Main Causes Of The Great Recession In USA

Housing Market Bubble

Discuss About The Main Causes Of The Great Recession In USA?

This paper will highlight the main causes of Great Depression in the USA. The crisis was caused due to several factors such as housing market bubble, credit default, stock market fluctuations, Lehman Brothers and dumping from China. This had an effect on the GDP, growth, inflation, unemployment rate and other indicators in the economy.

Recession refers to a significant decline or massive contraction in the economic activities. In such a situation, income, real GDP, a manufacturing, employment and retail sale declines drastically.  As the rate of unemployment increases, the purchasing power of the consumer’s declines and it also affects businesses. Such a situation also leads to bankruptcy. The main reason of financial crisis is that banks were able to create too much money in a very short time. This has also pushed the price of houses and thus it became easier to speculate the financial market. The financial crisis of 2007-2008 is known as global financial crisis and it was regarded as the worst financial crisis since the Great depression of 1930s. The crisis initially affected the subprime mortgage market in US and later on affected the entire banking system. This paper will highlight the main causes of great recession in the USA (Barro and Ursúa  2017).

Fig-Business Cycle

Source-Author’s Creation

The average housing prices in US has declined by 20% from 2006-2008. The easy credit and the belief of the people that the housing price will appreciate have encouraged the borrowers for adjustable mortgages.  The borrowers could not make huge payments because the interest rate was drastically falling and thus they try to refinance their mortgage.  In such a situation, refinancing also became difficult because the housing prices have been falling drastically. Thus, the borrowers in such a situation found it difficult to escape from the high amount of monthly payments which they had to pay through refinancing and thus they were in default (Dimitriou et al. 2013). The event of housing bubble will affect both the consumers and the investors in the later periods. This has also affected many developed market and thus there was fiscal detoriation in the fiscal position. The most important factor which affected housing market bubble in US was the deregulation of the market and the favourable terms of trade which affected the government and the individuals to apply for different mortages. This has affected the prime loans which were adhered to sustainable standards of lending (Kumar and Singh 2016).

Stock Market Fluctuations

The housing market has experienced steady growth rate during the period of 1995 to 1999. In case of stock market crash in 2000, there was huge shift of dollars from the stock market to the housing sector. Moreover in housing market bubble there was availability of cheap money for availing new loans in the period of economic recession. The banks and the federal reserve’s has appreciated the housing market for the creation of wealth and provision of secured assets which has helped people to borrow money and thus this has led the economy to grow further. There were also many financial innovations which was included in different types of lending processes such as zero down loans and interest only loans. The total sum of derivatives which was held by the financial institutions thus exploded and as a result it affected the cash reserves and thus it became very small (Babalos et al. 2016).

The stock market crash was a kick start to recession. Moreover, the confidence of the investors for the future can be predicted in stock market. Corporate earnings are dependent on the economy of US. A massive crash resulted in loss of confidence in the economy. The stock market crash in US led to recession. However, in certain cases, it can be said that stock market crash does not always lead the economy to recession. The financial companies knew that they will be forced to make losses and thus sustain the subprime mortgage crisis (Tan and Cheong 2016). When the values of the financial stocks fell, the companies knew that they hard time rising new capital to cover the losses and thus apply for new loans. Thus has led to decline in the stock market and thus put the bank out of businesses. Moreover, the banks do not have sufficient time to cover the downturn in the businesses. Thus, this has led to recession in the US economy. This crash destroyed the intention and interest of the investors in business investment. This has happened because the banks had used the money of the depositors to invest in Wall Street.  However, this was not the only reason of Great depression. There were many instances where people did not buy a single stock but has lost all their savings. This has led the economy in the path of financial crisis (Taylor 2014.).

The credit default rates of the consumers fell to a very low level since the beginning of economic recession. The credit default rate of the bank has increased from the previous years.  The bank card default rate also increased and this has led the economy to recession. The consumer credit default ahs dropped for the new loans while the default rate of the bank card has been increasing steeply. Since then the consumers have started to pay more attention to their debts especially in case of financial commitments such as car and home loans (Kouwenberg and Zwinkels 2014.). The bank card rate, mortgage default rate and auto loans were lower in pre-financial crisis. But in certain cases, it can be said that the bank card rate was volatile and thus it was more sensitive to consumer spending. The credit default swap included the insurance coverage and the contracts on the loans. This contract has to face several losses in case of certain securities. In such a situation, the buyers of the default credit insurance had to pay the premiums for longer period of time. Te banks and the insurance companies were regulated and thus it had led to credit market swap. This has led to swapping or trading of the contractors from different investors and thus it has also ensured the buyer to cove r the losses in case of security defaults. Moreover, in such a situation the investors flock to the swaps in the hope that such big corporations will help in flourishing the economy (Luciani 2015).

Credit Default

Another factor that caused the financial crisis in USA was the downfall of Lehman Brothers, which is considered one of the largest investment banks in the USA. The bank was involved in some of the biggest investment project of the economy. It was involved in investment business with the other firms. It did business in investment, banking, equity and trading activities.  The company was operational in these activities for the past 158 years before its downfall begun. However, 2008 saw the downfall of the Lehman Brothers due to their bankruptcy. As it was a financial firm serving globally, the downfall the firm was the main cause of the global financial crisis. The bankruptcy was due to the drop in the 500 points of Dow Jones in 2008, which was one of the biggest falls the past few years. Moreover, at that time the company has an asset of $639 billion and $619 billion. The crisis was also known as mortgage induced financial crisis due to the increasing debt of the company and the inability of the customers to repay back the loan. The beginning to the end of Lehman Brothers was the credit crisis that hit the economy in 2007 (Keyes et al. 2015). The company experienced a loss of $2.8 billion in June 2008, which worsen their situation. However, the company was able to raise an amount of $6 billion from its investors, which helped the company to reduce the negative effect of the crisis and gain some confidence of the public. The company filed a petition for their bankruptcy for the protection against such bankruptcy in future. In September 2008, Nomura Holdings Inc. acquired the company. The collapse of Lehman Brothers had a detrimental effect on the financial market of US for many weeks, as the company was huge and spread all over the economy. The bankruptcy resulted in $46 billion market value of the company to be wiped away (Subrahmanyam et al. 2014).

Dumping in other words means predatory pricing that the country charges for exporting their goods to another country. The country involved in the trade exports its goods to the other country in a comparatively low price. The process of dumping is done by the economy just to increase their share in the market. However, in such type of trading both the price and quality of the product is degraded by the source country. This had a lot of negative effect on the USA economy as the Chinese dumped their goods in the US market at a very low price. This is because China was exporting their goods the US market at a very low price. This caused the US market to import many Chinese gods into their market. Thus, it affected the domestic industry in US producing those goods as all the people stetted consuming the imported goods from china. Thus, there was shrinkage in the international trade due to the leakage of US currency from the economy. This in turn affected the financial reserve of the country causing the financial crisis of 2008 in US. US currency on the other hand became week because of this dumping, which was the biggest reflection of the shrinking economy of US and financial crisis (Albert2015).

Downfall of Lehman Brothers

The event that took place in US  economy such as dumping from china, housing market bubble, Lehman Brothers, stock market crisis and others. These factors has caused global financial crisis in US affecting the economy in various ways such as GDP, unemployment, trading partners of the company and aggregate demand. Even though the recession ended in 2009 , the effect of this crisis was for a longer period of time. The recovery was difficult ad extremely disappointing. Economic growth began to fell at the time of the recovery and the economy started taking steps to slow down the recession effect by reducing the gap between real GDP and potential GDP. On the other hand, the crisis has put a negative effect on the GDP of the US economy especially due to the shrinking credit rate during the bankruptcy of Lehman Brothers. Further, due to the dumping activity from China on the US economy has increased the demand for imported goods and reduced the aggregate demand for domestic goods(Ang and Longstaff 2013). This put a detrimental effect on the domestic industries resulting in their shrinkage. The dumping activity by China also caused an increase in unemployment rate in the economy, as most of the population that was engaged in domestic industries is no longer employed due to huge import. Unemployment rate seemed to be at 10.1 percent in the year 2009, which is just after the crisis. This showed that about 15.4 million worker got unemployed at that moment. Rising unemployment has a long-term effect on the economy as production will reduce and economy will shrink both in the domestic market and trade market. The recession also affected the inflation rate of the economy, which increased at a considerably high rate. The credit squeeze caused by the fall of the Lehman Brothers caused a price of risk, as there was a drop in the equity prices and there was an increasing volatility in the exchange rate. The effect of the financial crisis has put a threat among the economy that the emerging market will be affected badly. However, the effect was controlled by the foreign invention in the equity market, banking system and others (McInerney et al. 2013).

From the above discussion, it can be concluded that US has faced a global financial crisis in 2008 followed by a recession in the economy. The crisis was due to various reasons that affected the economy in a great way and resulted in their downfall. Some of the effects took place in the economy and others were due to the activity of the foreign market. The crisis was mainly caused due to the housing market bubble, the Lehman Brothers failure, dumping from China and others. The crisis has left a long term on the economy affecting various variables such as GDP, unemployment, export and import, national debt and others. Thus, the causes and affect of the crisis were both detrimental.

Reference List

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