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Late 2000s recession
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In 2008-2009 much of the industrialized world entered into a deep recession. The complex of vicious circles which contributed to this crisis included high oil prices, high food prices and the collapse of a substantial housing bubble centered in the United States, which sparked an interrelated and ongoing financial crisis.
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In 2008-2009 much of the industrialized world entered into a deep recession. The complex of vicious circles which contributed to this crisis included high oil prices, high food prices and the collapse of a substantial housing bubble centered in the United States, which sparked an interrelated and ongoing financial crisis. Around the world, many large and well established investment and commercial banks suffered massive losses and even faced bankruptcy. It has been argued that the huge increases in commodity and asset prices came as a consequence of an extended period of easily available credit and that the primary cause of the downturn was exceptionally financial. This crisis has led to increased unemployment, and other signs of contemporaneous economic downturns in major economies of the world.
In December 2008, the NBER declared that the United States had been in recession since December 2007, and several economists expressed their concern that there is no end in sight for the downturn and that recovery may not appear until as late as 2011. The recession is the worst since the Great Depression of the 1930s. However, so far many economists and politicians have avoided using the term depression, as it is generally recognized to refer to a downturn which lasts significantly longer and has a considerably higher unemployment rate.
Pre-recession conditions
Commodity boom
The decade of the 2000s saw a global explosion in prices, focused especially in commodities and housing, marking an end to the commodities recession of 1980-2000. In 2008, the prices of many commodities, notably oil and food, rose so high as to cause genuine economic damage, threatening stagflation and a reversal of globalization.
In January 2008, oil prices surpassed $100 a barrel for the first time, the first of many price milestones to be passed in the course of the year. In July, oil peaked at $147.30 a barrel and a gallon of gasoline was more than $4 across most of the U.S.A. These high prices caused a dramatic drop in demand and prices fell below $35 a barrel at the end of 2008.
The food and fuel crises were both discussed at the 34th G8 summit in July.
Sulfuric acid (an important chemical commodity used in processes such as steel processing, copper production and bioethanol production) increased in price 3.5-fold in less than 1 year while producers of sodium hydroxide have declared force majeur due to flooding, precipitating similarly steep price increases.
In the second half of 2008, the prices of most commodities fell dramatically on expectations of diminished demand in a world recession.
Housing bubble
By 2007, real estate bubbles existed in the recent past were still under way in many parts of the world, especially in the United States, Argentina, Britain, Netherlands, Italy, Australia, New Zealand, Ireland, Spain, France, Poland, South Africa, Israel, Greece, Bulgaria, Croatia, Canada, Norway, Singapore, South Korea , Sweden, Baltic states, India, Romania, Russia, Ukraine and China. U.S. Federal Reserve Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market)
it's hard not to see that there are a lot of local bubbles" . The Economist magazine, writing at the same time, went further, saying "the worldwide rise in house prices is the biggest bubble in history". Real estate bubbles are invariably followed by severe price decreases (also known as a house price crash) that can result in many owners holding negative equity (a mortgage debt higher than the current value of the property).
Inflation
In February 2008, Reuters reported that global inflation was at historic levels, and that domestic inflation was at 10-20 year highs for many nations. "Excess money supply around the globe, monetary easing by the Fed to tame financial crisis, growth surge supported by easy monetary policy in Asia, speculation in commodities, agricultural failure, rising cost of imports from China and rising demand of food and commodities in the fast growing emerging markets," have been named as possible reasons for the inflation.
In mid-2008, IMF data indicated that inflation was highest in the oil-exporting countries, largely due to the unsterilized growth of foreign exchange reserves, the term unsterilized referring to a lack of monetary policy operations that could offset such a foreign exchange intervention in order to maintain a country΄s monetary policy target. However, inflation was also growing in countries classified by the IMF as "non-oil-exporting LDCs" (Least Developed Countries) and "Developing Asia", on account of the rise in oil and food prices.
Inflation was also increasing in the developed countries, but remained low compared to the developing world.
Causes
Debate over origins
On October 15, 2008, Anthony Faiola, Ellen Nakashima, and Jill Drew wrote a lengthy article in The Washington Post titled, "What Went Wrong". In their investigation, the authors claim that former Federal Reserve Board Chairman Alan Greenspan, Treasury Secretary Robert Rubin, and SEC Chairman Arthur Levitt vehemently opposed any regulation of financial instruments known as derivatives. They further claim that Greenspan actively sought to undermine the office of the Commodity Futures Trading Commission, specifically under the leadership of Brooksley E. Born, when the Commission sought to initiate regulation of derivatives. Ultimately, it was the collapse of a specific kind of derivative, the mortgage-backed security, that triggered the economic crises of 2008.
While Greenspan's role as Chairman of the Federal Reserve has been widely discussed (the main point of controversy remains the lowering of Federal funds rate at only 1% for more than a year which, according to the Austrian School of economics, allowed huge amounts of "easy" credit-based money to be injected into the financial system and thus create an unsustainable economic boom), there is also the argument that Greenspan actions in the years 20022004 were actually motivated by the need to take the U.S. economy out of the early 2000s recession caused by the bursting of dot-com bubble although by doing so he did not help avert the crisis, but only postpone it.
Sub-prime lending as a cause
Based on the assumption that sub-prime lending precipitated the crisis, some have argued that the Clinton Administration may be partially to blame, while others have pointed to the passage of the Gramm-Leach-Bliley Act by the 106th Congress, and the over leveraging by banks and investors eager to achieve high returns on capital.
Some believe the roots of the crisis can be traced directly to sub-prime lending by Fannie Mae and Freddie Mac, which are government sponsored entities. The New York Times published an article that reported the Clinton Administration pushed for Sub-prime Lending: "Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people" (NYT, 30 September 1999).
In 1995, the administration also tinkered with the Carter's Community Reinvestment Act of 1977 by regulating and strengthening the anti-redlining procedures. It is felt by many that this was done to help a stagnated home ownership figure that had hovered around 65% for many years. The result was a push by the administration for greater investment, by financial institutions, into riskier loans. In a 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 it was shown that $467 billion of mortgage credit poured out of CRA-covered lenders into low and mid level income borrowers and neighborhoods. (See "The Community Reinvestment Act After Financial Modernization, April 2000).
Deregulation As A Cause
Additionally, in 1992, the Democratic Congress and Bill Clinton moved to remove oversight from Fannie Mae and Freddie Mac, so they would have more money to issue home loans. The Washington Post wrote: "Congress also wanted to free up money for Fannie Mae and Freddie Mac to buy mortgage loans and specified that the pair would be required to keep a much smaller share of their funds on hand than other financial institutions. Where banks that held $100 could spend $90 buying mortgage loans, Fannie Mae and Freddie Mac could spend $97.50 buying loans. Finally, Congress ordered that the companies be required to keep more capital as a cushion against losses if they invested in riskier securities. But the rule was never set during the Clinton administration, which came to office that winter, and was only put in place nine years later."
Other deregulation efforts have also been identified as contributing to the collapse. In 1999, the Republican Congress introduced the Gramm-Leach-Bliley Act which repealed part of the Glass-Steagall Act of 1933. The Glass-Steagall Act, introduced the separation of financial institutes in commercial and investment banks, according to their business, in order to prevent conflicts of interest and frauds. The Act was born as a consequence of the Wall Street Crash which had uncovered many unlawful activities on the part of financial firms. The repeal of that Act in 1999 effectively gave a free reign to banks, reintroducing them once again into the security business and eliminating the difference between categories. The result of this operation is described by the Washington Post: "Fanny and Freddie Mac enjoyed the nearest thing to a license to print money. The companies borrowed money at below-market interest rates based on the perception that the government guaranteed repayment, and then they used the money to buy mortgages that paid market interest rates." (WP, 14 September 2008).
Arguably, the lending deregulation during the Clinton years, and the repeal of the Glass-Steagall Act, may have had a significant impact on the exponential growth of sub-prime lending and the ensuing financial crisis.
Over-Leveraging, Credit Default Swaps and Collateralized Debt Obligations As A Cause
A likely additional the cause of the crisis -- and a factor that unquestionably amplified its magnitude -- is that banks and investors simply miscalculated the level of risk inherent in the unregulated Collateralized debt obligation and Credit Default Swap markets and over-leveraged their balance sheets. Under this theory, banks and investors systematized the risk by borrowing tremendous sums of money that they could only pay back if the housing market continued to increase in value.
The risk was further systematized by the use of David X. Li's Gaussian copula model function to rapidly price Collateralized debt obligations based on the price of related Credit Default Swaps. This formula assumed that the price of Credit Default Swaps was correlated with and could predict the correct price of mortgage backed securities. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies. According to one wired.com article: "Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected. The cracks became full-fledged canyons in 2008when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril...Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees."
The pricing model for CDOs clearly did not reflect the level of risk they introduced into the system. It has been estimated that the "from late 2005 to the middle of 2007, around $450bn of CDO of ABS were issued, of which about one third were created from risky mortgage-backed bonds...[o]ut of that pile, around $305bn of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi."
The average recovery rate for high quality CDOs has been approximately 32 cents on the dollar, while the recovery rate for mezzanine CDO's has been approximately five cents for every dollar. These massive, practically unthinkable, losses have dramatically impacted the balance sheets of banks across the globe, leaving them with very little capital to continue operations.
Other Causes
Many libertarians, including Congressman and former 2008 Presidential candidate Ron Paul and Peter Schiff in his book Crash Proof, predicted the crisis prior to its occurrence. They are critical of theories that the free market caused the crisis and instead argue that expansionary monetary policy and the Community Reinvestment Act are the primary causes of the crisis. However Alan Greenspan himself has conceded he was partially wrong to oppose regulation of the markets, and expressed "shocked disbelief" at the failure of the self interest of the markets.
It has also been debated that the root cause of the crisis is overproduction of goods caused by globalization (and especially vast investments in countries such as China and India by western multinational companies over the past 1520 years, which greatly increased global industrial output at a reduced cost). Overproduction tends to cause deflation and signs of deflation were evident in October and November 2008, as commodity prices tumbled and the Federal Reserve was lowering its target rate to an all-time-low 0.25%. On the other hand, Professor Herman Daly suggests that it is not actually an economic crisis, but rather a crisis of overgrowth beyond sustainable ecological limits. This reflects a claim made in the 1972 book Limits to Growth, which stated that without major deviation from the policies followed in the 20th century, a permanent end of economic growth could be reached sometime in the first two decades of the 21st century, due to gradual depletion of natural resources.
Effects
Trade and industrial production
In middle-October 2008, the Baltic Dry Index, a measure of shipping volume, fell by 50% in one week, as the credit crunch made it difficult for exporters to obtain letters of credit.
In February 2009, The Economist claimed that the financial crisis had produced a "manufacturing crisis", with the strongest declines in industrial production occurring in export-based economies.
In March 2009, Britain's Daily Telegraph reported the following declines in industrial output, from January 2008 to January 2009: Japan -31%, Korea -26%, Russia -16%, Brazil -15%, Italy -14%, Germany -12%.
Unemployment
The International Labour Organization (ILO) predicted that at least 20 million jobs will have been lost by the end of 2009 due to the crisis mostly in "construction, real estate, financial services, and the auto sector" bringing world unemployment above 200 million for the first time. The number of unemployed people worldwide could increase by more than 50 million in 2009 as the global recession intensifies, the ILO has forecast.
The rise of advanced economies in Brazil, India, and China increased the total global labor pool dramatically. Recent improvements in communication and education in these countries has allowed workers in these countries to compete more closely with workers in traditionally strong economies, such as the United States. This huge surge in labor supply has provided downward pressure on wages and contributed to unemployment.
Return of volatility
For a time, major economies of the 21st century were believed to have begun a period of decreased volatility, which was sometimes dubbed The Great Moderation, because many economic variables appeared to have achieved relative stability. The return of commodity, stock market, and currency value volatility are regarded as indications that the concepts behind the Great Moderation were guided by false beliefs.
Financial markets
January 2008 was an especially volatile month in world stock markets, with a surge in implied volatility measurements of the US-based S&P 500 index, and a sharp decrease in non-U.S. stock market prices on Monday, January 21, 2008 (continuing to a lesser extent in some markets on January 22). Some headline writers and a general news columnist called January 21 "Black Monday" and referred to a "global shares crash," though the effects were quite different in different markets.
The effects of these events were also felt on the Shanghai Composite Index in China which lost 5.14 percent, most of this on financial stocks such as Ping An Insurance and China Life which lost 10 and 8.76 percent respectively. Investors worried about the effect of a recession in the US economy would have on the Chinese economy. Citigroup estimates due to the number of exports from China to America a one percent drop in US economic growth would lead to a 1.3 percent drop in China's growth rate.
There were several large Monday declines in stock markets world wide during 2008, including one in January, one in August, one in September, and another in early October. As of October 2008, stocks in North America, Europe, and the Asia-Pacific region had all fallen by about 30% since the beginning of the year. The Dow Jones Industrial Average had fallen about 37% since January 2008.
The simultaneous multiple crises affecting the US financial system in mid-September 2008 caused large falls in markets both in the US and elsewhere. Numerous indicators of risk and of investor fear (the TED spread, Treasury yields, the dollar value of gold) set records.
Russian markets, already falling due to declining oil prices and political tensions with the West, fell over 10% in one day, leading to a suspension of trading, while other emerging markets also exhibited losses.
On September 18, UK regulators announced a temporary ban on short-selling of financial stocks. On September 19 the United States' SEC followed by placing a temporary ban of short-selling stocks of 799 specific financial institutions. In addition, the SEC made it easier for institutions to buy back shares of their institutions. The action is based on the view that short selling in a crisis market undermines confidence in financial institutions and erodes their stability.
On September 22, the Australian Securities Exchange (ASX) delayed opening by an hour after a decision was made by the Australian Securities and Investments Commission (ASIC) to ban all short selling on the ASX. This was revised slightly a few days later.
As is often the case in times of financial turmoil and loss of confidence, investors turned to assets which they perceived as tangible or sustainable. The price of gold rose by 30% from middle of 2007 to end of 2008. A further shift in investors preference towards assets like precious metals or land
is discussed in the media.
Insurance
A February 2009 research on the main British insurers showed that most of them do not consider officially to rise the insurance premiums for the year 2009, in spite of the 20% raise predictions made by The Telegraph or The Daily Mirror. However, it is expected that the capital liquidity will become an issue and determine increases, having their capital tied up in investments yielding smaller dividends, corroborated with the £644 million underwriting losses suffered in 2007.
Political instability related to the economic crisis
In January of 2009 the government leaders of Iceland were forced to call elections two years early after the people of due to the government's handling of the economy. against President Sarkozy's economic policies. Prompted by the financial crisis in Latvia, the opposition and trade unions there organized a rally against the cabinet of premier Ivars Godmanis. The rally gathered some 10-20 thousand people. In the evening the rally turned into a Riot. The crowd moved to the building of the parliament and attempted to force their way into it, but were repelled by the state's police. In late February many Greeks took part in a massive because of the economic situation and they shut down schools, airports, and many other services in Greece. Police and protesters where people protesting the economic conditions were shot by rubber bullets. In addition to , Asian countries have also seen various degrees of protest. Communists and others to protest the Russian government's economic plans. as demands from the west for exports have been dramatically reduced and unemployment has increased.
Beginning February 26, 2009 an Economic Intelligence Briefing was added to the daily intelligence briefings prepared for the President of the United States. This addition reflects the assessment of United States intelligence agencies that the global financial crisis presents a serious threat to international stability.
Policy responses
The financial phase of the crisis led to emergency interventions in many national financial systems. As the crisis developed into genuine recession in many major economies, economic stimulus meant to revive economic growth became the most common policy tool.
Economic stimulus plans were announced or under discussion in China, the United States, and the European Union. Bailouts of failing or threatened businesses were carried out or discussed in the USA, the EU, and India.
In the final quarter of 2008, the financial crisis saw the G-20 group of major economies assume a new significance as a focus of economic and financial crisis management.
Countries in economic recession
Many countries experienced recession in 2008. The countries currently in a technical recession are Estonia, Latvia, Ireland, New Zealand, Japan, Hong Kong, Singapore, Italy, Russia and Germany.
Denmark went into recession in the first quarter of 2008, but came out again in the second quarter. Iceland fell into an economic depression in 2008 following the collapse of its banking system.
The following countries went into recession in the second quarter of 2008: Estonia, Latvia, Ireland and New Zealand.
The following countries/territories went into recession in the third quarter of 2008: Japan, Sweden, Hong Kong, Singapore, Italy , Turkey and Germany. As a whole the fifteen nations in the European Union that use the euro went into recession in the third quarter. In addition, the European Union, the G7, and the OECD all experienced negative growth in the third quarter .
The following countries went into technical recession in the fourth quarter of 2008: United States, Spain and Britain.
Of the seven largest economies in the world by GDP, only China, France, Canada and Australia avoided a recession in 2008. France experienced a 0.3% contraction in Q2 and 0.1% growth in Q3 of 2008. In the year to the third quarter of 2008 China grew by 9%. This is interesting as China has until recently considered 8% GDP growth to be required simply to create enough jobs for rural people moving to urban centres. This figure may more accurately be considered to be 5-7% now that the main growth in working population is receding. Growth of between 5%-8% could well have the type of effect in China that a recession has elsewhere.
The following country went into technical depression in the fourth quarter of 2008: Japan, with a nominal annualized GDP growth of -12.7% ., and Taiwan.
Official forecasts in parts of the world
On November 3, 2008, according to all newspapers, the European Commission in Brussels predicted for 2009 only an extremely low increase by 0.1% of the GDP, for the countries of the Euro zone (France, Germany, Italy, etc.). They also predicted negative numbers for the UK (-1.0%), Ireland, Spain, and other countries of the EU. Three days later, the IMF at Washington, D.C., predicted for 2009 a worldwide decrease, -0.3%, of the same number, on average over the developed economies (-0.7% for the US, and -0.8% for Germany).
Economically, the car industry is especially concerned; as a consequence, several countries have already launched immediate help-packages, each involving several billions of dollars, euros or pounds.
According to new forecasts of the Deutsche Bank (end of November 2008), the economy of Germany will contract by more than 4% in 2009.
On January 19, 2009, the EU commission in Brussels updated their earlier predictions: the numbers are now -2.25 % for Germany and -1.8 % on average for the 27 EU countries.
On February 18, 2009, the US Federal Reserve cut their economic forecast of 2009, expecting the US output to shrink between 0.5% and 1.5%, down from its forecast in October 2008 of output between +1.1% (growth) and -0.2% (contraction).
Comparisons to the Great Depression
Although some casual comparisons between the late 2000s recession and the Great Depression have been made, there remain large differences between the two events. For example, over the 79 years between 1929 and 2008, great changes occurred in economic philosophy and policy, the recession of the early 30s lasted over three and a half years, and during the 1930s the supply of money (currency plus demand deposits) fell by 25% (where as in 2008 and 2009 the Fed "has taken an ultraloose credit stance"). Furthermore, the unemployment rate in 2008 and early 2009 and the rate at which it rose was comparable most of the recessions occurring after World War II, and was dwarfed by the 25% unemployment rate peak of the
Great Depression.
On January 4, 2009, Nobel prize winning economist Paul Krugman wrote that "This looks an awful lot like the beginning of a second Great Depression." On February 20, 2009, Paul Volcker, an economic adviser to US President Barack Obama, said "I don't remember any time, maybe even in the Great Depression, when things went down [happened] quite so fast, quite so uniformly around the world." On the same day, investor George Soros said that the turbulence during the current crisis may is worse than the Great Depression and compared it to the collapse of the Soviet Union. On February 22, NYU economics professor Nouriel Roubini said that the crisis was the worst since the Great Depression, and that without cooperation between political parties and foreign countries, and if poor fiscal policy decisions (such as support of zombie banks) are pursued, the situation "could become as bad as the Great Depression." Martin Jacques, former editor of Marxism Today, wrote about "[t]he financial meltdown now rapidly plunging the western world into what increasingly looks like a depression" and labels the current crisis "the New Depression." South Africa's Finance Minister Trevor Manuel said that "what started as a financial crisis might well become a second Great Depression."
In the late 1970s, Ravi Batra wrote the book The Downfall of Capitalism and Communism. In 1990, he was proven correct about the collapse of Soviet Communism. His consistently held prediction for a major financial crisis to engulf the capitalist system seems to be unfolding since 2007. If so, economic and social upheaval may follow that is comparable in magnitude of the Great Depression of the 1930s. On November 15, 2008, Batra said he is "afraid the global financial debacle will turn into a steep recession and be the worst since the Great Depression, even worse than the painful slump of 1980-1982 that afflicted the whole world".
Market strategist Phil Dow has noted that the fall in the Dow Jones Industrial Index is a "mirror image" of its fall at the beginning of the Great Depression.
Nicholas von Hoffman of The Nation wrote that the current crisis may be called "the Second Great Depression (SGD) or Great Depression II (GDII)."
See also
Further reading
- Brau, Eduard and McDonald, Ian (editors). Successes of the International Monetary Fund : untold stories of cooperation at work. New York : Palgrave Macmillan, 2009. ISBN 9780230203136 ISBN 0230203132
- Carney, Richard (editor). Lessons from the Asian financial crisis. New York, NY : Routledge, 2009. ISBN 9780415481908 (hardback) ISBN 0415481902 (hardback) ISBN 9780203884775 (ebook) ISBN 0203884779 (ebook)
- Funnell, Warwick N. In government we trust : market failure and the delusions of privatisation / Warwick Funnell, Robert Jupe and Jane Andrew. Sydney : University of New South Wales Press, 2009. ISBN 9780868409665 (pbk.)
- Hunnicutt, Susan, book editor. The American housing crisis. Farmington Hills, MI : Greenhaven Press, c2009. ISBN 9780737743104 (hbk.) ISBN 9780737743098 (pbk.)
- Lowenstein, Roger. While America aged : how pension debts ruined General Motors, stopped the NYC subways, bankrupted San Diego, and loom as the next financial crisis / Roger Lowenstein. New York : Penguin Press, 2008. 274 p. ; ISBN 9781594201677 ISBN 1594201676
- Read, Colin. Global financial meltdown : how we can avoid the next economic crisis / Colin Read. New York : Palgrave Macmillan, c2009. ISBN 9780230222182
- Robertson, Justin. US-Asia economic relations : a political economy of crisis and the rise of new business actors. Abingdon, Oxon ; New York, NY : Routledge, 2008. ISBN 9780415469517 (hbk.) ISBN 9780203890523 (ebook)
- United States. Congress. House. Committee on the Judiciary. Subcommittee on Commercial and Administrative Law. Working families in financial crisis : medical debt and bankruptcy : hearing before the Subcommittee on Commercial and Administrative Law of the Committee on the Judiciary, House of Representatives, One Hundred Tenth Congress, first session, July 17, 2007. Washington : U.S. G.P.O. : For sale by the Supt. of Docs., U.S. G.P.O., 2008. 277 p. : ISBN 9780160813764 ISBN 016081376X http://purl.access.gpo.gov/GPO/LPS99198
- Woods, Thomas E. Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse / Washington DC: Regnery Publishing 2009. ISBN 1596985879
- Zandi, Mark M. Financial shock : a 360° look at the subprime mortgage implosion, and how to avoid the next financial crisis / Mark Zandi. Upper Saddle River, N.J. : FT Press, c2009. Description: 270 p. : ISBN 0137142900 (hardback : alk. paper) ISBN 9780137142903 (hardback : alk. paper) 2830026
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