Introduction: The 2008, 2009, 2010 recession has had itsimpact felt across the globe, effecting the economies of many countries foryears to come, and has now been dubbed the ‘Great Recession’. Beginning withthe lending of subprime mortgages en masse in the US housing market became a full-blownrecession by the end 2007. There is an old saying that says when the US catchesa cold, the rest of the world sneezes.
This was proven true as large economiessuch as Japan and the European Union jointly went into a recession by mid-2008.2009 was the first time since the Second World War that the world entered intoa recession, an unfavorable turn of events from the positive, booming of theeconomy between 2002-2007. Causes: Money Markets When Americas housing market began its turnfor the worse, a chain reaction exposed how fragile the financial system was.Mortgage backed securities plummeted in value, assuming they had any value tobegin with. It became increasingly difficult to sell assets at almost anyprice, as no one was willing to take any investment risk, so investors began tohold their cash instead of investing in the markets. Trust, the glue that holdsall financial systems together began to deteriorate. Banks began to questionthe viability of their counterparties in 2007.
Chains of debt between lenders andinvestors were vulnerable to failing to one small link in the chain breaking.AIG, an American insurance giant, forced to dissolve under the weight ofcredit-risk protection they had sold, days after the bankruptcy of the LehmanBrothers, a large global bank. The entire financial system was exposed to havebeen built upon a foundation of betting on themselves with borrowed money,something that worked in the past when the economy was strong, but provedcatastrophic when it was failing. The major banks had not set aside enoughcapital to absorb losses and thus was the beginning of the largest collapse ofthe American economy of our generation. The role of AIG – the biggest insurancecompany in the world AIG was selling insurances for products ofthe financial market, not only typical health insurances. The most importantproduct they provided insurance for were credit default swaps (CDS’s). Theseworked in a way where AIG would insure an investor’s CDO, the investor would paya quarterly premium to AIG.
AIG would pay the investor out his losses in caseof default.AIG not only sold CDS to protect the ownersof CDO’s, but also sold them to speculators to wager against the CDO’s they didnot own. They were able to issue and sell mass quantities of them as there wasno legislation in place or regulations requiring CDS to put money aside in caseof default. When the CDO’s began to fail, it became apparent AIG could notprotect their investors and could not pay their duties. When AIG went bankrupt,the insurance policies they had issued defaulted. Central banks The central bankers did not keep economicimbalances in check and did not exercise proper oversight of the largefinancial institutions.
The government made no effort to curb or slow down thehousing bubble. They could have raised interest rates, lowered the maximumloan-to-value ratio on a mortgage that was available, or passed legislation to forcethe major banks to keep more capital on hand in case of mass insolvency. Banks operatedwith minimal equity, leaving them susceptible if anything were to go wrong.From the mid-1990s, they were more frequently allowed to use internal models toassess risk, essentially allowing themselves to create their own capitalrequirements.
A major error the government made was allowing the LehmanBrothers to go bankrupt, causing mass panic in the financial market. Upon thecollapse of the Lehman Bros., nobody trusted anybody and therefore would notlend. Companies began to hold their cash and assets and froze spending, as theycould not rely on being able to borrow money to purchase supplies or paysalaries of employees.
The decision by the Government to not intervene andallow Lehman to bankrupt ending up causing more government intervention lateron. Tons of companies needed bailing out by regulators to curb the subsequentpanic. Role of US subprime mortgages In the years leading up to the crisis, bankstook part in irresponsible mortgage lending, loaning money to ‘subprime’borrowers with bad credit who struggled to repay them, en masse.
The risky mortgages were passed on to thebig banks who turned them into what were supposed to be low-risk securities bypooling them together in large numbers. This only works when the risks of theloans are uncorrelated, but being all mortgage loans to predominantly subprimelenders, the risks were highly correlated. Starting in 2006, America began itsdecline into a nationwide housing market slump, where homes across the countrybegan to drop in valueThe pooled mortgages were used to ascollateral for pooled assets called Collateralized Debt Obligations or (CDO’s),which were separated into sections based on how safe from defaulting they were.Investors bought the safer CDO’s as they trusted the ratings that were assignedto them by agencies like Moody’s and S&P’s. Those agencies were paid by thebanks that created the CDO’s and thus were too generous in assessing them withtriple-A credit ratings.Investors felt comfortable investing intothese securitized products as they appeared relatively safe and it was a timewhen interest rates were low, and they were providing higher returns.
The low interest rates incentivized banks,hedge funds and investors to seek our other investments that albeit may havebeen riskier, but offered higher returns. The low interest rates also allowedinvestors to borrow and use the excess cash to invest further, based on theassumption that the returns would exceed the costs of borrowing. Ultimately, there was far too much money lentout to investors at low interest rates, along with the millions of subprimemortgages, which was a defining factor in what became the 2008-2010 recession. Getting off track: How Government Actionsand Interventions Caused, Prolonged, and Worsened the Financial Crisis by JohnB. Taylor. Hoover Institution Press.
2013 Impact on Canada’s economy, US economy(GDP, unemployment, inflation), The financial crises had several negativeimpacts on the local and global economy, banks, financial institutions,individual households and businesses.Many major banks suffered serious lossesand some forced into bankruptcy. Many banks lost large amounts of capital asconsumers lost faith in them and pulled their money out of their accounts,resulting in a shortage of funds.Because of the loose laws and regulationsthat were in place, which were partly responsible for the collapse of theeconomy, many financial institutions today are subject to stricterrequirements.Furthermore, the financial crisis affectedhouseholds as consumers’ confidence in the financial institutions fell, andthus people saved more and consumed less. Because of reduced consumptions byhouseholds, the profits of many firms decreased and thus they began to laypeople off, increasing unemployment. Households had less disposable income and manyhomes had to sign up for unemployment and food stamps, using more resources thegovernment did not have at the time.
Some statistics about the impact therecession had on the U.S. economy are as follows.U.S households lost an average of $5,800 inincome due to the reduction in economic growth during the period of timebetween September 2008 and the end of 2009.
The federal government spent on average$2,050 per U.S. household to mitigate the damage of the financial crisis.The average household lost nearly $100,000in declining stock and home values between July 2008 and March 2009. The U.S. lost an estimated $648 billion dueto slowed economic growth.
The U.S. lost $7.
4 trillion in stock wealthfrom July 2008 to March 2009.5.5 million American jobs were lost due toslower economic growth. The impact on theworld economy The United States economy was estimated tohave shrunk by 2.7 percent in 2009. The most severely affected weremiddle-incomes countries, especially in Central and Eastern Europe and theCommonwealth of Independent States. The primary causes being the combination ofthe major financial institutions being heavily reluctant to loan, and thedomestic imbalances such as the housing bubble and a large number of householdsand businesses with account deficits.
Due to its links with the United States,most of Latin America fell into a deep recession itself. Mexico was hit thehardest, their economy contracted by 7.1 percent in 2009 alone. Most low-incomecountries avoided a recession, but suffered seriously slowed growth, whichnonetheless had a negative impact for poverty going forward.
Based on the ILO’sGlobal Employment Trends, the number of registered unemployed persons wasestimated at 212 million in 2009, 34 million more than the number estimated in2007 before the recession had truly taken place. China and India have notablycontinued to grow strongly during the crisis, as they have large emerging economies,which are supported by domestic demand and government spending. Japan’seconomy, the world’s second largest, is deteriorating at its worst pace sincethe oil crisis of the 1970s, hurt by shrinking exports and anemic spending athome.
The U.K. government provided $88 billion to buy banks completely orpartially and promised to guarantee $438 billion in bank loans.