After the world experienced the impact of the Great Depression from 1929 to 1939, it enjoyed a revived economic performance that made investments and other forms of business operations to be active. However, in December 2007, an unexpected turn of events occurred following critical mistakes in the financial and banking sector. This resulted in a fateful economic downturn that forced the world into a deep crisis. The impact of the situation caused the production and employment rates to decline tremendously in the US. The situation lasted until June 2009, when the federal government introduced effective contingency measures to save the economy. The economic recession of 2007 to 2009 significantly impacted the economic growth of the US and other countries worldwide. Several factors contributed to the emergence of economic underperformance that forced most financial institutions and business organizations to be declared bankrupt.
Understanding the 2007 to 2009 Economic Recession Crisis
Generally, the economic recession began in the US following the massive financial crisis that happened following the bursting of the US housing bubble. This resulted in the contraction of liquidity in the global financial market. After the crisis took place, its impacts spread rapidly to other countries, making it an issue of concern. Before the period, that is, early 2001, the interest rates banks charged their customers, especially the low-risk clients, reduced significantly (Li & van Rijn, 2022). The decrease in rates allowed many people to borrow loans, even those who did not qualify for the products. Since the public had easy access to financial resources, they opted to purchase houses, increasing the demand for new homes and higher prices.
After some duration, that is, around 2005, the housing demand started to fall rapidly. This was stimulated by the sudden rise in interest rates making even qualified individuals unable to secure assets. The decrease in demand facilitated house prices to fall because the majority of the people who secured the homes could not finance them due to limited loans (Damianov & Elsayed, 2018). This prompted them to sell the properties to reduce the loan repayment burden. Previously, homeowners had the ability to have more loans from the banks against the mortgages. However, when the demand declined, the prices fell, making the homes valueless and unable to allow them to have financial support from the financial institutions. The challenge made the subprime borrowers and some prime mortgagors owe the banks more money than the value of their homes. Individuals could not easily sell the properties due to probable loss from such sales. As the case and issues continue pilling across the country, most financial institutions reduce their capacity to lend their subprime clients loans, thus fueling the reduction in prices and demand for homes.
Following the collapse of subprime mortgages, financial institutions were left in a critical situation since a significant number of their assets were in the form of loans given to the customers, limiting their ability to repay. The loans given to the customers became difficult to track, making the banks question the ability of each other regarding the lending issue. This made the banking facilities reduce the interbank loaning lowering the amount of money available for credit purposes. The effect made the financial institutions have less cash to lend, even the individuals with enough capability to repay the loans, including well-established business organizations.
Since most business organizations could not access financial support from the banks following the credit freeze, they opted to reduce their investment activities, causing massive job losses in the labor market. The impact resulted in a decline in the demand for goods and services produced by such firms because the majority of the consumers who were initially active employees became unemployed with limited cash to spend. Most of the companies that faced such challenges opted to merge with their counterparts that were financially healthy. Similarly, the banks chose to apply for government support through bailouts while the rest became bankrupt.
Following the trend, most consumers became scared of the economy, and their confidence was reduced, making them more cautious. In order to remain on the safest side, the clients reduced their overall spending, fearing the chances of hard times in the future. This kind of response lowered the money supply in the economy and made businesses incur significant losses. The above factors played in favor of the recession, making the economies experience a massive decline in active processes, including production, employment and financial lending.
Causes of the 2007- 2009 Economic Recession
There are several factors that contributed significantly to the economic depression of 2007 – 2009. Some of the causes include loose standards of lending in the housing sector, the crisis of subprime mortgages, the behavior of Wall Street, and excessive investments (Coghlan et al., 2018). These aspects played a vital role in stimulating and enhancing the spread and impacts of the economic downturn experienced during the period.
Loose Lending Standards
Before 2007, the housing market experienced a massive increase in rates. The value of real estate and other related properties was in a steadily state of increase, influencing the majority of people to invest and buy more homes. This aspect made the market boom, especially in the late 2000s. The situation attracted the mortgage lenders’ attention, and they opted to approve a large portion of loans following the desire to capture more profit. During this period, the financiers did not take into consideration the status of people with an inability to repay their loans. They gave offers to customers with inappropriate credit histories. The banks were reluctant and failed to value the sources of income of the people seeking the resources but instead just approved the applications randomly.
With minimum standards in place, individuals who previously could not access the mortgage facilities decided to take the opportunity to increase new homebuyers. In return, the overall demand for homes increased, making the prices high and leading to the housing bubble. The loose lending standards further prompted homeowners to secure more loans to repay their loans. However, when the interest rate changed and started rising, the majority, especially those with weak credit ability, could not afford to finance the products.
Before the economic recession occurred, the past two decades proved prosperous, encompassed by low inflation rates and a rise in the gross domestic product (GDP). Most people believed that the boom was a result of massive economic growth. This aspect blinded most investors, assuming the condition would remain stable for a long before experiencing a downtown. The financiers chose to spend immoderately, following the optimism they had concerning the current status of the economy. People thought the situation would remain and continue growing in the future. Individuals and financial institutions then opted to engage in traditional risky conducts such as securing more debts, aggressive investments and destructing lending because they speculated them as being safe.
Hazardous Wall Street Behavior
With the need to make more money outside the real estate investments, the financial institutions formulated other approaches to ripe more income. The facilities opted to sell the subprime mortgage loans by packaging in the process known as securitization. The approach allowed lenders to hustle the products to be sold to investment banks, which in turn vented them to more global vendors in the form of mortgage-backed securities (Coghlan et al., 2018). The process resulted in the selling of such loans in the secondary market. The actions were backed by the theory of Wall Street models, which assumed that the risks of collateralized debt obligations (CDO) were reduced by having a variety of mortgages.
Following the present market condition by then, institutional investors in different parts of the world opted to borrow huge amounts of money to purchase the CDOs. This happened because the vendors felt secure after believing the mathematical models of Wall Street. Furthermore, after the banks gained confidence on the matter, they even used credit default swaps (CDS) to ensure against possible defaults on the CDOs. These behaviors jeopardized the financial institutions, leading to significant fallout.
The Crisis of Subprime Mortgage
Before the economic downturn, the interest rates of subprime mortgages were relatively low. The condition changed, and they started to rise in 2004 following fear of inflation in the economy. Federal funds increased from about 1.3% in mid-2004 to over 5% in 2006 (Coghlan et al., 2018). During this time, real estate prices were going up, and demand was dropping. This made the overall supply of homes to be more than the demand in the housing market. The situations, which are high-interest rates and reduced prices, limited the abilities of homeowners to continue financing their properties. This led to a high number of defaults on subprime loans. The investment banks experienced a massive decline in their income. Most financial institutions lost their credibility in borrowing money and the confidence of their respective investors.
The Effects of the Economic Recession of 2007 – 2009
The sudden and impromptu decline in economic performance affected the world in a number of ways. The impacts of the economic recession were massive and spread across different countries, including the US. The effects were severe, and the majority of people and institutions felt the overall weight. The productivity rate declined, financial institutions became bankrupt, and most people lost their jobs (Folinas et al., 2018). Furthermore, the stock market crashed, real estate value drooped and low wages.
Reduced Productivity of Countries
Generally, engagement in the labor and capital sector influences the country’s productivity. Following the incident of economic depression, most banking institutions became scared of lending finances to investors, fearing the possibility of default. This promoted a sharp decrease in the intended business activities because of low funding to facilitate the processes. In other words, various sectors could not finance their operations, especially the ones that depend on loan products. Such inefficiency impacted the national economies’ overall output, leading to a tremendous decline in the GDP. For instance, the US real GDP fell by about 4% during the 2007 – 2009 depression (Matysiak et al., 2021). The massive drop was caused by the intense stress experienced in the financial markets that paralyzed key productivities, including industrial productions.
Increased Unemployment Rate
The period was characterized by slow economic processes such as manufacturing and other activities that could create employment opportunities. This sluggishness made it impossible for the nation to establish enough jobs to accommodate the rising number of potential job seekers. Based on the national statistics, the unemployment rate was roughly 5% and below before December 2007. However, after the economic recession, the research indicated an increase of over 9% by June 2009 (Smed et al., 2018). This data indicates how the economic depression significantly affects the creation of work in the countries. It is mostly attributed by the reduction in the productivity of the country. Employers such as companies tend to close down their operations or reduce recruitment to survive the strong waves of rising inflation.
The bankruptcy of Major Financial Institutions
The economic downturn majorly impacted the financial markets across the globe. Most banks ignored the possibility of a recession, making them make aggressive lending activities. For instance, increasing the proportion of subprime mortgages to customers with less creditworthiness. This activity resulted in more loans to the clients, leaving the organizations with limited funds to manage their operations. After the massive defaults by borrowers, the banking institutions were forced to be declared bankrupt because their capacity to operate with minimum credit was low.
Closure of Businesses
Most industries thrive with loans borrowed from financial institutions, but when the economic performance began to decline, most financiers were scared of financing business organizations (González-Pernía et al., 2018). During the recession period, a number of private-sector businesses closed their operations due to limited resources. This made it challenging for the firms to afford their operation demands leading to the closure of the entities. Furthermore, even new companies could not able to enter the respective market following the economic chaos.
Massive Loss of Jobs
Employed people encountered a hard time following massive layoffs by their respective employers. Most companies’ productivity reduction prompted the owners to lower the number of human resources to enable the industries to reduce the overall expenditure (Olanrewaju et al., 2018). The approach resulted in a million individuals losing job opportunities rendering them jobless without proper insurance. Similarly, firms that could not work withstand the economic pressure opted to close their activities, leaving employees with no work opportunities.
The Role of Monetary and Fiscal Policies in Reducing Economic Crisis
The need to stabilize the economy from the significant impacts of the recession may force the governments to resort to using various monetary and fiscal policies to enhance stability. The monetary approach is whereby the federal government applies the open market operations, reserve requirements and discount rate to manage inflation. On the other hand, a fiscal procedure entails using taxes to influence overall spending. These approaches played a huge role in the economic recession by promoting market firmness.
Following the deepening of the economic crisis, the US government took different measures to curb the spread and impact of the situation. The federal government formulated and launched fiscal stimulus programs that entailed the use of various tax reductions and government expenditures to improve economic growth. For instance, the rates of federal funds were reduced from over 5% to about 0.25% between the periods 2007 to 2008 March (Faria-e-Castro, 2021). This was aimed at lowering the interest rates to enhance borrowing for economic activities.
Apart from lowering the interest rates, the governments used open market operations that involved buying the assets containing the loan securities. Through this process, the national government introduced liquidity into the market to ease the ongoing financial crisis. For instance, the US federal adopted the large-scale asset purchase (LSAP) procedure by buying the US agencies’ mortgage-backed securities. It targeted home purchases to increase the credit for the sector that was mostly hit by the recession.
Macroeconomics Issues Involved in the Economic Crisis
Inflation played a major role in the financial and economic crisis of 2007 to 2009. Initially, before the 2000s, house rates were significantly stable, and people could easily secure loans to purchase them. However, by December 2007, there was a significant twist leading to a massive fall in the prices of real estate properties. The decrease in prices made the value of homes to be less than the mortgage worth they represent in the banks. The condition made homeowners unable to service their loans, making them become defaulters.
Unemployment is another crucial macroeconomic aspect witnessed during the financial and economic crisis. Following the reduction in the ability of many investors to secure adequate loans to finance their investments, they were forced to close most of their business activities hence lowering the job opportunities. This made the number of people without constructive work increase globally. For instance, before the economic downturn, the national rate of unemployment used to be around 5%; however, after the period, the number shifted to over 10% (Smed et al., 2018). This made joblessness an issue of concern as most families were left without income.
Generally, the national output of a country is based on the activity of labor and capital. If the two factors remain idle, then the performance and outcome decline. This is the case most countries experienced during the 2007 to 2009 recession. Most people lost their jobs, reducing the productivity of the labor market and the financial institutions crushed, leading to low capital to finance investment projects (Wu et al., 2019). As a result, the overall production rate of the nation declines, effectively making the GDP to be low.
In summary, the financial and economic crisis is a blow to the growth and development of countries. The 2007 to 2009 depression significantly impacted several countries across the globe. The situation resulted in massive unemployment, reduced production, business closure, and mass layoff. The decline in productivity was caused by different factors, including loose lending regulations, subprime mortgage disasters, the weak watchdog, and excessive investments. However, most governments applied monetary and fiscal policies to restore economic growth to correct the deepening effects of the recessions. Some of the measures used include reducing federal funding rates to allow for low interest for easy borrowing. The approaches were targeted to enable people and financial institutions to access more funds to enhance their business operations.
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