Catalysts for the 2008 Economic Recession
Inextricably bound to a myriad of issues, ranging from poor monetary policies to a gross lack of ethics on the part of financial institutions, the economic recession of 2008 began in the United States and continues to resonate across the globe. Routinely likened to the Great Depression of the 1930s (Harding 22), the recession of 2008 began with a collapse of financial markets, in particular credit markets, and quickly, virally filtered into other economic channels. The following inquiry explores the primary catalysts for the economic recession of 2008, affording particular respect to the context of, financial triggers for, and global spread of the recession.
Former United States Federal Reserve Board Chairman Alan Greenspan cited that the foremost cause of the Great Recession of 2008 was the "irrational exuberance" of banks and credit institutions. While the underlying, pervading attitudes of financial organizations will not be explored until a latter section of this inquiry, critical is it to note that the immediate causes of the crisis critiqued herein would not have yielded the detrimental effects they did without the unscrupulous, collective behavior of the financial world in the years preceding the crisis. In 2007, GDP output in the United States topped $14.4 trillion; this number declined steadily and rapidly throughout 2008 and most of 2009, rising only slightly during the third quarter of 2009. Since then, unemployment has continued to soar around the globe as other nations, including the United Kingdom and Australia, have felt the negative impact of the recession. In short, the Great Recession has brought even wealthy nations to their proverbial knees, with poor policies and unethical attitudes birthing a global crisis affecting billions of people worldwide.
Context of a Crisis
While the global economy has undoubtedly become an entity all its own, it is comprised by innumerable national and regional economies. These smaller, economic units are consistently in flux, growing and declining in wavelike, cyclical patterns. The cyclical changes of individual economies are not, however, predictable, though the dominating assumption among entire populations was, prior to 2008, that major economic changes could be anticipated. Patterns of economic success in conjunction with a relatively short memory regarding recessions and financial downturns birth economic growth. In his article entitled "Global Financial Crisis of 2008-09: Triggers, Trails, Travails, and Treatments," Subrahmanyam writes that "as the success pattern of a cycle ages, its mindset also recedes yielding place to a new one. For instance, the cycle of the 1930s was built on steel, trains and farms; that of 1970s on planes, plastics and electronics. The present cycle of the 21st century is built on computers, robots and satellites" (34). With each cycle, a new values system emerges in social institutions, defining the collective, consumer psyche by certain needs. Economic crises, then, are birthed out of a clash between the new value system, reflected in organizational policies, and what the market will bear.
The effects of globalisation, including the massive production and growth of transnational corporations (TNCs), foreign investment, and ever widening gap between the haves and have-nots, provided the context for the crisis of 2008. Individual, national economies became more tightly bound to one another and developing nations became wholly reliant on the new, massive, global economy. In short, when the United States fell, the global economy followed suit.
The financial triggers that directly birthed the recession were characterized as poor, national, monetary policies in the United States, a global savings glut, and, most importantly, sub-prime lending by banking institutions. These issues combined explosively with the interconnectivity of the world economy, birthing the viral downturn. Though hindsight has yielded significant discourse regarding the inevitability of the recession, few economists predicted that the recession would occur as quickly and as disastrously as it did.
American Monetary Policies and The Savings Glut
The United States had a prolonged policy of low interest rates, fostered in part by a twenty-five year history of relative, economic growth. In the aftermath of economic downturns, such as the dot-com bust of 2000, the federal government unfailingly resorts to lowering interest rates in order to strengthen consumer confidence. The downside of low interest-rates, however, is the savings glut and failure to innovate.
Large export nations such as China and Japan have systematically and steadily invested their export surpluses in the United States, thereby financing American debt. With low interest-rates not encouraging further technological advancement, housing became a strong economic focus during the mid-2000s. The United States, most of Western Europe, and Australia experienced enormous capital influxes aimed at the housing industry, and new, economic value system shifted away from technological innovation in these nations and toward housing.
Sub-Prime Lending and CDOs
The strong economic emphasis on housing, in the United States particularly, birthed a range of lending programs aimed at making homes affordable to lower income individuals. With the interest rates low in the United States, home ownership was possible for buyers that would have been perceived as far too risky to garner a mortgage prior to the mid-2000s. Additionally, low interest-rates birthed a buying frenzy of sorts even among financially sound buyers, leading to a surge in housing sales. The sub-prime lending strategies were built upon the incorrect assumption that housing prices could never go down, however, and were made possible through collateralized debt obligations (CDOs), or bundled mortgages and loans sold between financial institutions.
CDOs were rated as AA and AAA, presumably according to the level of risk they presented, and foreign banks believed that the instruments were essentially failsafe due to the nature of the American real estate market. The richest man in the world, Warren Buffet, warned that CDOs were effectively "weapons of mass financial destruction," but his words went unheeded. Subrahmanyam describes CDO sales as follows: "These CDOs are sold as baskets of securities with little knowledge about the quality or regularity of their cash flows. They are held by institutions far removed from their originators.... [C]oming up with a value for CDO entails analyzing more than 100 separate securities, each of which contains several thousand individual loans..." (38). By extension, values for CDOs were routinely, arbitrarily given. Were the housing bubble in the United States not about to burst, however, CDOs may not have held the detrimental effect on the world economy that they did.
Speculators diverge as to precisely why and where the housing market began to decline in the United States. Discourse has cited that overbuilding in Florida and Nevada led to a sudden and unprecedented drop in housing values in the nation which subsequently fostered a slight rise in interest rates. The rate rise in these areas coincided with one another and began to foster default on adjustable rate mortgages. Foreclosures birth significant drops in property values, and the effects are relatively immediate.
Because banks were basing mortgage profitability on debt and not the actual collateral of the house, widespread defaulting on mortgages is detrimental to the lending industry. In his article entitled "Anatomy of the Global Financial Crisis," Versi writes simply "a bank or building society can lend many times its capital and earn interest on money it has created. As long as you repay the loan, or failing which, as long as the bank can redeem the loan by selling your property, all is fine. But if you cannot repay the loan and the collateral on which the loan was raised is worth less than the original loan, the bank is in trouble" (22). Moreover, when this happens in a multiplicity of cases, the bank can simply not recover from its losses. When the housing bubble burst in 2008 in the United States, the defaults were massive. Because CDOs glued American banks with those of other nations, the UK included, the challenge posed to banks in the United States was the same posed to those in other nations.
When financial institutions get into trouble, their first strategy is to choke credit. Not being able to risk losing money by lending to high-risk buyers, banks around the world began cutting off credit to individuals and businesses alike. Consequently, collectively lower demand for goods and services birthed from global belt-tightening forces businesses, which can no longer garner credit as a financial cushion, to cut production. In turn, businesses cut working hours and begin layoffs, leading to higher unemployment; this begins the cycle all over again as unemployed workers buy less, thus demand is lower and companies cut production.
The American consumer had supported, in part, high-export nations such as China and Japan. With unemployment in the nation high and demand subsequently low, Japan's economy, for instance, shrunk 12% in a single quarter in 2008. Eastern Europe suffered similarly, no longer profiting from the demand of Western Europe. The entire, Euro-Zone economy contracted by nearly 2% in the same quarter in 2008.
A narrowing of global trade and concurrent rise in global unemployment has proved detrimental to the world economy. Despite the 2008 G-20 Summit's consensus that protectionism should not become a dominant strategy of national economies, most current reports suggest that it has, with trade restrictions soaring across the globe.The World Bank President warned that "economic isolationism can lead to a negative spiral of events such as those the world has seen in the 1930s, which made a bad situation much worse" (qtd. in Subrahmanyam 41). Still, world markets generally responded to the recession with increases in tariffs and trade defense measures.
Protectionism, in essence, substantially undermined efforts to revive the floundering American and UK economies, in particular (Subrahmanyam 41). Fears that the interconnectivity of the economy would foster a universal recession were well founded, however, making it difficult to fault those that resorted to protectionist policies. Concurrently, major financial institutions in the United States such as AIG and Merrill Lynch received considerable amounts of federal aid, despite the catalyzing role they played in the global recession.
Hindsight and Pervading Attitudes
Despite the policies and baby steps that undoubtedly contributed to the crisis, the underlying foundation for the 2008 recession was a pervasive lack scruples in the American banking industry. Time magazine summed up the catalyst for the recession appropriately as follows: "When greed exceeds fear, trouble follows.... Wall street has always been a greedy place and every decade or so it suffers a blow, resulting in a bout of hand-wringing and regret, which always seems to be quickly forgotten" (Sewer qtd. in Versi 24). While sub-prime lending undoubtedly was formidable force that fostered the recession, hindsight has revealed deep-seated issues of intentional oversights and other issues that have likely been engrained in the system for decades.
Widespread consumer debt, fostered by a culture of conspicuous consumption, provided a fertile ground for predatory lending ("Confronting"). A lack of government regulation- cultivated by laissez-faire capitalism and a fundamental tendency for Western nations to worship the free market- allowed these institutions to operate autonomously and largely without controls. Ironically, it was the government who was charged to rescue the institutions during the recession, becoming a very visible hand during the crisis.
Effects, Lessons, and Remedies
The inevitable increase in government regulation in the United States and Western nations gave way to public outcry. However, there was a moderate consensus among the American public that government should be, at the very least, overseeing derivative products and CDOs. The reality that emotional behaviors born out of greed had a valid and atrocious effect on financial markets has been a wake-up call in the collective world of finance. In short, cognizance now exists that financial entities are not unfailingly rational in their decision making and human emotions not usually associated with the banking world can create a global crisis.
Lessons learned from the crisis include the fact that housing markets are not immune to decline and that the interconnectivity of markets is not necessarily a positive outcome of globalisation. In the United States, the behavior of financiers prior to and during the crisis alerted the world over that government complicity is problematic in conjunction with unethical, and in some instances immoral, behavior by bank regulators. Some theorists have gone so far as to cite that the crisis marks the beginning of the fall of world powers such as the United States and the United Kingdom. In his article entitled "The Great Crash of 2008," Lal writes that "the parallel with Rome is instructive. The causes of Rome's decline were ultimately economic. As the past rents acquired during the empire's growth had been in part committed to a vast expansion of a welfare state without extending the domestic tax base, the empire faced an endemic fiscal crisis". Similarly, modern developed nations are struggling to reconcile the reality of their economies with an inflated, collective ego.
The credit crunch that ensued following the burst of the housing bubble fostered widespread fears that long-held beliefs regarding the immunity of solid economies were no longer founded; and yet, economic recovery depends critically on a certain amount of memory loss. If the world continued to operate in the shadow of the Great Depression, for example, economic growth would not have occurred for the better part of the twentieth century. The seizing up of markets that follows a credit crunch must be temporary in order for the economy to start moving again.
Consumer confidence has to be stimulated, employment must be stable, buying begins again, companies increase production, hire more workers, and a positive cycle begins. At present, the downward spiral continues. While the recession is widely believed to have ended ("Confronting"), unemployment continues to rise in most affected nations. By extension, true economic growth is not on the horizon.
The question is then, how much of the recession of 2008 should the world remember and to what extent does it need to forget in order to birth recovery? In short, the collective memories regarding the 2008 crisis must include the ills of the financial industry. Careful, future scrutiny of instruments such as CDOs and greater, government regulation of consumer lending is apparently necessary. If a single lesson has been learned from the events of the dawning, twenty-first century decade, it is that greed can be a salient enemy to the economy and not an unfailing support of capitalism as was once thought.
The economic recession that resonated within primarily East Asian markets during the 1990s led to widespread promises that globalisation would be made more friendly and inclusive toward developing nations. The 2008 recession demonstrated, however, that globalisation can negatively impact even economic giants. Rising unemployment, rampant foreclosures, and a suppressed economy have become realities for the United States, United Kingdom, and other fully industrialized nations not used to a recession of this magnitude. The bailout of financial institutions should have had a humbling effect on the surviving banks in these nations, but evidence suggests that profits have soared within institutions like Goldman Sachs.
With the irrevocable interconnectivity of markets at present, the ills of globalisation cannot be targeted as a catalyst for the crisis; they were part of the context but not the cause. If economic recovery is to occur, the connection between world markets needs to be more positively defined. In short, the perils of global finance stem largely from a failure of global policies to provide a mechanism for support during a crisis. The G20 Summit of 2009 collectively recognized that existing policies were inadequate and if the economy was to again function optimally in a manner that cultivates growth, policies need to be amended.
Efforts to provide higher levels of government regulation must be authentic and urgent, and international institutions like the World Bank need to be reformed. Emerging world powers, even more emerging following the crisis, such as China and India, need to be afforded a greater voice in such policies, as they have proven that they are formidable, economic entities. While they are still developing, they deserve to be collectively and politically recognized in global policy to a greater extent than they are at present. Finally, the over-leveraged institutions need to reexamined for their emphasis on short-term profitability.
Significant gaps in financial regulations were highlighted during and in the aftermath of the 2008 recession. Enormous concentrations of risk were widely and detrimentally ignored, leading directly to the hemorrhaging of major economies believed to be largely infallible. Undoubtedly, the recession of 2008 was not the first time a global recession occurred, but it was the first major downturn following the wake of globalisation that has come to define the modern marketplace. The crisis placed the proverbial spotlight on weaknesses in the policies and structures within individual economies, but, more importantly, it demonstrated how a single, national economy is inextricably bound to a multiplicity of others. The state of recovery from the economic recession of 2008, a state the world is likely to be in for quite some time, needs to be characterized by a purposeful effort to remember certain lessons and forget others; only in this way will another, similar crisis be averted whilst promoting the much needed consumer confidence, the driving force behind economic growth. Overall, the roots of the recession were poor financial policies and sub-prime lending in the United States. These roots were fed, however, by a general lack of scruples on the part of financiers in conjunction with an unfounded belief that growth was inevitable.
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