An Economic Analysis of Industries in the United States
Introduction
The 2008 economic crisis and the downturn that followed were severe and long-lasting compared to the eleven previous crises after the war. The great slump was an international economic slowdown that wrecked the global monetary markets, financial institutions, and real estate sectors. The outcome of the recession was a projected ten million job loss, and the Gross Domestic Product suffered a loss of over fifteen trillion US dollars. The national debt increased from 63% of the GDP in 2007 to 101% by 2012. The crisis also led to a rise in mortgage closures globally, and many individuals lost their savings and homes. The great recession of 2008 is perceived to be the long-lasting monetary downturn after the great recession of the 1930s.
A slump is a fall in the economic expansion of a country. The “International Monetary Fund (IMF)” defines an international slump as a fall in the per capita world GDP and other macroeconomic elements like industrial output, trade, oil consumption, and unemployment for a period spanning over two quarters a financial year. Even though the great recession’s effects were global, it was mostly felt and pronounced in the United States, stemming from the “subprime mortgage crisis.” Therefore, this paper aims to critically analyze the sources of the great slump of 2008 and further discuss the consequences or outcomes of this recession. A clear literature review will help define and understand the causes and consequences of this recession and analyze the topic with reference to the above-said objective.
Literature Review
“Causes of the Great Recession of 2008”
The great slump of 2008 in the US and the western part of Europe is majorly connected to the “subprime mortgage crisis.” These mortgages are house credits given to individuals with a substandard credit background, and therefore, the loans granted to them are considered high risk. With a lucrative housing sector in the US in the mid-2000s, lending mortgages opted to increase house costs and were less limited with the kinds of borrowers they granted the loans. As the housing costs continuously increased across “North America and Western Europe,” several monetary organizations issued these risky loans in massive amounts (basically in the kind of mortgage supported securities) as a form of investment intending to make profits. These choices, nevertheless, would turn out to disastrous.
Bursting of the US House Bubble
According to Astley et al. (2009), the economic crisis trigger, and the recession was the United States housing market. After the state reserve had started raising the rates, the negligence levels on house credits rose. The increased illicit loans, therefore, led to the failure of several United States’ mortgage lenders. In 2007, financial institutions were hard hit by the loan defaults and the closure of the “sub-prime market.” The “Federal Home Loan Mortgage Corporation” declared that it was no longer buying risky “subprime mortgages or any mortgage-related securities.” With the unavailability of the market for the homeowner’s loans they owned, and thus no means to sell them to recuperate their former investments, the mortgage lenders cracked under the crisis’s impact and the reducing housing market. Financial bodies like, ” Standard and Poor’s and the Moody’s” reduced ratings on over one hundred bonds supported by subprime mortgages. Over six hundred securities backed by subprime mortgages were placed on “credit watch.” As the home costs across the nation began to fall, many house owners and the loan lenders found themselves “underwater” because their houses cost less than their aggregate loans. In 2007, the monetary institutions had begun to reserve liquidity, which led to the “subprime mortgage market.” This freezing of a credit crunch led to a rise in risk avoidance and, therefore, a decrease in lending. The fall in lending was majorly aggravated by the collapse of the “Lehman Brothers” in 2008, an occurrence that nearly made the monetary framework to burst.
Poor Financial Regulations and Higher Yields
Dam (2009) opines that low rates and returns on federal bonds inspired investors to look for higher giving assets. Yields on markets or government bonds reduced to “T-bills,” which led to investors looking for higher profits: thus, house loan supported securities. Baily et al. (2008) postulate that lending institutions capitalized on low-interest rates to extend their US operations. However, having depleted legitimate lendees, they opted for the economy’s riskier sectors, the sub-prime mortgages, and bad credits. These events at a financial turnaround were enhanced by slack management of the monetary institutions. The loose regulation started in the 1990s and included in the “Gramm-Leach-Biley Act” of 1999, which overturned the restrictions on financial institutions presented by the “Glass-Steagall Act” of 1993.
Additionally, loaning was promoted by political powers that sought to boost house possession rates among the poor and low-earning individuals. A collaboration of irrational incentives in the monetary system and the objectives of raising house possession rates created an environment for the appearance of the “sub-prime housing market” in the United States. Therefore, such bad lendees who were not seen as creditworthy under normal saving levels were beneficial and critical targets by the profit-seeking investors. High levels of loaning and a decline in the lending merits during this period resulted in a rapid increase in “non-prime loans.” In 2006, 48% of all home origins were substandard a rise from 15% in 2001. The decline in the loaning merits that came with this rise in “sub-prime loans” was evident. Bailey et al. (2008) opine that individuals were getting “Adjustable Rate Mortgages” at some points with no initial valuation. To motivate lendees, these credits had lower reimbursement for the past few years, mainly called “teaser interest rates” (Bailey et al. 2008). With the increase in these forms of home loans, expectations, and speculations in states like Florida aided in fuelling the housing bubble. Both households and investors or lenders expected that the United States’ housing prices would keep increasing even in the future and, therefore, invested heavily in the sub-prime mortgage markets and mortgage-backed securities.
Market Failures
Islam and Verick (2011) argue that the classical market failure between the banks and their customers added to the growth of the great slump of 2008. Speculative asset price inflation was also considered a form of market failure, induced massive dislocation of capital, and colossal security damages after the bubble (Islam and Verick, 2011). The pre-crisis period was conceived that information asymmetry between the banks and their customers intentionally or unintentionally obscured their management risks. Therefore, the home price faltering and mortgage-backed securities were not sold investments as they used to; thus, financial institutions stopped leaning each other in fear of being stuck with substandard home loans and security. Islam and Verick (2011) further assert that the government reduced the interest rates in 2007, but it was successful since it was not enough. However, in November, the US Reserve tried to relieve the situation by establishing a fund for purchasing a distressed portfolio of low home loans developed to offer debt paying abilities to financial institutions and safeguard funds. Additionally, the government designed the “Term Auction Facility (TAF),” which provided interim loans to banks with substandard home loans, but it was too late also not enough. Hence, some esteem organizations such as the “Bear Stearns and Lehman Brothers” crushed while home loan giants like “Fannie Mae and Freddie Mac” were on the verge.
“Loose Monetary Policy and Global imbalances.”
According to Obstefeld and Rogoff (2009), the US financial bodies lowered the policy rates never seen before levels following the breaking of the “dot.com” bubble. Therefore, the Federal government propelled a debt-funded consumption boom that aimed at boosting the total worldwide demand. This move assured that the 2001 slump was weak and not lasting but, in turn, further led to the Great recession period of 2008-2009. Obstefeld and Roggof (2009) also allude that the US financial policy failed to handle the bubble’s growth in asset markets. Hence, the loose monetary policy anteceded the season of the surplus of low rates, which led to mortgages to substandard borrowers. Obstefeld and Roggof (2009) point out that the US Federal government bonds’ profit was naturally low before the crisis.
Additionally, the US’s low-interest economy persisted since the oil producers in Asia and export giants such as China adopted a rising need for creating foreign exchange reserves in US dollar-dominated assets (the US Federal bonds). Thus, this policy led to the rising of international instabilities that consisted of “excessive savings” by nations like China and “excessive consumption” by deficit nations led by the US. The international instabilities supporters argued that such instabilities were not feasible and would have unveiled at some points through the US subprime markets did not imply by mid-2007. Before the crisis, several economies experienced unfeasible deficits before the crisis (Obstefeld and Roggof, 2009). As a result of equity flows from China and other producing countries, feeding into the US housing bubble and loan growth with its depressing effect and bond profit mortgage rates were still low. Although the Central Bank started a strict financial policy in 2004, the US mortgage rates remained lower. Therefore, the international instruments into the US economy contributed highly to the subprime disaster, which later led to the Great Recession.
Consequences of the Great Recession
Federal Budget Deficit and Public Debt
Tseng (2015) alludes that in 1999, there existed a positive government budget, but in 2001 a negative budget rose to approximately 275 billion dollars. The technology breakout in 2000 and the 9/11 occurrence in 2001 led to an increase in deficit of $1.47 trillion in 2008 and $1.71trillion in 2010. The increase in budget deficits is attributed to banks’ bailouts, cuts in taxes, and increased unemployment payments and other expenditures due to economic balancing. The government budget deficits began to better in 2011, but the deficit was close to $1.2 trillion in 2012 (Tseng, 2015)
Public debt as a proportion of GDP had been slowly increasing from “54% in 2000 to 64% in 2007,” then skipped to 73% in 2008 and over 101% in 2012 (Tseng, 2015). According to the schedules presented by the “Government Accounting Office,” from 2007 to 2013, every year, the government debt rose by over one trillion US dollars. The most significant rise was in 2009, where the great slump struck, and the bailout initiative was at its peak. At the end of the financial year 2013, the federal debt was just over $1.67 trillion. The ever-expanding national debt made it hard for the state to undertake other stimulative fiscal strategies, and as a result, the economy grew steadily (Tseng, 2015). However, as the economy slowly expands, the federal deficit is projected to fall, and the national debt will balance out in the following years (Tseng, 2015).
A fall in the Housing Sector
According to Tseng (2015), the housing numbers jumped from “1507 thousand units in 2000 to 2273 thousand units in 2006” with a yearly expansion rate of 8.14%. The units then fell to “478 thousand units in 2009 with a decreasing yearly rate of 42.7% in two years”. According to a stock market measured by S&P 500, the stock had fallen from “1565.15 in October 2007 to 676.53 in March 2009 with a 56.78% fall in two years.” Even though the “housing price index” was still low by nearly 20% by the end of 2013, the index was fully recuperated at the year-end of 2013. New standards have been laid majorly because of the expansionary monetary strategies from the “Easing programs” and the almost zero rates, which significantly increased asset costs and led to a steady and slow but constant economic growth.
Unemployment
An increase in the unemployment rates was a significant outcome of the great slump on the US economy. Norstrom and Grongvist (2015) allude that from 2005 to 2008, the employment rates increased from approximately 133,126 thousand to 138,365 thousand with a rise of more than 5 million in less than four years. However, the Bureau of Economic Analysis state that the unemployment rates rose from 5.3% in 2007 to 10.1% by 2009. Nordstrom and Grongvist (2015) assert that a substantial reduction of more than 5 million unemployed individuals from the end of 2009 to 2014 may be linked to unusual expansionary financial policy, partial resurgence housing connected agencies the extensive market recovery from the great recession crisis of 2008. Following the slump, the job loss was higher among the males than the females. Besides, groups with historically higher unemployment rates, such as the young people, continued to experience a high employment rate reduced to 6.6% and further improved to 5.8% at the end of 2014 after about five years of financial and government stimulus initiatives. Furthermore, the Central Bank’s financial statement contributed about $4.3 trillion through 3 consecutive qualitative easings (Norstrom and Grongvist, 2015).
Bank Failures
As the substandard housing market crashed, many banking institutions experienced severe crises since a substantial amount of their assets had taken substandard credits or bonds substandard loans. According to Grigor and Salikhov (2009), the first credits in some stated MBS were hard to monitor for the institutions that held them. Thus, banks started to question each other’s creditworthiness, which eventually led to an interbank loan closure, which limited any banking institution’s capability to expand loans even to financially stable borrowers and entities. This effect forced entities to limit their investments and other expenses, which further led to job losses and reduced government bailouts. Others sought amalgamations with stable companies or declared bankruptcy. Besides, other entities whose goods were generally sold with consumer credit offered huge losses. Job and wealth losses, poverty, and increased economic recovery speed varied according to the individual’s socioeconomic classes. Generally, the Great slump aggravated wealth inequality in the US, which had already been vast.
Political repercussions
The effect of the Great recession in Iceland, for instance, led to the nationalization of its three largest banks. On the other hand, Latvia, along with other Baltic countries, experienced monetary crisis, the nation’s GDP dropped by 22% in that period (Tseng, 2015). Besides, Spain, Ireland, Portugal, and Greece faced national debt crises that needed interventions by the “European Union, European Central Bank, and the International Monetary Fund.” This strategy led to the infliction of harmful measures.
References
Astley, M. S., Giese, J., Hume, M. J., & Kubelec, C. (2009). Global imbalances and the financial crisis. Bank of England Quarterly Bulletin, Q3.
Dam, K. W. (2009). The subprime crisis and financial regulation: international and comparative perspectives. Chi. J. Int’l L., 10, 581.
Baily, M. N., Litan, R. E., & Johnson, M. S. (2008). The origins of the financial crisis.
Tseng, K. C. (2015). The aftermath of financial crisis and the great recession and what to do about them. Investment management and financial innovations, (12,№ 1), 9-18.
Obstfeld, M., & Rogoff, K. (2009). Global imbalances and the financial crisis: products of common causes.
Islam, I., & Verick, S. (2011). The great recession of 2008–09: Causes, consequences and policy responses. In From the great recession to labour market recovery (pp. 19-52). Palgrave Macmillan, London.
Norström, T., & Grönqvist, H. (2015). The Great Recession, unemployment and suicide. J Epidemiol Community Health, 69(2), 110-116.
Grigor′ ev, L., & Salikhov, M. (2009). Financial crisis 2008: Entering global recession. Problems of Economic Transition, 51(10), 35-62.