Free Essay: The Great Depression and Financial Crisis of 2008

It was during the 21st century that the economy contracted to the worst level. This global economic turnaround is what is termed as the Long Recession, Lesser Depression, or the global recession of 2009, but most commonly called The Great Depression and Financial Crisis (Breuss 331). The economy started to decline in the mid-year 2007, and by the end of the year, the situation had mutated into a full-blown recession. This blow, however, lasted until June 2009 (Breuss 331). This calamity lasted longer for it came as a surprise to many policymakers, multilateral agencies, academics, and investors. As the old proverbial saying which states that the rest of the world sneezes when the US catches cold was justified as essential economies in the European Union and Japan went into systemic depression by mid-2008 (Breuss 331). Ultimately, the entire world economy was affected by this depression, which happens to be the first since World War II, with some countries being affected more than others.

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The Great Depression and financial crisis of 2008 is symbolized by quite a number of economic imbalances within the system having been sparked by the Financial Crisis of 2007-2008. The Great Recession resulted in a considerable contraction of the GDP, with the capital investment dropping by 23.2%, companies lost up to $14.5 trillion globally (Breuss 331). The Great Depression and Financial Crisis of 2008 resulted from a number of causes, and brought along adverse effects. Therefore the government had to intervene and so came up with a number of policies to reinstate United States' economy. This essay covers all aspects of the calamity.

Financial Crisis

The Financial crisis of 2007-2008 was the worst financial crisis since the Great Depression that occurred during the 1930s. The financial crisis played a key role in the failure of the global recession, decline in consumer wealth, and the failure of businesses. The cause of this crisis was a threat of collapse of all large institutions, bailout of banks by government, and the fall of the stock market, and also the housing market. The main trigger of this crisis was the bursting of the United States housing bubble. Subprime and adjustable rate mortgages began to increase. As banks began to distribute loans to possible homeowners, the price of houses began to rise. Easy availability of credit encouraged people to obtain various types of loans, ultimately assuming an unprecedented debt load.

Causes of the Great Depression and Financial Crisis of 2008

Different sources have postulated different causes of the Great Depression and Financial crisis of 2008. However, the debate regarding the role of public monetary policy as well as private financial institutions practices remains to be same. Among the causes which pose some significant similarity in the various sources are global imbalances, interest rates, the perception of risks, and the regulation of the financial systems (excessive debt level). The government had initiated a policy to counter the Stock Market Crash of 2000 as well as the economic slowdown experienced during that period. In an attempt to achieve this, the Federal Reserve took it upon them to ease credit availability, not knowing it would spark the great economic recession. This strategy also brought about a decrease in the interest rates, lower than before. Due to lower interest rates, the resultant impact was the intensification of debt levels in the economy. Despite that issue, there was also a noticeable increase in the tax rates for the poor compared to the rich. One of the rich folks, Warren Buffet also commented about the taxes, saying that it was so unfortunate that he paid lower taxes than the people working for him. With such imbalances, it meant that the wealthy owners of stock benefited continuously whereas the middle class was left to bail out the large corporations owned by the rich folks.

Another factor that contributed to the Great Depression and Financial crisis is the creation of credit policies by the central government. Such a creation led to an artificial boom, and as it is known, for every boom there comes a bust. The monetary policy of the central bank provided cheap, easy credit by imposing lower interest rates than those expected for a free market. Majority of people planning to indulge in long-term projects such as housing and capital assets jumped to the opportunity of easy availability of credit. Because of such a policy, the initiative among people to save was neglected; bringing about an uncontrollable boom, attributed by poor investments and overconsumption.

The sudden decrease in housing prices destroyed the assets of the shadow banking system and therefore created conditions in which a run on the shadow banking system could occur. The run occurred in the summer of 2007, compelling the shadow banking system to trade its assets at reasonably low prices. The fall in assets broke the whole banking system and impeded its ability to intermediate not only house purchases but also investment more generally. The outcome became reduced credit, and so purchases of houses dropped, and consequently, the decrease in house prices were reinforced. With such declining sales, companies withdrew from the investment and hiring programs. All these factors backed each other, which in turn resulted in the tailspin of the economy (Verick and Iyanatul 2).

Effects of the Great Depression and Financial Crisis of 2008

Mortgage Crisis

Majority of the defaults of home mortgage loans caused a problem during the Great Depression and Financial Crisis of 2008. This threatened the well-being of the original mortgage lenders and any financial institutions that had acquired such loans and investments. A good number of the mortgage defaults were subprime mortgage loans (high interest-rate loans given to home buyers with higher than average credit risk). This call was made by the government in an attempt to offer more Americans homeownership.

During this mortgage crisis, banks lent money to investment companies who purchased mortgages from mortgage lenders. The mortgages initiative started being unstable and consequently led to investment funds blowing up. This caused them to be unable to repay loans borrowed from banks. Banks were unable to recover from the loans they had given out, and so they opted to limit the issuance of new loans. This did not turn out that well for the economy because consumers and businesses rely heavily on loans.

Securitization

Securitization refers to the process of slicing up and bundling groups of loans, corporate bonds, mortgages, and financial debts into new securities and is carried out by government regulators. Another name for these is "loan-backed securities." This decision allowed the banking system to shed risk thus making them safer. The securities attracted many private investors and other financial institutions because the loan backed securities rewarded higher interest returns compared to those backed by less risky mortgages.

Failure of Firms

During the Great Depression and Financial Crisis period, financial firms failed due to the collapse of securitization. In the beginning, big mortgage lenders underwent scrutiny since they had enormous debt. Nearly all major mortgage lenders fell, and Countrywide, Washington Mutual as well as Wachovia were amongst the lenders who experienced a downfall. Countrywide was the second largest mortgage lender and was saved by the Bank of America. Washington Mutual, the largest mortgage lender, was absorbed by JPMorgan Chase whereas Wachovia was almost gone bankrupt until Wells Fargo rescued them (Verick and Iyanatul 2).

Firms and investment banks that held loan-backed securities began to suffer huge losses also. Merrill Lynch is one, lost more in two years than they made in a decade, and was bought by Bank of America. Lehman Brothers did not have the privilege of being picked up was forced into bankruptcy. Other firms such as Goldman Sachs and Morgan Stanley rushed to become bank holding companies in order to get the emergency loans of the Federal Reserve. This tough time during the Great Recession forced the nightmare of a collapse of the U.S. financial system to become a possible reality.

Policy Responses

"As the global financial crisis unraveled, governments across the world realized the seriousness of turnaround and the need to do something about it to avoid the downfall of the real economy. The response consisted of three primary interventions; bailouts and injection of money into financial systems to keep credit flowing; cutting interest rates to stimulate borrowing and investment; extra fiscal spending to shore up aggregate demand" (Verick and Iyanatul 35). These methods were required to put an end to further deterioration and in the end, keep workers in jobs where possible or assist in creating new employment opportunities for the jobless.

Macroeconomic policies

Under this were the monetary policy and the fiscal policy. The monetary policy involved changes in the interest rates as well as other tools which were under the responsibility of the central bank of all countries across the globe. On the other hand, the fiscal policy aimed at bringing changes in taxation as well as the level of government purchases. This policy is manned by the law-makers of any given country. Occasionally, the term "stabilization policy" is used to generalize both the fiscal and monetary policies employed during the Great Depression and Financial recession of 2008 as it aims to prevent significant fluctuations in the real gross domestic product (real GDP) (Verick and Iyanatul 35).

Labor market and social policies

Other than macroeconomic policies, labor market and social policies played a role in reducing the impact of the crisis on workers, helping curb the gap between economic expansion and job availability, as well as inhibiting the consequence of unemployment continuity, and human capital deterioration. These policies assisted in educating the people on how the labor market adjusts as a result of the credit squeeze and collapse in aggregate demand. Institutional arrangements such as wage-setting institutions, unionization, and employment protection legislation are among the measures that chipped in under the labor and social policies, which had a significant positive result in the long-run (Verick and Iyanatul 35).

In conclusion, the Great Depression and Financial Recession of 2008 severely affected the United States involvement in their economy. This mishap destroyed the confidence of not only the American people but also their leaders. The future of their economy was unclear, and shaky strategies were implemented in an attempt to gain recovery into the economy before things got out of hand.

Works Cited

Breuss, Fritz. "THE CRISIS IN RETROSPECT: Causes, effects and policy responses." Routledge handbook of the economics of European integration, 2015, pp. 331. Retrieved from https://books.google.co.ke/books?hl=en&lr=&id=hgWpCgAAQBAJ&oi=fnd&pg=PA331&dq=Breuss,+Fritz.+"Causes,+effects+and+policy+responses."+Routledge+handbook+of+the+economics+of+European+integration+(2015)

Verick, Sher, and Iyanatul Islam. "The great recession of 2008-2009: causes, consequences and policy responses", 2010, pp. 2-62. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1631069