-crisis
Zingales, L. (2017, October 17). Who Is to Blame for the 2008 Financial Crisis? Pro Market. https://promarket.org/2017/10/17/blame-2008-financial-crisis/
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