Causes of the Financial Crisis
The 2008 Recession has been considered the worst economic downfall since the Great Depression in the 1930s. Before 2008-2009 the unemployment was steady around 4-5% and in 2009 it jumped all the way to 9.3% and at its worst, the unemployment rate was 9.6 in 2010. In other words, if you were walking down the street and passed 100 people 9-10 of those people would be without any job(U.S.: annual unemployment rate 1990-2018). When looking into the causes of the “Great Recession” I tried to identify a single reason the economy fell, however no such single event could be found. However, the recession was based around the housing bubble and the housing market. Lawrence Christiano, an Economics Professor at Northwestern University, called the build up to December of 2007 when the market crashed a “perfect storm” of events to make the market crash. The crash was mainly based around the housing market. The housing market was on the up and coming from the late 1990’s-2007. With this market growth came instability in the market and a decline in the housing bubble and no credit to help the financial institutions out.
In the year 1977 under the Jimmy Carter administration, they passed the Community Reinvestment Act to help lower income families purchase homes. In the beginning, this act was to ensure all incomes in a community could buy housing with the help of their banks. It was in a way a chance to equal the playing field for people of incomes (Kenton, 2019). In the late 1990s through the early 2000s the housing market exploded, and everyone wanted, their share of the profit. According to the University of North Carolina research, housing prices rose 124%, which for example if a housing was listed for $250,000, it was being sold at $310,000 before the recession. That’s $60,000 more that people are borrowing and inevitably having to pay back to the banks with interest (Boykin, 2019). With the housing bubble increasing, the banks started giving loans with low interest rates also named “Cheap Credit." Cheap Credit is low interest rates with gives the borrowers leverage because they save money. The idea is borrowers will be able to take out more money for the loan because they aren’t required to pay as much over the asking price (Kenton, 2019). The problem with this is people can take out much more money than they can afford because of the low interest rates. “When borrowers could afford to make their payments after the interest rate reset and their payments increased, structured products backed by those loans imploded. Bad debt, fueled by a desire for cheap money, brought down the economy.” Cheap Credit (Money) helped with the market’s instability. Banks’ ability to give out loans to people with low interest rates made the housing market increase in prices and soon the market started slowing down, as most would expect. The problem with the slowing down is people had payments on houses that were to expensive for their income and they couldn’t sell quickly. This ripple effect causes the banks to endure tons of losses because people weren’t able to make payments of mortgages. With the low interest rates the banks weren’t making as much money off the loans they were giving out because the idea was, they would give out more, sort of a quantity over quality. The banks credit dried up and people lost money. The belief and pride in America for homeownership only fueled the desire to give subprime mortgage candidates.
In 2006 the first signs of a recession started to appear in the economy as housing prices started to level off. This shouldn’t come as a major surprise, being that its just the law of averages. Things may be overpriced for a while but they always come back to normal sooner or later. That being said when the value of houses started to depreciate that’s when homeowners are eventually banks got into some real trouble. Banks had given out loans on housing that were not valued anywhere close to where they were valued after 2006 when the market went back to normal. When the housing market began to slow down and prices of the houses returned to a normal state, people began to be stuck with the mortgages they could not afford. One question I always didn’t understand was why these people didn’t just sell the houses to other people? The first reason is no one was buying houses because of fear they would leave their money in any investments. The second reason is critical to why the recession lasted for as long as it did. Recall earlier houses were being sold for 124% higher than their actual value. When the market slowed and prices leveled out, people couldn’t sell their houses for anywhere near the asking price, this left lower income families with thousands of dollars of debt.
Financial institution were caught in a tough situation when the economy fell, with no money coming in the larger corporations were feeling the pressure to meet financial needs. “For every $1 of equity, the $22 billion Carlyle Capital Corporation fund was leveraged with $32 of loans. In other words, it toppled over under the weight of unsustainable debt” (Mathiason, 2008). Banks all over the country were caught in the same predicament as CCC. Forcing a large number of banks to seek help for the government, also known as government bailouts. This came as a repercussion for not having a better system for giving people loans. The government felt the pressure and needed to step into the market to bailout the banks from there shortcoming of cash. President Bush signed a bill to bail out the banks with $700 billion to buy back mortgage-backed securities. This was called the Emergency Economic Stabilization Act of 2008. The reason this bill was necessary for the helping of the economy is because once the banks starting losing money, in one day, a record $140 billion were pulled out of money market accounts (Amadeo, 2018). Examples of money market accounts are saving accounts that require higher deposits and balances.
Amadeo, K. (2018, November 05). What Did the Bank Bailout Bill Really Do? Retrieved June 11, 2019, from https://www.thebalance.com/what-was-the-bank-bailout-bill-3305675
Boykin, R. (2019, March 12). The Great Recession's Impact on the Housing Market. Retrieved May 27, 2019, from https://www.investopedia.com/investing/great-recessions-impact- housing-market/
Kenton, W. (2019, April 17). Community Reinvestment Act (CRA). Retrieved June 09, 2019, from https://www.investopedia.com/terms/c/community_reinvestment_act.asp
Kenton, W. (2019, March 12). Cheap Money. Retrieved June 01, 2019, from https://www.investopedia.com/terms/c/cheap-money.asp
Mathiason, N. (2008, December 28). Banking Collapse of 2008: Three weeks that
changed the world. Retrieved June 09, 2019, from
https://www.theguardian.com/business/2008/dec/28/markets-credit-crunch-banking-2008
U.S.: Annual unemployment rate 1990-2018. (n.d.). Retrieved June 11, 2019, from https://www.statista.com/statistics/193290/unemployment-rate-in-the-usa-since-1990/
amjad55
CausesoftheFinancialCrisis.docx
0
