Question

What happened in the 2008-09 recession?

Answer 1

Greetings for the day,

Introduction:

The global economic crisis started in the United States of America mainly due to ‘sub-prime mortgages’ where the interest rate was slowing down and there was a great demand for housing loans. Later, American banks repackaged this debt to worldwide financial instruments called ‘Collateralized debt obligations’ and sold them worldwide, which resulted in unaffordable mortgage payments and many people defaulted or undertook foreclosure. Then these mortgages crisis-affected worldwide. Different views on the reasons of the crisis include sub-prime mortgage, securitization and repackaging of loans, excessive leverage, the mismatch between financial innovation and regulation, fair value accounting rules, typical characteristics of US financial system, failure of global corporate governance & complex interplay of multiple factors. Developed countries have so far been the most affected, with a decline in FDI inflows in 2008, mainly due to sluggish market prospects. Flows into developing economies continued to grow in 2008, but at a much lower rate than the year before.

First, we will understand the concept of subprime mortgages:

A subprime mortgage is one that’s normally issued to borrowers with low credit ratings. A prime conventional mortgage isn’t offered, because the lender views the borrower as having a greater-than-average risk of defaulting on the loan.

Lending institutions often charge interest on subprime mortgages at a much higher rate than on prime mortgages to compensate for carrying more risk. These are often adjustable-rate mortgages (ARMs) as well, so the interest rate can potentially increase at specified points in time.

What were the other major causes of economic crisis?

Subprime mortgages: G-20 summit (2008) viewed that the current global economic crisis has originated due to subprime mortgage in the USA in 2007. With the easy availability of credit at low-interest rates, real estate prices in the US had been rising rapidly since the late 1990s and investment in housing had assured financial return.

Securitization and repackaging of loans: The mortgage market crisis that originated in the US was a complex matter involving a whole range of instruments of the financial market that transcended the boundaries of the sub-prime mortgage

Excessive leverage: Global economic outlook (2008) reported that the final problem came from excessive leverage. Investors bought mortgage-backed securities by borrowing.

A mismatch between the financial regulation and innovation: It is not surprising that governments everywhere seek to regulate financial institutions to avoid crisis and to make sure a country’s financial system efficiently promotes economic growth and opportunity

Failure of global corporate governance: The financial system of the USA has changed dramatically since the 1930s. Many of America's big banks moved out of the "lending" business and into the "moving business".

So these were the major factors which lead to the economic crisis and as a result, it leads to the global economic downturn that devastated world financial markets as well as the banking and real estate industries. The crisis led to increases in home mortgage foreclosures worldwide and caused millions of people to lose their life savings, their jobs and their homes because many financial institutions suffer a high NPA and which create an impact on those whose savings were deposited in the banks. It’s generally considered to be the longest period of economic decline since the Great Depression of the 1930s. Although its effects were global, the Great Recession was most pronounced in the United States—where it originated as a result of the subprime mortgage crisis—and in Western Europe.

If you need any further details regarding the affected economy and sector I will provide you with the research PDF on this topic, here I am just providing you with the overview of this economic crisis.