Global financial crisis and the Great Recession

Transcription

1 Global financial crisis and the Great Recession In 2006 a chain of events shook the foundations of the international financial system and sent the global economy spiraling into a severe economic downturn known as the Great Recession. The causes of the crisis were complex and numerous but can ultimately be traced to rising debt, irresponsible banking practices, and the availability of credit. It had become common in the 2000s for banks in the United States to give loans to people who did not meet traditional requirements, such as adequate income and borrowing history. These so-called subprime loans carried a high risk of default, or inability of the borrowers to repay their debt. Subprime loans to purchase homes (also called mortgages) became a staple of the US financial system, triggering the growth of the housing market and a rise in the price of houses. Banks began to break subprime loans into smaller pieces and offer them with other, more reliable assets, such as stocks and securities (financial instruments that represent ownership of a portion of a company or part-ownership of a good). These packaged assets were then traded in the world's stock exchanges like any other financial instrument, distributing the risk of the subprime loans throughout the entire financial system. A bubble, a phenomenon in which the price of a financial instrument grows disproportionately to the value of the object it represents ownership of, formed in the American housing market as prices rose to levels far exceeding the actual value of houses. Banks issued larger and larger loans consistent with the rising price of houses, often with low starting interest rates that would rise to a higher level if they were not repaid within a set period. The privately operated Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, lending enterprises that worked in cooperation with the federal government to achieve their goal of fostering higher levels of homeownership came to hold large amounts of subprime mortgage debt. Although the banks and other institutions holding subprime debt appeared to be growing in value, it was actually an illusion that they cultivated by misrepresenting the risk of default (the failure to make a payment on a loan) on subprime mortgages. The

2 debt was valued with the assumption that the housing market would continue to grow, when the actual value of the houses contained in the mortgage did not. The Economist magazine claimed that the worldwide rise in house prices is the biggest bubble in history, joining a growing chorus in calling for government intervention to prevent catastrophe when the bubble inevitably burst. Economists actually had identified the housing bubble and the reckless lending that created it as potential threats in 2005, but there was a general consensus among most of them that the potential was just that. The probability of a national average decline in housing prices was not considered high. That failure to identify and accurately assess the situation led to the housing bubble burst in A higher number of borrowers defaulted on subprime mortgages than had been anticipated, pushing down the value of securities attached to the loans to such a degree that the market valuation of the banks holding them plummeted. Housing values began to fall, causing major US banks, such as Lehman Brothers, Goldman Sachs Group, and Bear Stearns, to lose huge amounts of capital as securities linked to mortgages declined in value. More than twenty-five of the banks responsible for issuing subprime mortgages filed for bankruptcy protection within the span of a few months, sparking what Bloomberg Businessweek magazine called a meltdown of unparalleled proportions. Loss of capital forced banks to decrease lending, restricting the availability of credit. Retraction of credit slowed overall economic activity, further reducing the valuation of the financial industry to the point that banks began to run out of funds available for withdrawal. Banks around the world, whose assets included securities backed by American mortgage debt, also began to lose liquidity, or cash assets, and decline in value. By late 2007 a fullscale credit crisis had begun, as banks around the world lost the ability to issue new loans. From 2007 to 2009 the global economy declined in overall production, especially in Western Europe, the United States, and Japan, where investment accounted for more wealth generation than the production of actual goods and services. Homelessness, unemployment, and inflation increased, while banks lost hundreds of billions of dollars,

3 contributing to the continued decline of the Great Recession. According to the US Department of Treasury, 8.8 million US jobs were lost along with more than ten trillion dollars in wealth during this period. The European and American financial systems threatened to fail completely and plunge the global economy into collapse as major banks were confronted with the need for capital to remain in business. Governments addressed this problem in different ways, with some injecting large amounts of money into their economies to promote lending and others controlling interest rates so as to prevent them from rising. The US government took drastic measures in response, first taking control of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation in order to relieve mortgage debt and then authorizing the emergency buyout of failing banks by their better-performing competitors. When those measures failed to curb the falling value of the US stock market, the government passed an economic stabilization bill that allocated seven-hundred-billion dollars to be given directly to ailing banks, as well as low-interest loans and the purchase of debt. Opinion among economists, officials, and the public was divided about whether or not the government should help the banking industry out of its mess. Supporters claimed that the role of the banks in the economy was too important to let them fail. They reasoned that the only way to restore the global economy to prerecession levels was for the government to give banks enough money to stay operational and that international trade and income would follow. Opponents argued that the government should not give taxpayer money to the banks, which were private businesses, and that the natural consequence of poor business practices in a capitalist system is failure. In the end a number of major US banks narrowly escaped bankruptcy by accepting government money. Economic stimulus bills (legislation passed to ease financial difficulties caused by the Great Recession) in the EU and the United States helped to counteract the lack of consumer spending resulting from high unemployment and inflation, and by June 2009 economic growth had resumed, marking the official end of the Great Recession in the United States. Different economies recovered from the recession at different times, while many nations in the EU experienced a second recession linked to

4 financial troubles in Greece. This chart details the jobs lost and time required for recovery of employment in various countries during several economic recessions between the years 1929 to GALE, CENGAGE LEARNING Aftermath The underlying problems that caused the Great Recession, as well as the economic conditions that it produced, still remained, and the idea of government noninterference that had motivated economic liberalization and free trade development was set aside. Policy makers decided that it was impossible for the global economy to remain stable without the direct oversight and management of administrators. Leaders were forced to address problematic practices and attitudes within the global financial infrastructure, in which banks deliberately and systematically deceived investors by neglecting to accurately account for the risk attached to mortgage-backed debt, conducted excessive subprime lending, manipulated the stock

5 market, avoided government regulations with loopholes and forged accounting. Many nations, including the United States, England, and Germany, created regulations and laws that required stricter compliance with official standards and more open accounting. Greater international coordination became an important focus for many governments. The spread of the credit crisis and subsequent lull in trade demonstrated the tendency for interwoven markets to be more sensitive to the effects of events in the markets of their trade partners and highlighted the importance of steady but controlled growth through international cooperation. The need for more international and government regulation of the global economy remained at the end of 2013, however. The World Bank (an IGO that is the world's biggest development bank, working to end global poverty through a range of programs, projects, initiatives, and investments) stated in its annual report, Global Financial Development Report, for 2013 that a national government has a crucial role in the financial sector it needs to provide strong prudential supervision, ensure healthy competition, and enhance financial infrastructure. The economies of the United States and much of the EU did not return to the levels of growth they had maintained prior to the wars in Iraq and Afghanistan until late 2012, and even in 2014 the effects of the Great Recession were still evident around the world. Unemployment, loan defaults, investment losses, debt, and almost no increase in wages held back growth and recovery for most of the US workforce. In reality the vast majority of the wealth being generated was concentrated among the very richest individuals of the population, who owned or worked for one of a network of multinational corporations and banks that dominated American industry and international trade. The economic outlook for all but the wealthiest 5 percent of Americans did not improve at a rate consistent with economic output (the amount of goods and services produced by a country) in the years after 2009, and the average household income actually declined. From 2012 to 2013 the national debt threatened to exceed the limit accepted under national law. Congress passed a series of budget cuts intended to lower the national debt, but in 2014

6 the national debt of over seventeen trillion dollars still exceeded the total value of the economy. Recovery in Europe had its own setbacks, mostly stemming from national debt. The governments of Greece, Spain, Italy, and Portugal cut spending and raised taxes, together known as austerity measures, so as not to default on their loans from other EU nations. Austerity measures caused unemployment to jump to as high as 50 percent in Greece and only slightly lower in Italy and Spain in some urban areas. Poland was the only EU nation not to experience the Great Recession, while several countries in Central Europe did not experience recession. Housing markets in Europe stabilized more quickly than in the United States due to stricter government controls on housing prices, but homelessness remained higher than in prerecession years. By 2014 the euro had stabilized and the economy of the EU had largely returned to steady economic growth. "The Global Economy." UXL Civics. Rebecca Valentine. Vol. 3: US Foreign Policy and Global Affairs. Farmington Hills, MI: UXL, Web. 11 Aug URL eg02263&it=r&p=gvrl&sw=w&asid=88d2f1255fd069abcf5b9ece3fb778b a