The Great Recession: How it tanked the American Economy

The emergence of a huge speculative housing bubble in the mid-2000s in the US, accompanied by an accommodative interest rates, friendly tax lending standards, leniency in mortgage regulations, and unrestricted growth of loan securitization triggered an overexpansion of consumer borrowing. The flood of new and unsophisticated homebuyers with access to easy credit caused the house prices to hike to unprecedented levels in relation to disposable income or rents.

Equity gained from the rapid appreciation of home values provided homebuyers with billions of dollars in spendable cash, which gave consumer spending a boost. The increase in consumption was accompanied by an increase in household debt in relation to income and a decrease in the rate of personal saving.

The consistent rise in home prices encouraged lenders to further ease credit mainly on the assumption that this trend would continue. The easy access to mortgage loans especially sub-prime mortgages further attracted a vast population of Americans towards home ownership.

Expectations were that the trend in home prices would remain for a very long time. The surge in demand further pushed the prices up. Americans continued to borrow more against equity in their houses. The activity was turning out to be very profitable for the financial sector since the home prices were increasing and investors were getting good returns on their investments.

However, when the optimistic assumptions failed, the housing bubble began to lose attractiveness, triggering a chain of events that led to an economic and financial crisis – The Great Recession, which began in December 2007 and lasted till June 2009. It is considered as one of the most relentless economic contraction since 1947 as calculated by the peak-to-trough depression in real Gross Domestic Product. The Great Recession of 2007-2009 caused a significant shift in consumer spending behavior.

In 2005, new house building construction started to drop. In 2006, the housing bubble finally burst causing a loss of $7 billion. They began cutting back costs, especially on newly built houses. Consequently, there was a decline in household demand.

People who had borrowed mortgages were not even in a position to pay their bills. Banks started to foreclose on mortgage loans, causing panic among bankers and investors of hedge funds who had purchased sub-prime mortgage backed securities and suffered great loses.  

In 2007, financial institutions narrowed down their policy and were afraid to lend to each other. It became so difficult for businesses to borrow money and keep enough money to make bill payments. As a result, they had to fire a number of employees. The recession claimed about 9 million jobs and the U.S employment rate increased to 11%.  

While there are many interpretations of the reasons of the Great Recession, however, the truth is that there are no easy answers. The real reasons of the recession are quite complicated and interlinked with other problems of the time.