8/13/2019 Great Recession 2007

1/2

Great Recession 2007

According to the U.S. National Bureau of Economic Research (the official arbiter of U.S.

recessions) the US recession began in the United States in December 2007 and ended in

June 2009, and thus spanned over 18 months.[22][23] US mortgage-backed securities,

which had risks that were hard to assess, were marketed around the world. A more broad

based credit boom fed a global speculative bubble in real estate and equities, which

served to reinforce the risky lending practices.[24][25]

The bad financial situation was made more difficult by a sharp increase in oil and food

prices. The emergence of sub-prime loan losses in 2007 began the crisis and exposed

other risky loans and over-inflated asset prices. With loan losses mounting and the fall of

Lehman Brothers on 15 September 2008, a major panic broke out on the interbank loan

market. As share and housing prices declined, many large and well established

investment and commercial banks in the United States and Europe suffered huge losses

and even faced bankruptcy, resulting in massive public financial assistance.

Origin

The immediate or proximate cause of the crisis in 2008 was the failure or risk of failure at

major financial institutions globally, starting with the rescue of investment bank Bear

Stearns in March 2008 and the failure of Lehman Brothersin September 2008. Many of

these institutions had invested heavily in risky securities that lost much or all

of their value when U.S. and European housing bubbles began to deflate during the 2007-

2009 period. Further, many institutions had become dependent on short-term (overnight)

funding markets subject to disruption.

The origin of these housing bubbles involved two major factors:

1)low interest rates in the U.S. and Europe following the 2000-2001 U.S. recession;

and 2) significant growth in savings available from developing nations due to

ongoing trade imbalances.These factors drove a large increase in demand for high-

8/13/2019 Great Recession 2007

2/2

yield investments. Large investment banks connected the housing markets to this

large supply of savings via innovative new securities, fueling housing bubbles in the

U.S. and Europe.

Many institutions lowered credit standards to continue feeding the global demand for

mortgage securities, generating huge profits while passing the risk to investors. However,

while the bubbles developed, household debt levels rose sharply after the year 2000

globally. Households became dependent on being able to refinance their mortgages.

Further, U.S. households often had adjustable rate mortgages, which had lower initial

interest rates and payments that later rose. When global credit markets essentially stopped

funding mortgage-related investments in the 2007-2008 period, U.S. homeowners were

no longer able to refinance and defaulted in record numbers, leading to the collapse of

securities backed by these mortgages that now pervaded the system.

The failure rates of subprime mortgages were the first symptom of a credit boom turned

to bust and of a real estate shock. But large default rates on subprime mortgages cannot

account for the severity of the crisis. Rather, low-quality mortgages acted as an accelerant

to the fire that spread through the entire financial system. The latter had become fragile as

a result of several factors that are unique to this crisis: the transfer of assets from the

balance sheets of banks to the markets, the creation of complex and opaque assets, the

failure of ratings agencies to properly assess the risk of such assets, and the application of

fair value accounting. To these novel factors, one must add the now standard failure of

regulators and supervisors in spotting and correcting the emerging weaknesses.