🗽us history – 1865 to present review
12.3 Great Recession and Economic Challenges
Last Updated on July 31, 2024
The Great Recession of 2008 rocked the U.S. economy, triggering a global financial crisis. Risky lending practices and a housing bubble burst led to the collapse of major financial institutions, causing widespread economic turmoil and job losses.
The government responded with bailouts, stimulus packages, and regulatory reforms. These measures aimed to stabilize the economy and prevent future crises. However, the recession's long-term effects included increased income inequality, a widening wealth gap, and reduced social mobility.
Causes and consequences of the 2008 crisis
Subprime mortgage crisis and housing bubble burst
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- Risky lending practices fueled the subprime mortgage crisis
- Lenders offered mortgages to borrowers with poor credit histories or limited income
- Adjustable-rate mortgages (ARMs) had low initial rates that later increased, making payments unaffordable
- Housing bubble burst as home prices declined and borrowers defaulted on their mortgages
Collapse of major financial institutions
- Lehman Brothers collapsed in September 2008, the largest bankruptcy in U.S. history
- American International Group (AIG) nearly collapsed and required a government bailout of $85 billion
- Credit crunch ensued as banks became reluctant to lend to each other and to businesses and consumers
- Loss of confidence in the financial system led to a severe downturn in the stock market
Economic consequences of the financial crisis
- Global stock markets experienced sharp declines, erasing trillions of dollars in wealth
- Dow Jones Industrial Average fell by more than 50% from its peak in October 2007 to its low in March 2009
- International trade decreased as demand for goods and services fell worldwide
- U.S. GDP contracted by 4.3% in the fourth quarter of 2008, the largest decline since the 1950s
Characteristics of the Great Recession
- High unemployment rates, peaking at 10% in October 2009
- Declining real estate values, with home prices falling by more than 30% in some areas
- Slowdown in economic growth, with the U.S. economy contracting for four consecutive quarters
- Long-term unemployment became a significant issue, with many workers struggling to find jobs for months or years
Challenges in the automotive industry
- General Motors and Chrysler filed for bankruptcy in 2009
- U.S. government provided bailouts to GM and Chrysler, totaling more than $80 billion
- Restructuring of the automotive industry led to plant closures, job losses, and renegotiated labor contracts
- Ford Motor Company did not require a bailout but still faced significant financial challenges during the recession
Government response to the economic crisis
Monetary policy measures by the Federal Reserve
- Federal Reserve reduced interest rates to near-zero levels to stimulate borrowing and economic growth
- Quantitative easing involved the Fed purchasing Treasury securities and mortgage-backed securities to lower long-term interest rates
- Expanded lending facilities provided liquidity to financial markets and institutions
- Forward guidance communicated the Fed's intention to keep interest rates low for an extended period
Troubled Asset Relief Program (TARP)
- TARP authorized the U.S. Treasury to purchase up to $700 billion in troubled assets from financial institutions
- Capital injections provided to banks in exchange for preferred stock and warrants
- Aimed to stabilize the banking system and restore confidence in financial markets
- Controversial program due to the perception of bailing out Wall Street at taxpayers' expense
Fiscal policy measures and economic stimulus
- Economic Stimulus Act of 2008 provided tax rebates to individuals and incentives for business investment
- American Recovery and Reinvestment Act of 2009 included $787 billion in spending and tax cuts
- Infrastructure spending on projects like roads, bridges, and renewable energy
- Aid to state and local governments to prevent layoffs of public sector workers
- Expansion of unemployment benefits and food assistance programs
Financial regulatory reform
- Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in 2010
- Created the Consumer Financial Protection Bureau (CFPB) to protect consumers from abusive financial practices
- Volcker Rule prohibited banks from engaging in proprietary trading and limited their investments in hedge funds and private equity funds
- Increased capital and liquidity requirements for banks to enhance their resilience to financial shocks
- Established the Financial Stability Oversight Council (FSOC) to identify and address systemic risks to the financial system
Assistance to homeowners
- Home Affordable Modification Program (HAMP) provided incentives for lenders to modify mortgages for struggling homeowners
- Home Affordable Refinance Program (HARP) allowed homeowners with little or no equity to refinance their mortgages at lower interest rates
- Neighborhood Stabilization Program provided grants to states and local governments to purchase and redevelop foreclosed and abandoned properties
- Hardest Hit Fund targeted assistance to states with the highest unemployment rates and steepest declines in home prices
Impact of the Great Recession on society
Disproportionate impact on low-income and minority households
- Higher rates of unemployment among low-income and minority workers
- Subprime mortgages were more prevalent in minority communities, leading to higher foreclosure rates
- Wealth loss due to declining home values and retirement account balances
- Increased food insecurity and reliance on public assistance programs
Challenges faced by young adults
- Difficulty finding employment, particularly in fields related to their education
- Student loan debt burden exacerbated by limited job opportunities and stagnant wages
- Delayed milestones such as homeownership, marriage, and starting families
- Increased number of young adults living with their parents
Impact on older workers
- Job losses leading to early retirement or difficulty finding new employment
- Reduced retirement savings due to stock market declines and low interest rates
- Increased claims for Social Security benefits and disability insurance
- Strained personal finances and increased reliance on family members for support
Global economic impact
- Worldwide economic slowdown, with many countries experiencing reduced GDP growth and increased unemployment
- European Union (EU) entered a recession in 2009, with some member states (Greece, Spain, Portugal) facing severe debt crises
- Emerging economies (China, India, Brazil) experienced slower growth rates but fared better than advanced economies
- Increased volatility in global financial markets and currency fluctuations
Eurozone debt crisis
- High levels of public debt in countries like Greece, Ireland, and Portugal
- Investor concerns about the sustainability of debt levels led to higher borrowing costs
- EU and International Monetary Fund (IMF) provided bailout packages to debt-ridden countries in exchange for austerity measures
- Austerity measures, including spending cuts and tax increases, contributed to social unrest and political instability
Long-term effects of the economic crisis
Exacerbation of income inequality
- Top 1% of earners captured a disproportionate share of income gains during the recovery
- Middle- and lower-income households experienced stagnant wage growth
- CEO-to-worker pay ratio increased, with CEO compensation growing much faster than average worker pay
- Decline of labor unions and erosion of collective bargaining power
Widening wealth gap
- Affluent households benefited from rising stock prices and recovering real estate values
- Lower-income households struggled to rebuild wealth due to limited assets and slower wage growth
- Racial wealth gap widened, with African American and Latino households experiencing greater losses and slower recovery
- Concentration of wealth among the top 0.1% of households
Reduced social mobility
- Increased income inequality and wealth concentration limit opportunities for upward mobility
- Challenges in accessing quality education, stable employment, and affordable housing
- Intergenerational mobility declined, with children from low-income families facing greater barriers to moving up the economic ladder
- Persistence of poverty and limited access to social networks and resources
Political polarization and social unrest
- Occupy Wall Street movement protested income inequality and the influence of money in politics
- Tea Party movement advocated for limited government and lower taxes
- Increased partisan divide on issues related to economic policy, taxation, and the role of government
- Rise of populist movements and anti-establishment sentiment in the U.S. and Europe
Impact of COVID-19 pandemic
- Low-income and minority communities disproportionately affected by job losses and health disparities
- Exacerbation of existing inequalities in access to healthcare, education, and digital infrastructure
- Increased reliance on gig economy and precarious employment arrangements
- Potential long-term effects on small businesses, commercial real estate, and consumer behavior
Key Terms to Review (25)
Economic stimulus: Economic stimulus refers to government actions aimed at encouraging economic growth and increasing consumer spending during periods of economic downturn. It often involves measures such as increased public spending, tax cuts, and monetary policy adjustments designed to inject liquidity into the economy and promote investment, job creation, and overall demand.
Unemployment rate: The unemployment rate is a measure of the percentage of the labor force that is jobless and actively seeking employment. It reflects the health of the economy and can indicate economic distress or recovery depending on its fluctuations. High unemployment rates are typically associated with economic downturns, while lower rates suggest a recovering or booming economy.
Volcker Rule: The Volcker Rule is a financial regulation that was established as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, aimed at preventing excessive risk-taking by banks. Specifically, it restricts the ability of banks to engage in proprietary trading and limits their investments in hedge funds and private equity funds. This rule was named after former Federal Reserve Chairman Paul Volcker, who advocated for stricter regulations in response to the financial crisis during the Great Recession.
Home Affordable Refinance Program (HARP): The Home Affordable Refinance Program (HARP) was a government initiative established in 2009 to help homeowners refinance their mortgages and lower their monthly payments, particularly those who owed more on their homes than their homes were worth. This program aimed to provide relief during the aftermath of the Great Recession by making it easier for financially stressed homeowners to access refinancing options, ultimately stabilizing the housing market and supporting economic recovery.
Foreclosure crisis: The foreclosure crisis refers to a significant spike in home foreclosures that began in the mid-2000s, particularly due to the collapse of the housing bubble and the subprime mortgage market. This crisis resulted in millions of homeowners losing their properties and played a critical role in the Great Recession, leading to widespread economic challenges and a long recovery period for both individuals and the overall economy.
American Recovery and Reinvestment Act of 2009: The American Recovery and Reinvestment Act of 2009 was a significant piece of legislation enacted in response to the Great Recession, aimed at stimulating the economy through a combination of tax cuts, infrastructure investments, and social welfare programs. This act was intended to create jobs, promote economic recovery, and mitigate the impact of the recession on American households. The legislation represented a pivotal moment in U.S. economic policy as it sought to address widespread unemployment and restore consumer confidence.
Home Affordable Modification Program (HAMP): The Home Affordable Modification Program (HAMP) was a federal initiative launched in 2009 aimed at helping struggling homeowners avoid foreclosure by modifying their mortgage loans to make them more affordable. By providing financial incentives to lenders and borrowers, HAMP sought to stabilize the housing market during the Great Recession, which was characterized by high rates of unemployment and widespread home loan defaults.
Tea Party Movement: The Tea Party Movement is a conservative political movement in the United States that emerged in the late 2000s, primarily in response to the federal government’s economic policies, particularly during and after the Great Recession. It is characterized by a strict interpretation of the Constitution, advocating for lower taxes, reduced government spending, and a return to founding principles. This grassroots movement significantly influenced American politics, especially within the Republican Party, promoting candidates and policies that align with its core values.
Troubled Asset Relief Program (TARP): The Troubled Asset Relief Program (TARP) was a financial bailout program enacted in 2008 in response to the Great Recession, aimed at stabilizing the U.S. financial system by purchasing distressed assets and providing capital to banks. TARP played a crucial role in preventing the collapse of major financial institutions, restoring confidence in the banking sector, and facilitating economic recovery during a time of unprecedented economic challenges.
Financial Stability Oversight Council (FSOC): The Financial Stability Oversight Council (FSOC) is a U.S. government entity established under the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Its primary purpose is to monitor and address systemic risks in the financial system to promote stability and prevent future financial crises. FSOC aims to improve accountability and transparency within the financial sector while enhancing regulatory oversight, particularly following the Great Recession, which exposed vulnerabilities in financial institutions.
Occupy Wall Street: Occupy Wall Street was a progressive protest movement that began in September 2011, primarily focused on issues of economic inequality, corporate greed, and the influence of money in politics. The movement started in New York City's Zuccotti Park and quickly spread across the United States and internationally, symbolizing a larger discontent with the financial system and calling for social and economic reforms.
Fannie Mae and Freddie Mac: Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) that play a crucial role in the U.S. housing finance system by providing liquidity, stability, and affordability to the mortgage market. They buy mortgages from lenders, package them into mortgage-backed securities, and sell these securities to investors, which helps to ensure that banks have enough capital to issue new loans. Their operations became particularly significant during the Great Recession as they were placed under conservatorship due to severe financial distress.
Austerity measures: Austerity measures refer to government policies aimed at reducing public spending and increasing revenue to address budget deficits and stabilize the economy. These measures often involve cuts to social services, public sector wages, and government programs, as well as tax increases, and they are typically implemented in response to a financial crisis or economic downturn.
Gdp growth: GDP growth refers to the increase in the market value of all final goods and services produced in a country over a specific period, usually expressed as a percentage. This metric is crucial for understanding economic health, as it indicates how well an economy is performing and whether it is expanding or contracting. During periods like the Great Recession, GDP growth can dramatically slow or even turn negative, highlighting economic challenges and influencing government policies aimed at recovery.
Ben Bernanke: Ben Bernanke is an American economist who served as the 14th Chair of the Federal Reserve from 2006 to 2014. His leadership during the Great Recession was pivotal in implementing unconventional monetary policies aimed at stabilizing the economy, including quantitative easing and low interest rates, to combat the financial crisis and its aftermath.
Quantitative easing: Quantitative easing (QE) is a monetary policy tool used by central banks to stimulate the economy by increasing the money supply and lowering interest rates. This is typically done by purchasing government securities or other financial assets to inject liquidity into the financial system, encouraging lending and investment. QE aims to combat economic downturns, particularly during periods of low inflation and high unemployment, by making borrowing cheaper and boosting consumer spending.
Tim Geithner: Tim Geithner is an American banker and public official who served as the 75th Secretary of the Treasury from 2009 to 2013 under President Barack Obama. His tenure is most notable for his management of the financial crisis following the Great Recession, where he played a pivotal role in shaping economic policy responses and stabilizing the banking system.
Lehman Brothers Collapse: The Lehman Brothers collapse refers to the bankruptcy of Lehman Brothers Holdings Inc., a global financial services firm, on September 15, 2008. This event is widely recognized as a critical moment in the Great Recession, signaling the severity of the financial crisis and leading to widespread panic in global markets. The collapse exposed vulnerabilities in the financial system and underscored the impact of risky financial practices, such as excessive leverage and exposure to mortgage-backed securities.
Emergency Economic Stabilization Act: The Emergency Economic Stabilization Act (EESA) was a significant piece of legislation enacted in October 2008 aimed at addressing the financial crisis resulting from the Great Recession. This act authorized the U.S. Treasury to purchase or insure up to $700 billion in troubled assets, particularly those linked to mortgage-backed securities, to stabilize the banking sector and restore confidence in the financial system.
Dodd-Frank Act: The Dodd-Frank Act is a comprehensive financial reform legislation passed in 2010 in response to the Great Recession, aimed at reducing risks in the financial system and preventing future economic crises. This act established new regulatory agencies, imposed stricter rules on financial institutions, and sought to increase transparency in financial markets, highlighting its critical role in addressing the economic challenges that emerged during the recession.
Credit default swaps: Credit default swaps (CDS) are financial derivatives that allow an investor to 'swap' or offset their credit risk with that of another investor. They essentially act like insurance against the default of a borrower, enabling parties to hedge against potential losses from credit events. The rise in the use of CDS played a significant role in the financial crisis, particularly in relation to mortgage-backed securities and the overall instability in the banking system.
Subprime mortgage crisis: The subprime mortgage crisis refers to a financial crisis that occurred in the late 2000s, primarily resulting from the collapse of the housing market due to an excessive number of high-risk mortgage loans granted to borrowers with poor credit histories. This crisis was characterized by rising mortgage delinquencies and foreclosures, which ultimately triggered a global economic downturn, significantly impacting financial institutions and economies around the world.
Great Recession of 2007-2009: The Great Recession of 2007-2009 was a severe global economic downturn that began in the United States, marked by a decline in economic activity, rising unemployment, and significant drops in consumer wealth. It was triggered by the collapse of the housing market and financial institutions due to risky mortgage lending practices and the proliferation of complex financial instruments, which led to widespread bank failures and a credit crisis.
Income inequality: Income inequality refers to the unequal distribution of income among individuals or groups within a society. This concept highlights the disparities between different socioeconomic classes, often resulting in significant gaps between the rich and the poor. It has broad implications on economic stability, social cohesion, and political dynamics, influencing policies and reforms aimed at addressing these disparities.
Federal Reserve: The Federal Reserve, often referred to as the Fed, is the central banking system of the United States, established in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. It plays a crucial role in regulating the economy by controlling the money supply, setting interest rates, and serving as a lender of last resort during financial crises. Its policies significantly influenced economic and social conditions during various periods, especially the 1980s and the Great Recession.