The Great Recession and Government Response

Overview

• Great event: A major economic event from 2007-2009, the most severe recession since the Great Depression.
• Unemployment rates: Doubled from 4% to 10%, Young people's unemployment rates went up to 20-25%.

Causes of the Great Recession

• Preceding Housing Boom: Low-interest rates and easy credit led to a boom in the housing market.
  • Causes of the boom: low-interest rates, easy credit, and developments in the mortgage market.
• Subprime Borrowers: Easier for people with poor credit to get mortgages.
• Securitization of Mortgages: Investment banks pooled mortgages into securities and sold them, spreading the risk.
• Belief in Housing Market Stability: Historically, housing prices hadn’t fallen nationwide for 50 years.

Mechanics of Securitization

• Investment banks pooled numerous mortgages and sold portions of them to investors.
• Advantage: Diversification across different regions, reducing risk.
• Disadvantage: Banks were incentivized to give more risky loans since they did not bear the risk.

The Housing Bubble

• Bubbles: Created when assets are bought not for intrinsic value but because their prices are rising.
  • Example: Dutch Tulip Bulb Bubble.
• Bubble Burst: Housing prices fell by 30% after peaking in 2006.
  • Result: Defaults, foreclosures, and loss of value in mortgage-backed securities.

Consequences of the Recession

• Financial Institutions: Major institutions like IndyMac Bank, Countrywide, and Washington Mutual collapsed.
• Credit Crunch: Difficult borrowing environment increased unemployment and reduced investments.

Government Response

1. Expansionary Fiscal Policy
   • Increase in government spending and decrease in taxes.
   • Stimulus Package: Close to $800 billion to boost the economy.
2. Expansionary Monetary Policy
   • The Federal Reserve dropped interest rates to zero and conducted quantitative easing (printing money).
3. Bank Bailouts
   • Government provided funds to financial institutions to prevent collapse.
   • Troubled Asset Relief Program (TARP): Provided bailout money mainly in the form of loans that were eventually paid back with interest.

Outcome of the Response

• Recovery: The combination of policies resulted in economic recovery post-2009.
• Long-Term Debt: Concerns about increasing national debt, but no immediate crisis.
• Economist Consensus: Majority agree that the government actions were necessary and effective.

Final Thoughts

• Bubbles and Market Crashes: Historical context reminds us that economic bubbles periodically happen and lead to market crashes.
• Importance of Regulation and Oversight: Government intervention can stabilize economies during crises, underscoring the need for effective regulation.

Upcoming Topic

• Phillips Curve: Understanding the relationship between inflation and unemployment, unraveling the history and development of these economic models.