📜History of American Business Unit 18 – Great Recession and 2008 Financial Crisis

Background and Economic Context

• U.S. economy experienced a period of significant growth and expansion in the years leading up to the 2008 financial crisis
• Housing market boom fueled by low interest rates, lax lending standards, and a belief that housing prices would continue to rise
• Rapid growth in subprime mortgage lending, which involved providing loans to borrowers with lower credit scores and higher risk of default
• Securitization of mortgages allowed lenders to package and sell loans to investors, creating complex financial instruments (mortgage-backed securities and collateralized debt obligations)
• Global imbalances, such as large trade deficits and surpluses, contributed to the availability of cheap credit and increased risk-taking
• Deregulation of the financial industry in the decades prior to the crisis reduced oversight and allowed for the growth of shadow banking system
• Low interest rates set by the Federal Reserve encouraged borrowing and risk-taking

Key Players and Institutions

• Investment banks (Goldman Sachs, Morgan Stanley, Lehman Brothers) played a central role in creating and selling complex financial products
• Mortgage lenders (Countrywide Financial, Washington Mutual) originated large volumes of subprime loans
• Credit rating agencies (Moody's, Standard & Poor's, Fitch) assigned high ratings to mortgage-backed securities, despite the underlying risks
• Federal Reserve responsible for setting monetary policy and regulating the banking system
• U.S. Department of the Treasury involved in designing and implementing the government's response to the crisis
• Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) government-sponsored enterprises that played a significant role in the housing market
• American International Group (AIG) provided insurance for complex financial products through its credit default swaps

Causes and Contributing Factors

• Housing market bubble and subsequent collapse driven by a combination of factors
  • Low interest rates and easy credit encouraged borrowing and speculation
  • Relaxed lending standards and the growth of subprime mortgages
  • Belief that housing prices would continue to rise, leading to increased risk-taking
• Securitization of mortgages and the creation of complex financial instruments
  • Mortgage-backed securities allowed lenders to transfer risk to investors
  • Collateralized debt obligations further obscured the underlying risks
• Lack of transparency and understanding of the complex financial products
• Credit rating agencies assigned high ratings to risky mortgage-backed securities
• Excessive leverage and risk-taking by financial institutions
• Inadequate regulation and oversight of the financial system
  • Deregulation of the banking industry in the decades prior to the crisis
  • Growth of the largely unregulated shadow banking system
• Global imbalances and the availability of cheap credit

Timeline of Major Events

• December 2007: Great Recession officially begins
• March 2008: Bear Stearns, a major investment bank, collapses and is acquired by JPMorgan Chase with government assistance
• July 2008: Housing prices decline sharply, and foreclosures increase significantly
• September 7, 2008: Government places Fannie Mae and Freddie Mac into conservatorship
• September 15, 2008: Lehman Brothers files for bankruptcy protection
• September 16, 2008: Federal Reserve provides emergency loan to AIG to prevent its collapse
• October 3, 2008: Congress passes the Emergency Economic Stabilization Act, creating the $700 billion Troubled Asset Relief Program (TARP)
• November 2008: Federal Reserve initiates the first round of quantitative easing (QE1)
• February 2009: Congress passes the American Recovery and Reinvestment Act, a $787 billion stimulus package
• June 2009: National Bureau of Economic Research declares the end of the Great Recession

Government Response and Interventions

• Federal Reserve lowered interest rates to near-zero levels to stimulate borrowing and economic activity
• Quantitative easing programs involved the Federal Reserve purchasing Treasury securities and mortgage-backed securities to inject liquidity into the financial system
• Troubled Asset Relief Program (TARP) provided capital injections to struggling banks and financial institutions in exchange for equity stakes
• Bailouts and government assistance for key institutions (Bear Stearns, Fannie Mae, Freddie Mac, AIG) to prevent further systemic damage
• Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) introduced sweeping changes to financial regulation
  • Created the Consumer Financial Protection Bureau (CFPB) to protect consumers from abusive practices
  • Established the Financial Stability Oversight Council (FSOC) to monitor systemic risks
  • Introduced the Volcker Rule to restrict proprietary trading by banks
• Economic stimulus measures, such as the American Recovery and Reinvestment Act, aimed at boosting demand and job creation

Impact on Various Sectors

• Housing market experienced a significant decline in prices and a wave of foreclosures
  • Homeowners faced negative equity as property values fell below mortgage balances
  • Construction and real estate industries suffered job losses and reduced activity
• Financial sector underwent major restructuring and consolidation
  • Lehman Brothers filed for bankruptcy, while other institutions were acquired or received government support
  • Increased regulation and scrutiny of financial practices in the aftermath of the crisis
• Automotive industry faced severe challenges, with General Motors and Chrysler requiring government bailouts and restructuring
• Unemployment rate rose sharply, peaking at 10% in October 2009
  • Job losses were widespread across sectors, with construction, manufacturing, and financial services particularly affected
• Consumer spending and confidence declined as households faced financial strain and uncertainty
• Global economy impacted as the crisis spread to other countries through financial linkages and reduced trade

Long-Term Consequences

• Slow economic recovery, with GDP growth remaining subdued for several years after the crisis
• Prolonged period of low interest rates and unconventional monetary policy
  • Concerns about potential asset bubbles and financial stability risks
  • Challenges for savers and fixed-income investors
• Increased income and wealth inequality, as the benefits of the recovery were unevenly distributed
• Structural changes in the labor market, with some jobs permanently lost and a shift towards part-time and temporary employment
• Increased government debt levels due to stimulus measures and reduced tax revenues
• Heightened public scrutiny and mistrust of the financial industry and regulatory bodies
• Shifts in consumer behavior and attitudes towards debt and financial risk-taking

Lessons Learned and Reforms

• Importance of effective regulation and oversight of the financial system
  • Need for a macroprudential approach to identify and mitigate systemic risks
  • Strengthening of capital and liquidity requirements for banks
• Increased transparency and accountability in the financial industry
  • Improved disclosure and reporting standards for complex financial products
  • Reforms to credit rating agencies to address conflicts of interest
• Recognition of the interconnectedness of the global financial system and the need for international cooperation
• Emphasis on consumer protection and financial literacy
  • Creation of the Consumer Financial Protection Bureau (CFPB) to safeguard consumer interests
  • Efforts to improve financial education and promote responsible borrowing and investing
• Importance of timely and coordinated policy responses during economic crises
  • Collaboration between monetary and fiscal authorities
  • Balancing short-term stabilization with long-term sustainability
• Debate over the appropriate balance between free markets and government intervention
• Ongoing efforts to enhance the resilience of the financial system and prevent future crises