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The Great Recession of 2007 to 2009 marked a huge disruption in the global financial system, rivaled only by the Great Depression in scale and severity. Rooted in excessive risk-taking, lax financial regulations, and the collapse of the US housing market, the crisis triggered widespread economic turmoil, massive job losses, and a deep cut in global GDP.
Though recovery eventually followed, the crisis reshaped economic policy, financial regulation, and global markets for years to come.
Curious about the Great Recession? Click through now.
The Great Recession (2007 to 2009) was the longest economic downturn since the Great Depression in the 1930s.
In 2007, a sharp decline in economic activity occurred. It started when the US housing market went from "boom to bust."
In response to the Great Recession, federal authorities implemented unprecedented fiscal, monetary, and regulatory policies, which some credit for the recovery.
The term “Great Recession” is a play on the term “Great Depression” from the 1930s. This was a time when gross domestic product (GDP) declined by more than 10% and unemployment hit 25%.
Most economists agree that the downturn of 2007 until 2009 was not actually a depression, though no explicit criteria exist to differentiate a depression from a severe recession.
During the Great Recession, US GDP declined by 0.3% in 2008 and 2.8% in 2009, while unemployment reached 10% briefly.
The "Great Recession" is applicable to both the US recession which lasted from December 2007 to June 2009, as well as the global recession in 2009.
According to a 2011 report by the Financial Crisis Inquiry Commission, the Great Recession was avoidable.
The report identified the government's failure to regulate the financial industry. This included the Federal Reserve's inability to stop banks from handing out mortgages to people who were bad credit risks.
Many financial firms took excessive risks, particularly in the shadow banking system, which operated with little regulation. When it collapsed, credit flow to consumers and businesses was severely disrupted.
The report also included borrowing by consumers and businesses that was considered excessive. Additionally, lawmakers didn't understand the collapsing financial system. This created an asset bubble where mortgages were extended at low interest rates to unqualified buyers who then couldn't repay.
Next, houses were being sold off causing prices to dip and leaving many homeowners underwater. This impacted the mortgage-backed securities that banks and institutional investors were holding.
The 2001 dot-com bubble burst, coupled with the September 11 attacks, dealt a heavy blow to the US economy. In response, the Fed cut interest rates to historic lows, maintaining them until mid-2004 to stimulate growth.
Federal policy was combined with these low interest rates and that helped cause a boom in real estate and financial markets.
New financial products, including subprime and adjustable-rate mortgages, enabled many high-risk borrowers to secure home loans. These loans were granted under the assumption that interest rates would stay low and home prices would keep rising.
Unfortunately, from 2004 through 2006, the Federal Reserve raised interest rates to control inflation. Also, rates for existing adjustable mortgages and exotic loans began to reset at higher-than-expected rates.
Monthly mortgage payments began rising well beyond borrowers' ability to pay and thus they started to sell.
During the US housing boom, financial institutions heavily sold mortgage-backed securities and complex derivatives. When the real estate market crashed in 2007, these assets lost significant value.
The credit markets that financed the housing bubble soon followed housing prices into a downturn and the credit crisis began unfolding in 2007.
The solvency of over-leveraged banks and financial institutions hit a breaking point with the collapse of Bear Stearns in March 2008.
The crisis escalated in September 2008 when Lehman Brothers, the fourth-largest US investment bank, declared bankruptcy. The fallout quickly spread to global markets, especially in Europe.
More than 8.7 million jobs were lost in the US in the Great Recession, thereby doubling the unemployment rate.
Approximately US$19 trillion in net worth was lost when the stock markets plunged.
The Fed took aggressive monetary policies along with other central banks globally. This helped prevent further damage to the economy.
The Fed cut a key interest rate to nearly zero to boost liquidity and, in an unprecedented step, injected US$7.7 trillion into banks through a policy called quantitative easing (QE).
The US government sought to stimulate the economy via $787 billion in spending under the American Recovery and Reinvestment Act (ARRA). It was subsequently raised to $831 billion.
Slowly but surely the American economy began to heal and rebound. In 2009, the GDP bottomed out and took approximately three-and-a-half years to reach pre-recession levels.
The Dow Jones Industrial Average (DJIA) began its recovery in March 2009 after losing more than half its value from its 2007 peak. It took four years to fully rebound, surpassing its 2007 high in March 2013.
While the financial markets rebounded, it took a lot longer for workers and households to do so.
Sources: (Investopedia) (Britannica) (Federal Reserve History) (History)
See also: The 'Trumpcession' and its implications for the US economy
What was the Great Recession, and how did it happen?
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The Great Recession of 2007 to 2009 marked a huge disruption in the global financial system, rivaled only by the Great Depression in scale and severity. Rooted in excessive risk-taking, lax financial regulations, and the collapse of the US housing market, the crisis triggered widespread economic turmoil, massive job losses, and a deep cut in global GDP.
Though recovery eventually followed, the crisis reshaped economic policy, financial regulation, and global markets for years to come.
Curious about the Great Recession? Click through now.