What Caused the Great Recession

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What Caused the Great Recession?
It's finally ending. Let the blaming begin.
By Jacob Weisberg | NEWSWEEK

As the financial crisis of 2008–09 nears a close, stories of the meltdown are flooding bookstores,
think tanks are cranking out white papers, and four different congressional committees are
investigating what went wrong. Now that the debate over how to prevent the next collapse has
begun, it might not be a bad idea to figure out how the last one happened. The only near-
consensus is on the question of what triggered the not-quite-a-depression. In 2007 the housing
bubble burst, leading to a high rate of defaults on subprime mortgages. Exposure to bad
mortgages doomed Bear Stearns in March 2008 and then led to a banking crisis that fall. A
global recession became inevitable once the government decided not to rescue Lehman Brothers.
But right about here, agreement ends.

There are no strong candidates for what logicians call sufficient conditions—a single factor that
would have caused the crisis in the absence of any others. There are, however, a number of
plausible necessary conditions—factors without which the crisis would not have occurred. Most
analysts find former Fed chairman Alan Greenspan at fault, for varying reasons. Conservatives
tend to blame Greenspan for keeping interest rates too low between 2003 and 2005 as the real-
estate bubble inflated, spurring a frenzy of irresponsible borrowing.

Other analysts look to the underlying mindset that encouraged the meltdown: shortsightedness,
stupidity, and greed. But those are weak explanations, unless you think human nature changed in
the final decades of the 20th century to make people greedier or more foolish. I've left out some
farther-fetched interpretations of the cause of the crisis. Libertarians and The Wall Street Journal
editorial page continue to insist that government did it. One author theorizes that after the Cold
War, capitalism could go wild because Western governments no longer had to worry about
competing with communism. This is a fascinating idea, with no evidence to support it.

Historians are still debating what caused the Great Depression, so it's not likely this argument
will be settled any time soon. But if we haven't at least learned that our financial markets need
stronger regulatory supervision to prevent bad bets by big firms from going viral, we'll be back
in the same place faster than you can say "30 times leverage."

Houses Aren’t Worth As Much As We Really Thought
Wise men, we are informed by the most authoritative Source of wisdom, build their homes on a
rock; the foolish build theirs on sand. For decades, millions of Americans have been building
their homes on a financial bubble created by the Federal Reserve's loose money policies. The
housing bubble, in turn, has inflated a huge consumer credit bubble as homeowners, exploiting
decreases in Fed-controlled interest rates, have repeatedly refinanced their mortgages to
consolidate debt. The inevitable bursting of those bubbles may result in an unprecedented
financial catastrophe.

The twin engines pumping credit into the housing market are the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Federal Home
Loan Mortgage Corporation, commonly known as Freddie Mac, privately owned, government-
sponsored organization that uses private capital to buy home mortgages as a means to help lower
housing costs. Corporation), which collectively own or guarantee 70 percent of all American
mortgage debt--roughly four trillion dollars. Fannie and Freddie are "Government-Sponsored
Enterprises" (GSEs), nominally private institutions backed by the "full faith and credit" of the
U.S. government. This means, in essence, that the taxpayer is on the hook to bail them out in the
event they succumb to widespread mortgage defaults or some other financial cataclysm.

Fannie and Freddie also enjoy direct federal subsidies, which in 2000 amounted to more than $10
billion. And until recently, they were provided with a $2.5 billion emergency line of credit with
the Treasury Department--a relatively minuscule amount, to be sure, but one that created the
perception that Washington wouldn't allow them to fail. GSEs are the very embodiment of
corporatism--the economic component of fascism. Their profits are privatized, their risks are
subsidized, and their losses are socialized.
How Lack of Confidence Hurt the Economy
Much of the remaining confidence Americans had in the economy is lessening. Unfortunately,
that could play right into a vicious economic cycle.

"Lowering consumer confidence predicts less consumer spending or buying, which could further
hurt the already deteriorating economy since consumer spending accounts for more than two-
thirds of the nation's economic activity," according to the Associated Press.

"A big worry is the employment market, which has been shedding jobs in recent months. The
Labor Department is expected to show another loss of 65,000 when it releases its April report
Friday; that follows a 80,000 job loss in March. Analysts also estimate that the unemployment
rate will remain at 5.1 percent," according to the AP.

The lack of confidence in the flagging economy has been spurred on by rising gas and food
prices and weakening job prospects. As a result, "a widely watched measure of consumer
sentiment [reached] a five-year low, a private research group said Tuesday," according to the AP.

Other economic reports capture the same dismal outlook. The housing market's continued slump
was measured by Standard & Poor's/Case-Shiller index, which recently indicated that "housing
prices dropped in February at the fastest rate ever," according to the AP.

Housing prices have fallen 15 percent since their peak levels in 2006, according to the AP, and
may continue to fall. Robert Shiller, the economist behind Standard & Poor's/Case-Shiller index,
said he predicted that housing prices might fall by more than 30 percent, eclipsing the housing
slump seen during the Great Depression.

"The percentage of respondents surveyed who intended to take a vacation over the next six
months has fallen to a 30-year-low, another indication that consumers are turning more frugal,"
according to the AP. Even teenagers are becoming more frugal; for more on that, see our blog
post Recession Forces Teens To Curb Spending.

The Federal Reserve is widely expected to cut interest rates by another quarter point tomorrow
and then hold interest rates steady for the rest of this year. The Fed's repeated interest rate cuts
have been attempts to boost the economy without encouraging inflation.
The Credit Crunch Is Killing the Economy
The credit crunch refers to a sudden shortage of funds for lending, leading to a resulting decline
in loans available.

A Credit Crunch can occur for various reasons:

      Sudden increase in interest rates (and this means (higher/lower) buying?)
      Direct money controls by the government

Steps to 2007 / 08 Credit Crunch

   1. US mortgage lenders sell many inappropriate mortgages to customers with low income
      and poor credit. It is hoped with a booming housing market, the mortgages will remain
   2. Often there were lax contols in the sale of mortgage products. Mortgage brokers got paid
      for selling a mortgage, so there was an incentive to sell mortgages even if they were too
      expensive and high chance of default.
   3. To sell more profitable subprime mortgages, mortgage companies bundled the debt into
      consolidation packages and sold the debt on to other finance companies. In other words,
      mortgage companies borrowed to be able to lend mortgages. The lending was not
      financed out of saving accounts, for example.
   4. These mortgage debts were bought by financial intermediaries. The idea was to spread
      the risk, but, actually it just spread the problem.
   5. Usually subprime mortgages would have a high risk assessment rating. But, when the
      mortgage bundles got passed onto other lenders, rating agencies gave these risky
      subprime mortgages a low risk rating. Therefore, the financial system denied the extent
      of risk in their balance sheets.
   6. Many of these mortgages had an introductory period of 1-2 years of very low interest
      rates. At the end of this period, interest rates increased.
   7. In 2007, the US had to increase interest rates because of inflation. This made mortgage
      payments more expensive. Furthermore, many homeowners who had taken out mortgages
      2 years earlier now faced ballooning mortgage payments as their introductory period
      ended. Homeowners also faced lower disposable income because of rising health care
      costs, rising petrol prices and rising food prices.
   8. This caused a rise in mortgage defaults, as many new homeowners could not afford
      mortgage payments. These defaults also signalled the end of the US housing boom. US
      house prices started to fall and this caused more mortgage problems. For example, people
      with 100% mortgages now faced negative equity. It also meant that the loans were no
      longer secured. If people did default, the bank couldn’t guarantee to recoup the initial
   9. The number of defaults caused many medium sized US mortgage companies to go
       bankrupt. However, the losses weren’t confined to mortgage lenders, many banks also
       lost billions of pounds in the bad mortgage debt they had bought off US mortgage
       companies. Banks had to write off large losses and this made them reluctant to make any
       further lending, especially in the now dangerous subprime sector.
   10. The result was that all around the world, it became very difficult to raise funds and
       borrow money. The cost of interbank lending has increased significantly. Often it was
       very difficult to borrow any money at all. The markets dried up.
   11. This affected many firms who had been exposed to the subprime lending. It also affected
       a wide variety of firms who now have difficulty borrowing money. For example, biotech
       companies rely on ‘high risk’ investment and are now struggling to get enough funds.
   12. The slow down in borrowing has contributed to a slowing economy with the possibility
       of recession in the US a real problem.

How Long will the Credit Crunch Last?

The credit crunch could last a long time. This is because:

   1. House prices are still falling in the US, reducing the value of mortgage loans
   2. Many homeowners still face rising interest rates, when their introductory periods come to
      an end
   3. It can be difficult to regain confidence in the financial markets
   4. A recession in the US and global downturn could cause a further rise in bad loans

Data Set #1

   1. Summarize the story in two to three sentences.

   2. What are the strengths and weakness of this story (the most believable part of the story

       and the part you are most skeptical of)?

   3. What are the problems you see or questions you have with/about this particular story?

Data Set #2

   1. Summarize the story in two to three sentences.

   2. What are the strengths and weakness of this story?

What are the problems you see or questions you have with/about this particular story?
   1. Summarize the story in two to three sentences.

   2. What are the strengths and weakness of this story?

   3. What are the problems you see or questions you have with/about this particular story?

Data Set #4

   1. Summarize the story in two to three sentences.

   2. What are the strengths and weakness of this story?

   3. What are the problems you see or questions you have with/about this particular story?
NAME:                                                      HOUR:

Bellringer: What happened in the 2009 Recession?         What is a recession? Who is
someone who has been impacted by the recession?

Do the following assignment at the end.
Answer the following questions using a Main Idea sentence (1st sentence), and two details that
support your main idea (your argument). This paragraph will be 6-8 sentences and worth 10
3 pts- Main Idea
2 pts- Supporting Detail 1 (with Link)
2 pts- Supporting Detail 2 (with Link)
2 pts- Good conclusion (reflects main idea argument and includes information from the whole
1 point- Proper Grammar, Spelling

What caused the 2008/09 American Recession?

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