As the world has changed in the last few months with the breakout of COVID-19 few terms like recession & depression are bouncing back into our ears. On 28th March 2020, IMF chief Kristalina Georgieva said- “We have entered recession” owing to the successive lockdowns in different countries leading to a sharp decline in demand and supply of goods, companies are forced to cut down their expenses in form of job layoffs. It’s Just a decade since we heard about Recession but do we really remember how at all it occurred.
As briefly mentioned in the stock market overview (read here) here we will discuss the great recession of 2007.
The Great Recession (2007-09)
Triggered in the U.S. by the financial crisis of 2007–08 and quickly spread to other countries also. Commencing in late 2007 and lasting till mid-2009, it had been the longest and deepest economic decline in many countries, since the Great Depression (1929 –1939).
A severe contraction of liquidity in global financial markets began in 2007 due to the booming U.S. housing bubble. From 2001 successive reduction within the prime rates (the rate of interest charged by the banks from their “prime,” or low-risk, clientele) had enabled banks to issue mortgage loans to many of their customers due to lower interest rates, who normally wouldn’t have qualified for them, and subsequent purchases greatly increased new housing demand, driving land market even higher.
When interest rates began increasing again in 2005, demand for housing reduced causing a steep decline in the housing sector. Partly owing to high-interest rates, most borrowers who held adjustable-rate mortgages (ARMs), couldn’t afford their loan repayments. Nor could they save themselves by borrowing against the increased value of their estate or by selling it at a profit. (Indeed, many borrowers, found themselves in a soup, i.e they owed more on their mortgage loans than their actual property worth).Since, the number of foreclosures increased, banks stopped lending to such customers, which further led to reduced demand and costs.
What led to interbank credit freeze?
As the subprime mortgage market collapsed, many banks found themselves in distress. A good portion of their assets comprised of subprime loans or bonds created out of them alongside less-risky sorts of consumer debt (mortgage-backed security aka MBS i.e bundle of home loans bought from banks that issued them). Since, subprime loans in any given MBS were difficult to trace, even for the institution that owned them, banks began to doubt each other’s creditworthiness, resulting in an interbank credit freeze. This impaired the power of banks to increase credit even to financially healthy consumers, including businesses. Consequently, businesses were trying to scale back their expenses and investments, resulting in widespread job losses. This was further reducing their product demand, as most of the consumers were now unemployed or had reduced purchasing power.
The portfolios of even prestigious banks and investment firms were discovered to be fictional. They supported nearly worthless assets, most of those institutions applied for the govt. bailouts soughing mergers with healthier firms or declared themselves bankrupt (including Lehman Brothers, a 4th largest investment bank in the U.S. on Sep.15, 2008).
How it affected other businesses?
Other major businesses whose products are generally bundled with consumer loans were also suffering substantial losses. The car companies General Motors and Chrysler, for instance, filed for bankruptcy in 2009. They were obliged to accept partial government ownership through bailout programs. The buyer confidence within the economy was reasonably reduced. This led most Americans to curtail their expenses in anticipation of tough times ahead. The trend that further affected business sentiments. of these factors together extended a deep recession within the U.S. From the recession starting in December 2007 to its end in June 2009, the Country’s GDP declined by 4.3 percent. Unemployment increased from 5 percent to 9.5 percent, peaking to 10 percent by October 2009.
Job losses resulted in increased Poverty
Lakhs of individuals lost their homes, jobs, and savings. The poverty within the U.S. increased, from 12.5 percent in 2007 to quite 15 percent in 2010. However, a greater increase in poverty was deterred by federal legislation, the 2009 American Recovery and Reinvestment Act (ARRA).
They infused funds to make and preserve jobs and other safety programs. Enormous capital was lost as U.S. stock prices—represented by the S&P 500 which fell nearly to 43 percent of its value between 2007 and 2009 (by 2013 the S&P recovered this loss, and soon exceeded the 2007 peak). Altogether, between late 2007 and early 2009, Americans lost an estimated $16 trillion in net worth.
Households headed by younger adults, particularly by individuals born within the 1980s, lost the major chunk of the wealth compared to what had been accumulated by earlier generations of similar age groups & took the longest time to recover. A number of them still hadn’t recovered even a decade after the recession peak. In 2010 wealth of a median household headed by an individual born within the 1980s was nearly 25 percent below what earlier generations of an equivalent age bracket had accumulated. The shortfall increased to 41 percent in 2013 and remained above 34 percent as late as 2016. Those sets of young adults were termed as “lost generation”. Due to the good Recession, this set was poorer than earlier generations for the remaining life.
And then it spread to other parts of the world
The financial crisis gradually spread from the U.S. to other countries. Even in western Europe, where several major banks had invested profoundly in the American MBS recession was imminent. Most industrialized nations experienced economic slowdowns of varying severity and lots of responded with stimulus packages like ARRA. Some countries were suffering from serious political aftermaths due to recession. Iceland was one of them, where the govt collapsed, and later the country’s three largest banks were nationalized. Altogether the countries suffering from the Great Recession, recovery was slow and uneven. The broader social consequences of the downturn like lower fertility rates, historically high levels of student debt, and diminished job prospects among young adults remained for several years.
It took almost 2 years for countries to recover from the last recession. This time the magnitude of the recession seems worse. Let’s hope economies recover better compared to the last one before we fall into the trap of the Great Depression.
Check out our outlook on Indian stock market crash in 2020 in the video (in Hindi) below
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