12.3 Great Recession and Economic Challenges

The Great Recession of 2008 rocked the U.S. economy, triggering a global financial crisis. Risky lending practices and a housing bubble burst led to the collapse of major financial institutions, causing widespread economic turmoil and job losses.

The government responded with bailouts, stimulus packages, and regulatory reforms. These measures aimed to stabilize the economy and prevent future crises. However, the recession's long-term effects included increased income inequality, a widening wealth gap, and reduced social mobility.

Causes and consequences of the 2008 crisis

Subprime mortgage crisis and housing bubble burst

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• Risky lending practices fueled the subprime mortgage crisis
• Lenders offered mortgages to borrowers with poor credit histories or limited income
• Adjustable-rate mortgages (ARMs) had low initial rates that later increased, making payments unaffordable
• Housing bubble burst as home prices declined and borrowers defaulted on their mortgages

Collapse of major financial institutions

• Lehman Brothers collapsed in September 2008, the largest bankruptcy in U.S. history
• American International Group (AIG) nearly collapsed and required a government bailout of $85 billion
• Credit crunch ensued as banks became reluctant to lend to each other and to businesses and consumers
• Loss of confidence in the financial system led to a severe downturn in the stock market

Economic consequences of the financial crisis

• Global stock markets experienced sharp declines, erasing trillions of dollars in wealth
• Dow Jones Industrial Average fell by more than 50% from its peak in October 2007 to its low in March 2009
• International trade decreased as demand for goods and services fell worldwide
• U.S. GDP contracted by 4.3% in the fourth quarter of 2008, the largest decline since the 1950s

Characteristics of the Great Recession

• High unemployment rates, peaking at 10% in October 2009
• Declining real estate values, with home prices falling by more than 30% in some areas
• Slowdown in economic growth, with the U.S. economy contracting for four consecutive quarters
• Long-term unemployment became a significant issue, with many workers struggling to find jobs for months or years

Challenges in the automotive industry

• General Motors and Chrysler filed for bankruptcy in 2009
• U.S. government provided bailouts to GM and Chrysler, totaling more than $80 billion
• Restructuring of the automotive industry led to plant closures, job losses, and renegotiated labor contracts
• Ford Motor Company did not require a bailout but still faced significant financial challenges during the recession

Government response to the economic crisis

Monetary policy measures by the Federal Reserve

• Federal Reserve reduced interest rates to near-zero levels to stimulate borrowing and economic growth
• Quantitative easing involved the Fed purchasing Treasury securities and mortgage-backed securities to lower long-term interest rates
• Expanded lending facilities provided liquidity to financial markets and institutions
• Forward guidance communicated the Fed's intention to keep interest rates low for an extended period

Troubled Asset Relief Program (TARP)

• TARP authorized the U.S. Treasury to purchase up to $700 billion in troubled assets from financial institutions
• Capital injections provided to banks in exchange for preferred stock and warrants
• Aimed to stabilize the banking system and restore confidence in financial markets
• Controversial program due to the perception of bailing out Wall Street at taxpayers' expense

Fiscal policy measures and economic stimulus

• Economic Stimulus Act of 2008 provided tax rebates to individuals and incentives for business investment
• American Recovery and Reinvestment Act of 2009 included $787 billion in spending and tax cuts
• Infrastructure spending on projects like roads, bridges, and renewable energy
• Aid to state and local governments to prevent layoffs of public sector workers
• Expansion of unemployment benefits and food assistance programs

Financial regulatory reform

• Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in 2010
• Created the Consumer Financial Protection Bureau (CFPB) to protect consumers from abusive financial practices
• Volcker Rule prohibited banks from engaging in proprietary trading and limited their investments in hedge funds and private equity funds
• Increased capital and liquidity requirements for banks to enhance their resilience to financial shocks
• Established the Financial Stability Oversight Council (FSOC) to identify and address systemic risks to the financial system

Assistance to homeowners

• Home Affordable Modification Program (HAMP) provided incentives for lenders to modify mortgages for struggling homeowners
• Home Affordable Refinance Program (HARP) allowed homeowners with little or no equity to refinance their mortgages at lower interest rates
• Neighborhood Stabilization Program provided grants to states and local governments to purchase and redevelop foreclosed and abandoned properties
• Hardest Hit Fund targeted assistance to states with the highest unemployment rates and steepest declines in home prices

Impact of the Great Recession on society

Disproportionate impact on low-income and minority households

• Higher rates of unemployment among low-income and minority workers
• Subprime mortgages were more prevalent in minority communities, leading to higher foreclosure rates
• Wealth loss due to declining home values and retirement account balances
• Increased food insecurity and reliance on public assistance programs

Challenges faced by young adults

• Difficulty finding employment, particularly in fields related to their education
• Student loan debt burden exacerbated by limited job opportunities and stagnant wages
• Delayed milestones such as homeownership, marriage, and starting families
• Increased number of young adults living with their parents

Impact on older workers

• Job losses leading to early retirement or difficulty finding new employment
• Reduced retirement savings due to stock market declines and low interest rates
• Increased claims for Social Security benefits and disability insurance
• Strained personal finances and increased reliance on family members for support

Global economic impact

• Worldwide economic slowdown, with many countries experiencing reduced GDP growth and increased unemployment
• European Union (EU) entered a recession in 2009, with some member states (Greece, Spain, Portugal) facing severe debt crises
• Emerging economies (China, India, Brazil) experienced slower growth rates but fared better than advanced economies
• Increased volatility in global financial markets and currency fluctuations

Eurozone debt crisis

• High levels of public debt in countries like Greece, Ireland, and Portugal
• Investor concerns about the sustainability of debt levels led to higher borrowing costs
• EU and International Monetary Fund (IMF) provided bailout packages to debt-ridden countries in exchange for austerity measures
• Austerity measures, including spending cuts and tax increases, contributed to social unrest and political instability

Long-term effects of the economic crisis

Exacerbation of income inequality

• Top 1% of earners captured a disproportionate share of income gains during the recovery
• Middle- and lower-income households experienced stagnant wage growth
• CEO-to-worker pay ratio increased, with CEO compensation growing much faster than average worker pay
• Decline of labor unions and erosion of collective bargaining power

Widening wealth gap

• Affluent households benefited from rising stock prices and recovering real estate values
• Lower-income households struggled to rebuild wealth due to limited assets and slower wage growth
• Racial wealth gap widened, with African American and Latino households experiencing greater losses and slower recovery
• Concentration of wealth among the top 0.1% of households

Reduced social mobility

• Increased income inequality and wealth concentration limit opportunities for upward mobility
• Challenges in accessing quality education, stable employment, and affordable housing
• Intergenerational mobility declined, with children from low-income families facing greater barriers to moving up the economic ladder
• Persistence of poverty and limited access to social networks and resources

Political polarization and social unrest

• Occupy Wall Street movement protested income inequality and the influence of money in politics
• Tea Party movement advocated for limited government and lower taxes
• Increased partisan divide on issues related to economic policy, taxation, and the role of government
• Rise of populist movements and anti-establishment sentiment in the U.S. and Europe

Impact of COVID-19 pandemic

• Low-income and minority communities disproportionately affected by job losses and health disparities
• Exacerbation of existing inequalities in access to healthcare, education, and digital infrastructure
• Increased reliance on gig economy and precarious employment arrangements
• Potential long-term effects on small businesses, commercial real estate, and consumer behavior