In 2006, the subprime mortgage crisis erupted. Experts said low-interest rates and the strength of the U.S. economy would restrict it to the real estate industry. Instead, the subprime canary flew out of the coal mine, spreading seeds of crisis everywhere.
02The Recession Begins
The economy shrank 0.7% in the first quarter of 2008. That signaled the start of The Great Recession. Unfortunately, experts didn't realize it until the third quarter, when the economy started a slump that lasted for four quarters in a row. Housing prices dropped 28%. The last time this happened? The Great Depression of 1929.
03The $787 Billion Stimulus Package
Even before he took office, Barack Obama's campaign platform had a well-formulated plan to fix the economy. In March 2009, Congress approved his $787 billion Economic Stimulus Plan, also called ARRA. It ended the recession by July of that year. It granted $288 billion in tax cuts, $224 billion in unemployment benefits, and $275 billion for "shovel-ready" public works. It also included $54 billion in tax write-offs for small businesses. Later, the FY 2011 budget added $64 billion to extend many of the credits.
Obama's Economic Team was challenged to creatively address one of the worst economic crises in modern times. As the effects dragged on, economic stimulus alone was not enough.
On February 18, 2009, Obama announced a $75 billion plan to help stop foreclosures. The Homeowner Stability Initiative (HSI) was designed to help the 7-9 million homeowners avoid foreclosure by restructuring or refinancing their mortgage. before they get behind in their payments. Most banks won't allow a loan modification until the borrower misses three payments. It provides a $1,000-a-year principal payment for borrowers who stay current. It's paid out of TARP funds.
It also helps borrowers who are upside down in their mortgages. Most banks won't refinance a mortgage unless the amount owed is less than 80% of the total value of the home, which doesn't help homeowners who have seen the value of their home plummet below the mortgage level. The government subsidizes some cost to banks of reducing the size of the mortgage.
The plan has three components:
- Enable 4-5 million homeowners to refinance.
- Provide loan modifications.
- Increase funding to Fannie Mae and Freddie Mac.
The BEA final report revised its U.S. GDP growth rate for Q4 2008 to a negative 6.3%, worse than the 6.1% drop it reported in its preliminary report last month. (It was since revised to an 8.1% decline.) This was the worst slowdown since Q1 1982 when GDP fell 6.4%. A strong dollar coupled with the global recession cut exports, while the recession in the U.S. caused domestic demand to slump. Economic growth for all of 2008 was an anemic 1.1%. (Source: GDP News Release)
The bailout spending in 2008 kept the economy from collapse, while the economic stimulus has not yet had a chance to work. Therefore, expect continued economic decline for one or two more quarters. This means additional layoffs. However, most recessions last no longer than two years, so most economists predict we will be out of this one by the end of 2009. For a review of the most recent GDP reports, see GDP Current Statistics.
07April 2009: Making Home Affordable Launched to Help Upside-Down Homeowners
The Making Home Affordable was an initiative launched by the Obama Administration to help homeowners avoid foreclosure. The program generated more than 630,000 loan modifications in its lifespan. That wasn't nearly enough.
HARP (Homeowner Affordable Refinance Program) was one of its programs. It was designed to stimulate the housing market by allowing up to 2 million credit-worthy homeowners who were upside-down in their homes to refinance, taking advantage of lower mortgage rates. Unfortunately, banks are just too risk-averse to help those with less-than-stellar credit. Instead, they've been cherry-picking applicants. The Obama Administration introduced HARP in April 2009. Two years later, only 810,00 homeowners were helped. More than 90% were less than 5% upside down.
08August: Obama Asks Banks to Modify Loans
By August, foreclosures kept mounting. That dimmed hopes of an economic recovery. Banks could have, but didn't, prevent foreclosures by modifying loans. That's because it would further hurt their bottom line. But record foreclosures (360,149 in July) only made things worse for them as well as American families. July's foreclosure rate was the highest since RealtyTrac began keeping records in 2005. It was 32% higher than in 2008.
Banks believed it was more profitable to foreclose on a house than to make a loan modification, according to some industry analysts. Foreclosures continued rising as more adjustable-rate mortgages came due at higher rates.
More than half (57%) of foreclosures were from just four states: Arizona, California, Florida, and Nevada. California banks beefed up their foreclosure departments, expecting higher home losses.
The Obama administration asked banks to voluntarily double loan modifications by November 1. Some analysts said that banks were waiting for housing prices to improve before making loan modifications in the hopes they won't lose as much profit.
Many of these alternatives to a bailout were eventually implemented anyway. These included coordinated central bank rate cuts, and the Federal Reserve stepping in as a commercial lender of last resort.
The bill stopped the bank credit panic, allowed LIBOR rates to return to normal, and made it possible for everyone to get loans. Without credit market functioning, businesses are not able to get the capital they need to run their day-to-day business. Without the bill, it would have been impossible for people to get credit applications approved for home mortgages and even car loans. In a few weeks, the lack of capital would have lead to a shut-down of small businesses, who can't afford the high-interest costs. Also, those whose mortgage rates reset would see their loan payments jump. This would have caused even more foreclosures. The Great Recession would have been a global depression.
11Why Not Let the Banks Go Bankrupt?
There is a lot of anger about the $350 billion in taxpayer dollars that have been used to bail out the banks since last October. Many people feel that there has been no oversight, the banks are just using the money for executive bonuses, and they should not be rescued for making bad decisions based on greed. The argument goes that, if we just let the banks go bankrupt, the worthless assets will be written off, and other companies will purchase the good assets and the economy will be much stronger as a result. In other words, let capitalism do its thing.
In fact, that is what Former Treasury Secretary Hank Paulson attempted to do with Lehman Brothers in September. The result was a market panic, and a run on the ultra-safe money market funds, which threatened to shut down cash flow to all businesses, large and small. In other words, the free market couldn't solve the problem without government help.
In fact, most of the government funds have been used to create the assets that allow the banks to write down about $1 trillion in losses already. The problem is that there is probably $1 - $2 trillion left to go. The other problem is that there are no "new companies," i.e. other banks, that have the funds to purchase these banks. Even Citigroup required a bailout to keep going, and it was one of the banks that the government had hoped would bail out the other banks.
I agree that the U.S. has too much debt, but unfortunately, we have no other recourse at this time. It is just unfortunate that, during the most prosperous time in our nation's history, we ran up $9 trillion in debt unnecessarily. Now, when we really need the government's assistance, we have to worry about a $12 trillion total debt, instead of $4 0 $5 trillion debt.
If we let the major banks go bankrupt, there are no other companies to buy them..we just end up with no financial system. Then we truly could have another great depression on our hands.
12October - Bank Lending Down 15%
A Federal Reserve report showed that lending was down 15% from the nation's four biggest banks: Bank of America, JPMorgan Chase, Citigroup, and Wells Fargo. Between April and October of 2009, these banks cut their commercial and industrial lending by $100 billion. Loans to small businesses fell 4%, or $7 billion, during the same period, according to Treasury Department data.
Lending from all banks surveyed showed the number of loans made was down 9% from October 2008. But the outstanding balance of all loans made went up 5%. This means banks made larger loans to fewer recipients.
Why was bank lending down? A variety of reasons, depending on who you talk to. The banks said there were fewer qualified borrowers thanks to the recession. Businesses said the banks tightened their lending standards. But if you looked at the 18 months of potential foreclosures in the pipeline, it looked like banks were hoarding cash to prepare for future write-offs. Banks were sitting on $1.1 trillion in government subsidies.
Bank of America pledged to President Obama it would increase lending to small and medium-sized businesses by $5 billion in 2010. But that was only after slashing lending by 21% ($58 billion) in 2009.
The unemployment rate rose to 10.0% in October, the worst since the 1982 recession. Nearly 6 million jobs were lost in the 12 months prior to that. Employers were adding temporary workers, too cautious about the economy to add full-time employees. However, the fields of healthcare and education continued to expand. This typically happens during a recession, as people either often react to unemployment by getting sicker from the stress or returning to school to get a new skill.
14Why Didn't Obama Do More to End the Recession?
Part of the problem was that Obama wanted to accomplish some of his other objectives before the mid-term elections. He launched sorely-needed health care reform. But many people didn't agree that Obamacare, or the Affordable Care Act, was the correct way to do it. He also supported the Dodd-Frank Wall Street Reform Act. That, and new Federal Reserve regulations were designed to prevent another banking collapse. It also made banking much more conservative. As a result, many banks didn't lend as much. They were conserving capital to conform to regulations and write-down bad debt. Bank lending was needed to spur the small business growth needed to create new jobs. For more, see What Has Obama Done? and What Else Happened During the Financial Crisis in 2009?
The cause of the meltdown was deregulation of derivatives that were so complicated that even their originators didn't understand them. Find out what they are, how they work, and how they will muck up the economy for years to come.
16Other Economic Crises
The U.S. economy has suffered from many other economic crises. That gives us hope because we learned more about how the economy works and became smarter about managing it. Without that knowledge, we would be in much worse shape today.
- Is the U.S. Headed Towards the Second Great Depression?
- Why Japan Can't Get Out of Deflation
- Japan Earthquake, Tsunami and Nuclear Disaster
- Iceland Goes Bankrupt - Is the U.S. Next?
- Long Term Capital Management - 1997
- Savings and Loan Crisis - 1987
- How Did the Financial Crisis Compare to the S&L Crisis?
- Three Mile Island
- Hurricane Katrina
- BP Gulf Oil Spill Facts
- Why Was the Chernobyl Nuclear Disaster So Bad?
The Great Recession of 2008: Explanation with Dates
What Happened and When?
The first signs of the Great Recession started in 2006 when housing prices began falling. By August 2007, the Federal Reserve responded to the subprime mortgage crisis by adding $24 billion in liquidity to the banking system. By September 2008, Congress approved a $700 billion bank bailout, now known as TARP. By March 2009, Obama proposed the $787 billion economic stimulus package. Learn how economic stimulus ended a global depression. To find out the causes and earlier events, see Financial Crisis 2007 and Financial Crisis Timeline.