1

THE GREAT RECESSION

Introduction
The global financial crisis of 2007 has cast its long shadow on the economic fortunes of many
countries, resulting in what has often been called the Great Recession.1 What started as
seemingly isolated turbulence in the sub-prime segment of the US housing market mutated
into a full blown recession by the end of 2007. The Great Recession was related to the U.S.
financial crisis of 200708 and subprime mortgage crisis of 200709. The old proverbial
truth that the rest of the world sneezes when the US catches a cold appeared to be vindicated
as systemically important economies in the European Union and Japan went collectively into
recession by mid-2008. Overall, 2009 was the first year since World War II that the world
was in recession, a calamitous turn around on the boom years of 2002-2007.
The crisis came largely as a surprise to many policymakers, multilateral agencies, academics
and investors. On the eve of the outbreak of the financial crisis, Jean-Philippe Cotis of the
OECD (2007) declared: for the OECD area as a whole growth is set to exceed its potential
rate for the remainder of 2007 and 2008, supported by buoyancy in emerging market
economies and favourable financial conditions. In the wake of the global recession of
20082009, the economics profession has come under a great deal of criticism from leading
scholars. Krugman (2009a) chides fellow economists for their blindness to the very
possibility of catastrophic failures in a market economy. Galbraith (2009) offers a robust
critique of the economics profession and argues that both explicit and implicit intellectual
collusion made it difficult for the leading members of the profession (invariably associated
with elite American universities) to encourage a genuine discourse based on alternative
views. The result was that a rather limited intellectual conversation took place between
essentially like-minded scholars.
Therefore, it is not surprising that, for much of 2008, the severity of this global downturn was
underestimated. Subsequently, leading forecasters, including the IMF and World Bank, made
a number of revisions to its growth forecasts during 2008 and into 2009 as the magnitude of
the crisis grew.2 Of course, there were some voices that issued dire warnings of a brewing
storm, but they were not enough to catch the attention of many who were lulled into a
Rampell (2009) traces the evolution of the term and points out with some irony that it has

also been used to describe all post-war recessions. Reinhart and Rogoff (2009) refer to the
crisis as the Second Great Contraction.
collective sense of complacency in the years leading up to the crisis. Some policymakers,
after being caught by surprise at the seemingly sudden appearance of a global downturn,
confidently noted that nobody could have predicted the crisis. Thus Glenn Stevens (2008),
Governor of the Reserve Bank of Australia observed: I do not know anyone who predicted
the course of events. Yet, there were economists and other professional analysts, albeit small
in numbers, who were prescient enough to issue a warning about a gathering storm. One
paper (Bezemer 2009a: table 1, p.9) claims that 12 economists and professional analysts
predicted (between 2005 and 2007) a likely recession based on models in which private
sector debt accumulation played a major role,3 while another cites an even smaller number
(Foreign Policy 2009).
In retrospect, however, the warning signs were there: large current deficits in the US, UK and
other advanced economies that were being financed by the excess savings of emerging
economies and oil exporters (the global current account imbalance); loose monetary policy
(most notably in the US in the wake of the mild recession of 2001); the search for yield and
misperception of risk; and lax financial regulation.
Following events in 2008, particularly the collapse of Lehman Brothers in September,
riskloving banks and investors around the world rapidly reversed their perceptions. Due to the
complexity of the mortgage-backed securities, they were, however, unaware of the true extent
of the liabilities linked ultimately to a rapidly deteriorating US housing sector. Consequently,
liquidity quickly dried up, almost bringing the global financial system to its knees. Some
commentators even questioned whether American-style capitalism itself had been dealt a
death blow.
Determined to avoid mistakes made by policymakers during previous crises, governments in
both advanced and developing countries reacted aggressively by injecting massive amounts
of credit into financial markets and nationalizing banks, slashing interest rates, and increasing
discretionary spending through fiscal stimulus packages. This response helped avoid a
catastrophic depression in many countries though the effectiveness of policies has varied
depending on the magnitude of the response and vulnerabilities of the domestic economy.

However, despite these interventions, the global financial crisis quickly evolved into a global
jobs crisis, as the crisis-induced credit crunch strangled the real economy and trade flows
collapsed. Unemployment in OECD countries has surged, while in countries without social
security schemes, the downturn has threatened to push millions into poverty.
Many but by no means all developing and emerging economies felt the deleterious effects
of the US recession by the end of 2008. The typical outcome was a growth deceleration
(ranging from mild to major) in many parts of the developing world, but there were cases of
outright recessions too. Hard-hit countries include Armenia, Mexico, South Africa, Turkey,
the Baltic States, and Ukraine. At the same time, the two most successful globalizers of recent
times have avoided a major downturn, which has been crucial for kick-starting the recovery
in 2009. China has, in particular, managed to keep their economy growing in 2009 at a rate of
8.7 per cent, which was supported by the massive stimulus package put together by the
Chinese authorities (amounting to US$585 billion). With a smaller stimulus, the Indian
economy has also proven to be resilient thanks to strong domestic demand, with growth only
falling to 6.7 per cent in 2009.
Nonetheless, the world economy enters 2010 in an environment fraught with considerable
degree of uncertainty. While the worst seems to be over, and while one hears proclamations
of a robust recovery, the jury is still out on the lessons and legacies of the tumultuous
economic events of 2008 and 2009. How apposite is the epithet of the Great Recession?
What were the historical and global circumstances that led to its seemingly sudden
emergence? To what extent were policy errors by past US administrations responsible for the
crisis? How have policymakers across the world responded to such economic volatility? How
effective have these responses been? What is the way forward in a post-crisis world? These
are the questions that are probed in this paper. In raising these questions and seeking to
respond to them, the paper does not intend to offer a blueprint for a post-crisis world, nor
does it aim to offer policy prescriptions that seek to uphold the institutional agenda of any
particular international organization or national government.
This paper provides both an historical perspective on the period leading up to the crisis and
insights into the events surrounding the crisis of 2007. This task is undertaken in section 2,
which discusses the notions of the Lost Decades and the Great Moderation, and the
prevalence of crises throughout history, before turning to the boom years of 2002-2007,
which was also accompanied by a food and oil crisis in developing countries. Next, the paper

provides a summary of the causes, consequences and policy responses of governments to the
global financial crisis that took hold in 2007 (sections 3-4). The succinct account of these
issues highlights both the severity of the crisis and the diversity in its impact on both
advanced and developing economies. Section 5 considers the recovery phase that tentatively
began in mid-2009 and the potential risks that remain. Finally, section 6 provides some
concluding remarks.

Overview
The Great Recession only met the IMF criteria for being a global recession, requiring a
decline in annual real world GDP per-capita (Purchasing Power weighted), in the single
calendar year 2009.[3][4] Despite the fact that quarterly data is being utilized as recession
definition criteria by all G20 members, representing 85% of the world GDP,[15] the
International Monetary Fund (IMF) has decidedin the absence of a complete data setnot
to declare/measure global recessions according to quarterly GDP data. The seasonally
adjusted PPP-weighted real GDP for the G20-zone, however, is a good indicator for the
world GDP, and it was measured to have suffered a direct quarter on quarter decline during
the three quarters from Q3-2008 until Q1-2009, which more accurately mark when the
recession took place at the global level.
According to the U.S. National Bureau of Economic Research (the official arbiter of U.S.
recessions) the US recession began in December 2007 and ended in June 2009, and thus
extended over 18 months.
The years leading up to the crisis were characterized by an exorbitant rise in asset prices and
associated boom in economic demand.Further, the U.S. shadow banking system (i.e., nondepository financial institutions such as investment banks) had grown to rival the depository
system yet was not subject to the same regulatory oversight, making it vulnerable to a bank
run.
US mortgage-backed securities, which had risks that were hard to assess, were marketed
around the world, as they offered higher yields than U.S. government bonds. Many of these
securities were backed by subprime mortgages, which collapsed in value when the U.S.
housing bubble burst during 2006 and homeowners began to default on their mortgage
payments in large numbers starting in 2007.
The emergence of sub-prime loan losses in 2007 began the crisis and exposed other risky
loans and over-inflated asset prices. With loan losses mounting and the fall of Lehman
Brothers on 15 September 2008, a major panic broke out on the inter-bank loan market. There
was the equivalent of a bank run on the shadow banking system, resulting in many large and
well established investment and commercial banks in the United States and Europe suffering

huge losses and even facing bankruptcy, resulting in massive public financial assistance
(government bailouts).
The global recession that followed resulted in a sharp drop in international trade, rising
unemployment and slumping commodity prices. Several economists predicted that recovery
might not appear until 2011 and that the recession would be the worst since the Great
Depression of the 1930s. Economist Paul Krugman once commented on this as seemingly the
beginning of "a second Great Depression.
Governments and central banks responded with fiscal and monetary policies to stimulate
national economies and reduce financial system risks. The recession has renewed interest in
Keynesian economic ideas on how to combat recessionary conditions. Economists advise that
the stimulus should be withdrawn as soon as the economies recover enough to "chart a path
to sustainable growth".
The distribution of household incomes in the United States has become more unequal during
the post-2008 economic recovery, a first for the US but in line with the trend over the last ten
economic recoveries since 1949. Income inequality in the United States has grown from 2005
to 2012 in more than 2 out of 3 metropolitan areas. Median household wealth fell 35% in the
US, from $106,591 to $68,839 between 2005 and 2011.

A history of crises
Given the historical evidence, insufficient attention was paid to the costs associated with low
frequency, high impact events, particularly among the proponents of the Great Moderation.
This inadequate perception of risk stands in contrast to the fact that between 1970 and 2008,
there were: 124 systemic banking crises; 208 currency crises; 63 sovereign debt crises; 42
twin crises; 10 triple crises; a global economic downturns about every ten years; and several
price shocks (two oil shocks in the 1970s, the food and energy price shock in 2007-2008
discussed below).
Contemporary studies of the historical evidence such as IMF (2009a) and Reinhart and
Rogoff (2009) have shown that such financial crises typically induce a sharp recession, which
last approximately two years. Consumption, private investment and credit flows are also slow
to improve, which is driven by deleveraging of debts and risk perceptions. As a consequence,
recovery is slow with unemployment levels continuing to rise for a number of years after the
economy has started to grow again.
Economic crises are not just a peculiarity of advanced economies. Indeed, developing
countries have been highly vulnerable to a plethora of banking, external debt, currency, and
inflation crises during recent decades. The debt crisis of the 1980s, the Asian financial crisis
of the late 1990s and the more recent debt crisis in Latin America in the 1990s and 2000s
have all resulted in deep recessions. Many developing countries have repeatedly suffered
crises due to poor macroeconomic management and policymaking. For example, Argentina
has experienced four banking crises since 1945 (Reinhart and Rogoff 2009).
In developing countries, how households cope with economic downturns and external shocks
impose social costs that are not always easy to reverse.
there was an increase in the incidence of poverty, ranging between 3.1 per cent (Thailand)
and 7.6 per cent (Indonesia) and a decline in real wages ranging between -8.9 per cent
(Korea) to about -40 per cent (Indonesia).
Overall, it is clear that, despite the Great Moderation, the costs associated with
lowfrequency, high-impact events are high. This means that risk management strategies
aimed at containing these costs should be a core part of economic policymaking

The crisis before the crisis jobless growth, sluggish real wages and the
food and energy crisis
One legacy of the global boom of 2002 and 2007 was that insufficient attention was being
given to the stresses and strains that afflicted labour markets across the world even during the
high-growth era. Quantitative expansions in employment in many parts of the world,
particularly in developing countries, were juxtaposed with sluggish real wage growth,
persistence of the informal economy, casualization of the work-force, declining wage shares
in national output and rising inequality. This is a familiar theme in recent ILO reports,11 but
other organizations, such as the OECD and the World Bank, have also highlighted the
problems of growing economic insecurity and inequality in regional and global labour
markets.12 Decent work remains an elusive goal in many low and middle-income countries.
One key shortcoming of the boom period was the failure for increases in economic growth to
translate into improvements in household incomes. For example, in three major developing
and emerging economies Indonesia, South Africa and Turkey - real wages in the 2000s
hardly showed any sustained improvement.13 Even in consumption-led economies like the
US, incomes remained relatively stagnant over this period (Figure 1). However, in contrast to
developing countries where this situation translates to stubborn levels of poverty, American
households were able to increase consumption by tapping into their wealth, namely the
increase in household equity that accompanied rising prices (Baily et al. 2008). This increase
in consumption was reflected in the worsening US current account deficit, which rose from
US$398.3 billion (3.9% of GDP) in 2001 to $803.6 billion (6.0% of GDP) in 2006.

Figure 1: Growing consumpti0on in the US during the boom years despite stagnant real
wages, 2000-2007
In addition to this phenomenon, during 2007 and the early part of 2008, many developing
countries were buffeted by food and energy price shocks that impaired the fiscal and current
balances of the affected economies, led to food riots and protests in many countries and
pushed millions into poverty.This process was also an outcome of the global boom and the
surging demand for goods in China, India and other fast-growing emerging economies. This
situation was more pronounced for the non-oil or mineral exporters, but even within countries
benefiting from the commodity bonanza, the poor were suffering from skyrocketing inflation
without seeing much of the returns from the exports. The 2007-2008 food and energy price
shocks appears to have pushed more than 100 million people in the developing world into
transient episodes of poverty.In comparison, the World Bank estimates that the Great
Recession of 2008-2009 has resulted in an increase in poverty of 64 million people (by 2010)
(World Bank 2010). The food and oil crisis was (and is), therefore, arguably a much greater
concern for low and middle-income countries than the global financial crisis that affected
rich, highly globalized economies more severely.

10

CAUSES
Panel reports
The majority report of the U.S. Financial Crisis Inquiry Commission, composed of six
Democratic and four Republican appointees, reported its findings in January 2011. It
concluded that "the crisis was avoidable and was caused by: Widespread failures in financial
regulation, including the Federal Reserves failure to stem the tide of toxic mortgages;
Dramatic breakdowns in corporate governance including too many financial firms acting
recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by
households and Wall Street that put the financial system on a collision course with crisis; Key
policy makers ill prepared for the crisis, lacking a full understanding of the financial system
they oversaw; and systemic breaches in accountability and ethics at all levels.
There were two Republican dissenting FCIC reports. One of them, signed by three
Republican appointees, concluded that there were multiple causes. In his separate dissent to
the majority and minority opinions of the FCIC, Commissioner Peter J. Wallison of the
American Enterprise Institute (AEI) primarily blamed U.S. housing policy, including the
actions of Fannie & Freddie, for the crisis. He wrote: "When the bubble began to deflate in
mid-2007, the low quality and high risk loans engendered by government policies failed in
unprecedented numbers.
In its "Declaration of the Summit on Financial Markets and the World Economy," dated 15
November 2008, leaders of the Group of 20 cited the following causes:
During a period of strong global growth, growing capital flows, and prolonged stability
earlier this decade, market participants sought higher yields without an adequate appreciation
of the risks and failed to exercise proper due diligence. At the same time, weak underwriting
standards, unsound risk management practices, increasingly complex and opaque financial
products, and consequent excessive leverage combined to create vulnerabilities in the system.
Policy-makers, regulators and supervisors, in some advanced countries, did not adequately
appreciate and address the risks building up in financial markets, keep pace with financial
innovation, or take into account the systemic ramifications of domestic regulatory actions.

11

Narratives
U.S. residential and non-residential investment fell relative to GDP during the crisis
There are several "narratives" attempting to place the causes of the recession into context,
with overlapping elements. Four such narratives include:
There was the equivalent of a bank run on the shadow banking system, which includes
investment banks and other non-depository financial entities. This system had grown to rival
the depository system in scale yet was not subject to the same regulatory safeguards. Its
failure disrupted the flow of credit to consumers and corporations
The U.S. economy was being driven by a housing bubble. When it burst, private residential
investment (i.e., housing construction) fell by nearly 4% GDP and consumption enabled by
bubble-generated housing wealth also slowed. This created a gap in annual demand (GDP) of
nearly $1 trillion. The U.S. government was unwilling to make up for this private sector
shortfall.
Record levels of household debt accumulated in the decades preceding the crisis resulted in a
balance sheet recession (similar to debt deflation) once housing prices began falling in 2006.
Consumers began paying off debt, which reduces their consumption, slowing down the
economy for an extended period while debt levels are reduced.
U.S. government policies encouraged home ownership even for those who could not afford it,
contributing to lax lending standards, unsustainable housing price increases, and
indebtedness.
Underlying narratives #1-3 is a hypothesis that growing income inequality and wage
stagnation encouraged families to increase their household debt to maintain their desired
living standard, fueling the bubble. Further, this greater share of income flowing to the top
increased the political power of business interests, who used that power to deregulate or limit
regulation of the shadow banking system.
Trade imbalances and debt bubbles
U.S. households and financial businesses significantly increased borrowing (leverage) in the
years leading up to the crisis

12

The Economist wrote in July 2012 that the inflow of investment dollars required to fund the
U.S. trade deficit was a major cause of the housing bubble and financial crisis: "The trade
deficit, less than 1% of GDP in the early 1990s, hit 6% in 2006. That deficit was financed by
inflows of foreign savings, in particular from East Asia and the Middle East. Much of that
money went into dodgy mortgages to buy overvalued houses, and the financial crisis was the
result."
In May 2008, NPR explained in their Peabody Award winning program "The Giant Pool of
Money" that a vast inflow of savings from developing nations flowed into the mortgage
market, driving the U.S. housing bubble. This pool of fixed income savings increased from
around $35 trillion in 2000 to about $70 trillion by 2008. NPR explained this money came
from various sources, "[b]ut the main headline is that all sorts of poor countries became kind
of rich, making things like TVs and selling us oil. China, India, Abu Dhabi, Saudi Arabia
made a lot of money and banked it."
Describing the crisis in Europe, Paul Krugman wrote in February 2012 that: "What were
basically looking at, then, is a balance of payments problem, in which capital flooded south
after the creation of the euro, leading to overvaluation in southern Europe."
Monetary policy
Another narrative about the origin has been focused on the respective parts played by the
public monetary policy (in the US notably) and by the practices of private financial
institutions. In the U.S., mortgage funding was unusually decentralised, opaque, and
competitive, and it is believed that competition between lenders for revenue and market share
contributed to declining underwriting standards and risky lending.
While Alan Greenspan's role as Chairman of the Federal Reserve has been widely discussed
(the main point of controversy remains the lowering of the Federal funds rate to 1% for more
than a year, which, according to Austrian theorists, injected huge amounts of "easy" creditbased money into the financial system and created an unsustainable economic boom), there is
also the argument that Greenspan's 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 the dot-com bubblealthough by doing so he did not help avert the crisis, but only
postpone it.

13

High private debt levels

Another narrative focuses on high levels of private debt in the US economy. USA household
debt as a percentage of annual disposable personal income was 127% at the end of 2007,
versus 77% in 1990. Faced with increasing mortgage payments as their adjustable rate
mortgage payments increased, households began to default in record numbers, rendering
mortgage-backed securities worthless. High private debt levels also impact growth by making
recessions deeper and the following recovery weaker. Robert Reich claims the amount of debt
in the US economy can be traced to economic inequality, assuming that middle-class wages
remained stagnant while wealth concentrated at the top, and households "pull equity from
their homes and overload on debt to maintain living standards.
The IMF reported in April 2012: "Household debt soared in the years leading up to the
downturn. In advanced economies, during the five years preceding 2007, the ratio of
household debt to income rose by an average of 39 percentage points, to 138 percent. In
Denmark, Iceland, Ireland, the Netherlands, and Norway, debt peaked at more than 200
percent of household income. A surge in household debt to historic highs also occurred in
emerging economies such as Estonia, Hungary, Latvia, and Lithuania. The concurrent boom
in both house prices and the stock market meant that household debt relative to assets held
broadly stable, which masked households growing exposure to a sharp fall in asset prices.
When house prices declined, ushering in the global financial crisis, many households saw
their wealth shrink relative to their debt, and, with less income and more unemployment,
found it harder to meet mortgage payments. By the end of 2011, real house prices had fallen
from their peak by about 41% in Ireland, 29% in Iceland, 23% in Spain and the United States,
and 21% in Denmark. Household defaults, underwater mortgages (where the loan balance
exceeds the house value), foreclosures, and fire sales are now endemic to a number of
economies. Household deleveraging by paying off debts or defaulting on them has begun in
some countries. It has been most pronounced in the United States, where about two-thirds of
the debt reduction reflects defaults.

Pre-recession economic imbalances

The onset of the economic crisis took most people by surprise. A 2009 paper identifies twelve
economists and commentators who, between 2000 and 2006, predicted a recession based on

14

the collapse of the then-booming housing market in the United States. Dean Baker, Wynne
Godley, Fred Harrison, Michael Hudson, Eric Janszen, Steve Keen, Jakob Brchner Madsen,
Jens Kjaer Srensen, Kurt Richebcher, Nouriel Roubini, Peter Schiff, and Robert Shiller.
Housing bubbles
By 2007, real estate bubbles were still under way in many parts of the world, especially in the
United States, France, United Kingdom, Spain, The Netherlands, Australia, United Arab
Emirates, New Zealand, Ireland, Poland,[61] South Africa, Israel, Greece, Bulgaria,
Croatia,Norway, Singapore, South Korea, Sweden, Finland, Argentina, Baltic states, India,
Romania, Ukraine, and China. U.S. Federal Reserve Chairman Alan Greenspan said in mid2005 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 (by definition of the
word "bubble") followed by a price decrease (also known as a housing price crash) that can
result in many owners holding negative equity (a mortgage debt higher than the current value
of the property).
Ineffective or inappropriate regulation
Several analysts, such as Peter Wallison and Edward Pinto of the American Enterprise
Institute, have asserted that private lenders were encouraged to relax lending standards by
government affordable housing policies. They cite The Housing and Community
Development Act of 1992, which initially required that 30 percent or more of Fannies and
Freddies loan purchases be related to affordable housing. The legislation gave HUD the
power to set future requirements, and eventually (under the Bush Administration) a 56
percent minimum was established. To fulfil the requirements, Fannie Mae and Freddie Mac
established programs to purchase $5 trillion in affordable housing loans, and encouraged
lenders to relax underwriting standards to produce those loans.
These critics also cite, as inappropriate regulation, The National Homeownership Strategy:
Partners in the American Dream (Strategy), which was compiled in 1995 by Henry
Cisneros, President Clintons HUD Secretary. In 2001, the independent research company,
Graham Fisher & Company, stated: While the underlying initiatives of the [Strategy] were
broad in content, the main theme ... was the relaxation of credit standards.

15

The Community Reinvestment Act (CRA) is also identified as one of the causes of the
recession, by some critics. They contend that lenders relaxed lending standards in an effort to
meet CRA commitments, and they note that publicly announced CRA loan commitments
were massive, totaling $4.5 trillion in the years between 1994 and 2007.
However, the Financial Crisis Inquiry Commission (FCIC) concluded that Fannie & Freddie
"were not a primary cause" of the crisis and that CRA was not a factor in the crisis. Further,
since housing bubbles appeared in multiple countries in Europe as well, the FCIC Republican
minority dissenting report also concluded that U.S. housing policies were not a robust
explanation for a wider global housing bubble. The view that U.S. government housing
policy was a primary cause of the crisis has been widely disputed, with Paul Krugman
referring to it as "imaginary history."
Derivatives
Author Michael Lewis wrote that a type of derivative called a credit default swap (CDS)
enabled speculators to stack bets on the same mortgage securities. This is analogous to
allowing many persons to buy insurance on the same house. Speculators that bought CDS
protection were betting that significant mortgage security defaults would occur, while the
sellers (such as AIG) bet they would not. An unlimited amount could be wagered on the same
housing-related securities, provided buyers and sellers of the CDS could be found. When
massive defaults occurred on underlying mortgage securities, companies like AIG that were
selling CDS were unable to perform their side of the obligation and defaulted; U.S. taxpayers
paid over $100 billion to global financial institutions to honor AIG obligations, generating
considerable outrage.
Derivatives such as CDS were unregulated or barely regulated. Several sources have noted
the failure of the US government to supervise or even require transparency of the financial
instruments known as derivatives. A 2008 investigative article in the Washington Post found
that leading government officials at the time (Federal Reserve Board Chairman Alan
Greenspan, Treasury Secretary Robert Rubin, and SEC Chairman Arthur Levitt) vehemently
opposed any regulation of derivatives. In 1998 Brooksley E. Born, head of the Commodity
Futures Trading Commission, put forth a policy paper asking for feedback from regulators,
lobbyists, legislators on the question of whether derivatives should be reported, sold through
a central facility, or whether capital requirements should be required of their buyers.
Greenspan, Rubin, and Levitt pressured her to withdraw the paper and Greenspan persuaded

16

Congress to pass a resolution preventing CFTC from regulating derivatives for another six
months when Born's term of office would expire. Ultimately, it was the collapse of a
specific kind of derivative, the mortgage-backed security, that triggered the economic crisis
of 2008.
Shadow banking system
Paul Krugman wrote in 2009 that the run on the shadow banking system was the "core of
what happened" to cause the crisis. "As the shadow banking system expanded to rival or even
surpass conventional banking in importance, politicians and government officials should have
realised that they were re-creating the kind of financial vulnerability that made the Great
Depression possible and they should have responded by extending regulations and the
financial safety net to cover these new institutions. Influential figures should have proclaimed
a simple rule: anything that does what a bank does, anything that has to be rescued in crises
the way banks are, should be regulated like a bank." He referred to this lack of controls as
"malign neglect."
During 2008, three of the largest U.S. investment banks either went bankrupt (Lehman
Brothers) or were sold at fire sale prices to other banks (Bear Stearns and Merrill Lynch). The
investment banks were not subject to the more stringent regulations applied to depository
banks. These failures exacerbated the instability in the global financial system. The remaining
two investment banks, Morgan Stanley and Goldman Sachs, potentially facing failure, opted
to become commercial banks, thereby subjecting themselves to more stringent regulation but
receiving access to credit via the Federal Reserve. Further, American International Group
(AIG) had insured mortgage-backed and other securities but was not required to maintain
sufficient reserves to pay its obligations when debtors defaulted on these securities. AIG was
contractually required to post additional collateral with many creditors and counter-parties,
touching off controversy when over $100 billion of U.S. taxpayer money was paid out to
major global financial institutions on behalf of AIG. While this money was legally owed to
the banks by AIG (under agreements made via credit default swaps purchased from AIG by
the institutions), a number of Congressmen and media members expressed outrage that
taxpayer money was used to bail out banks.
Economist Gary Gorton wrote in May 2009: "Unlike the historical banking panics of the 19th
and early 20th centuries, the current banking panic is a wholesale panic, not a retail panic. In
the earlier episodes, depositors ran to their banks and demanded cash in exchange for their

17

checking accounts. Unable to meet those demands, the banking system became insolvent. The
current panic involved financial firms running on other financial firms by not renewing sale
and repurchase agreements (repo) or increasing the repo margin (haircut), forcing massive
deleveraging, and resulting in the banking system being insolvent."
The Financial Crisis Inquiry Commission reported in January 2011: "In the early part of the
20th century, we erected a series of protections the Federal Reserve as a lender of last
resort, federal deposit insurance, ample regulations to provide a bulwark against the panics
that had regularly plagued Americas banking system in the 20th century. Yet, over the past
30-plus years, we permitted the growth of a shadow banking system opaque and laden with
short term debt that rivaled the size of the traditional banking system. Key components of
the market for example, the multitrillion-dollar repo lending market, off-balance-sheet
entities, and the use of over-the-counter derivatives were hidden from view, without the
protections we had constructed to prevent financial meltdowns. We had a 21st-century
financial system with 19th-century safeguards."
Systemic crisis
The financial crisis and the recession have been described as a symptom of another, deeper
crisis by a number of economists. For example, Ravi Batra argues that growing inequality of
financial capitalism produces speculative bubbles that burst and result in depression and
major political changes. Feminist economists Ailsa McKay and Margunn Bjrnholt argue that
the financial crisis and the response to it revealed a crisis of ideas in mainstream economics
and within the economics profession, and call for a reshaping of both the economy, economic
theory and the economics profession. They argue that such a reshaping should include new
advances within feminist economics and ecological economics that take as their starting point
the socially responsible, sensible and accountable subject in creating an economy and
economic theories that fully acknowledge care for each other as well as the planet.

18

EFFECTS
Effects on the United States
In the U.S., persistent high unemployment remained as of December 2012, along with low
consumer confidence, the continuing decline in home values and increase in foreclosures and
personal bankruptcies, an increasing federal debt, inflation, and rising petroleum and food
prices. A 2011 poll found that more than half of all Americans thought that the U.S. was still
in recession or even depression, although economic data showed a historically modest
recovery. This could have been because both private and public levels of debt were at historic
highs in the U.S. and in many other countries
Real gross domestic product (GDP) began contracting in the third quarter of 2008 and did not
return to growth until Q1 2010. CBO estimated in February 2013 that real U.S. GDP
remained only a little over 4.5 percent above its previous peak, or about $850 billion. CBO
projected that GDP would not return to its potential level until 2017. In 2009 the U.S GDP
was at $14.4 trillion. By the final quarter of 2014, the US GDP had grown by 18.6%, equal to
$17.7 trillion. Canada, the United States' largest trading partner by then, had a GDP of $1.37
trillion in 2009, but by 2014 reached $2 trillion, growing by over 31%. Both countries now
have the fastest growing economies within the G8 and G20, and both countries has increased
daily trade with each other from $1.5 Billion in 2011, to $4 Billion in 2014, equating to over
$1.3 trillion in annual trade.
The unemployment rate rose from 5% in 2008 pre-crisis to 10% by late 2009, then steadily
declined to 7.3% by March 2013. The number of unemployed rose from approximately 7
million in 2008 pre-crisis to 15 million by 2009, then declined to 12 million by early 2013.
Residential private investment (mainly housing) fell from its 2006 pre-crisis peak of $800
billion, to $400 billion by mid-2009 and has remained depressed at that level. Non-residential
investment (mainly business purchases of capital equipment) peaked at $1,700 billion in 2008
pre-crisis and fell to $1,300 billion in 2010, but by early 2013 had nearly recovered to this
peak.
Housing prices fell approximately 30% on average from their mid-2006 peak to mid-2009
and remained at approximately that level as of March 2013.

19

Stock market prices, as measured by the S&P 500 index, fell 57% from their October 2007
peak of 1,565 to a trough of 676 in March 2009. Stock prices began a steady climb thereafter
and returned to record levels by April 2013.
The net worth of U.S. households and non-profit organisations fell from a peak of
approximately $67 trillion in 2007 to a trough of $52 trillion in 2009, a decline of $15 trillion
or 22%. It began to recover thereafter and was $66 trillion by Q3 2012.
U.S. total national debt rose from 66% GDP in 2008 pre-crisis to over 103% by the end of
2012.
For the majority, income levels have dropped substantially with the median male worker
making $32,137 in 2010, and an inflation-adjusted income of $32,844 in 1968. The recession
of 20072009 is considered to be the worst economic downturn since the Great Depression.
and the subsequent economic recovery one of the weakest. The weak economic performance
since 2000 has seen the percentage of working age adults actually employed drop from 64%
to 58% (a number last seen in 1984), with most of that drop occurring since 2007.
Approximately 5.4 million people have been added to federal disability rolls as discouraged
workers give up looking for work and take advantage of the federal program.
The United States has seen an increasing concentration of wealth to the detriment of the
middle class and the poor with the younger generations being especially affected. The middle
class dropped from 61% of the population in 1971 to 51% in 2011 as the upper class
increased its take of the national income from 29% in 1970 to 46% in 2010. The share for the
middle class dropped to 45%, down from 62% while total income for the poor dropped to 9%
from 10%. Since the number of poor increased during this period the smaller piece of the pie
(down to 9% from 10%) is spread over a greater portion of the population. The portion of
national wealth owned by the middle class and poor has also dropped as their portion of the
national income has dropped, making it more difficult to accumulate wealth. The younger
generation, which would be just starting their wealth accumulation, has been the most hard
hit. Those under 35 are 68% less wealthy than they were in 1984, while those over 55 are
10% wealthier.

Much of this concentration has happened since the start of the Great

Recession. In 2009, the wealthiest 20% of households controlled 87.2% of all wealth, up
from 85.0% in 2007. The top 1% controlled 35.6% of all wealth, up from 34.6% in 2007. The
share of the bottom 80% fell from 15% to 12.8%, dropping 15%.

20

Inflation-adjusted median household income in the United States peaked in 1999 at $53,252
(at the peak of the Internet stock bubble), dropped to $51,174 in 2004, went up to 52,823 in
2007 (at the peak of the housing bubble), and has since trended downward to $49,445 in
2010. The last time median household income was at this level was in 1996 at $49,112,
indicating that the recession of the early 2000s and the 20082012 global recession wiped out
all middle class income gains for the last 15 years. This income drop has caused a dramatic
rise in people living under the poverty level and has hit suburbia particularly hard. Between
2000 and 2010, the number of suburban households below the poverty line increased by 53
percent, compared to a 23 percent increase in poor households in urban areas.
A 2011 poll found that more than half of all Americans think the U.S. is still in recession or
even depression, despite official data that shows a historically modest recovery. In 2013 the
Census Bureau defined poverty rate decreased to roughly 14.5% of the population. As late as
2014, and early 2015, a majority of Americans still believed that the nation remained in a
recession.
Effects on Europe
The crisis in Europe generally progressed from banking system crises to sovereign debt
crises, as many countries elected to bailout their banking systems using taxpayer money.
Greece was different in that it faced large public debts rather than problems within its
banking system. Several countries received bailout packages from the "troika" (European
Commission, European Central Bank, International Monetary Fund), which also implemented
a series of emergency measures.
Many European countries embarked on austerity programs, reducing their budget deficits
relative to GDP from 2010 to 2011. For example, according to the CIA World Factbook
Greece improved its budget deficit from 10.4% GDP in 2010 to 9.6% in 2011. Iceland, Italy,
Ireland, Portugal, France, and Spain also improved their budget deficits from 2010 to 2011
relative to GDP.
However, with the exception of Germany, each of these countries had public-debt-to-GDP
ratios that increased (i.e., worsened) from 2010 to 2011, as indicated in the chart at right.
Greece's public-debt-to-GDP ratio increased from 143% in 2010 to 165% in 2011to 185% in
2014. This indicates that despite improving budget deficits, GDP growth was not sufficient to
support a decline (improvement) in the debt-to-GDP ratio for these countries during this

21

period. Eurostat reported that the debt to GDP ratio for the 17 Euro area countries together
was 70.1% in 2008, 79.9% in 2009, 85.3% in 2010, and 87.2% in 2011.
According to the CIA World Factbook, from 2010 to 2011, the unemployment rates in Spain,
Greece, Italy, Ireland, Portugal, and the UK increased. France had no significant changes,
while in Germany and Iceland the unemployment rate declined. Eurostat reported that
Eurozone unemployment reached record levels in September 2012 at 11.6%, up from 10.3%
the prior year. Unemployment varied significantly by country.
Economist Martin Wolf analysed the relationship between cumulative GDP growth from
2008-2012 and total reduction in budget deficits due to austerity policies (see chart at right)
in several European countries during April 2012. He concluded that: "In all, there is no
evidence here that large fiscal contractions [budget deficit reductions] bring benefits to
confidence and growth that offset the direct effects of the contractions. They bring exactly
what one would expect: small contractions bring recessions and big contractions bring
depressions." Changes in budget balances (deficits or surpluses) explained approximately
53% of the change in GDP, according to the equation derived from the IMF data used in his
analysis.
Economist Paul Krugman analysed the relationship between GDP and reduction in budget
deficits for several European countries in April 2012 and concluded that austerity was
slowing growth, similar to Martin Wolf. He also wrote: "... this also implies that 1 euro of
austerity yields only about 0.4 euros of reduced deficit, even in the short run. No wonder,
then, that the whole austerity enterprise is spiraling into disaster.
Countries that avoided recession
Poland and Slovakia are the only two members of the European Union to have avoided a
GDP recession during the years affected by the Great Recession. As of December 2009, the
Polish economy had not entered recession nor even contracted, while its IMF 2010 GDP
growth forecast of 1.9 percent was expected to be upgraded. Analysts have identified several
causes for the positive economic development in Poland: Extremely low levels of bank
lending and a relatively very small mortgage market; the relatively recent dismantling of EU
trade barriers and the resulting surge in demand for Polish goods since 2004; the receipt of
direct EU funding since 2004; lack of over-dependence on a single export sector; a tradition
of government fiscal responsibility; a relatively large internal market; the free-floating Polish

22

zloty; low labour costs attracting continued foreign direct investment; economic difficulties at
the start of the decade, which prompted austerity measures in advance of the world crisis.
While India, Uzbekistan, China, and Iran experienced slowing growth, they did not enter
recessions.
South Korea narrowly avoided technical recession in the first quarter of 2009. The
International Energy Agency stated in mid September that South Korea could be the only
large OECD country to avoid recession for the whole of 2009. It was the only developed
economy to expand in the first half of 2009.
Australia avoided a technical recession after experiencing only one quarter of negative
growth in the fourth quarter of 2008, with GDP returning to positive in the first quarter of
2009.
The financial crisis did not affect developing countries to a great extent. Experts see several
reasons: Africa was not affected because it is not fully integrated in the world market. Latin
America and Asia seemed better prepared, since they have experienced crises before. In Latin
America, for example, banking laws and regulations are very stringent. Bruno Wenn of the
German DEG suggests that Western countries could learn from these countries when it comes
to regulations of financial markets.

23

Timeline of effects
The table below displays all national recessions appearing in 2006-2013 (for the 71 countries
with available data), according to the common recession definition, saying that a recession
occurred whenever seasonally adjusted real GDP contracts quarter on quarter, through
minimum two consecutive quarters. Only 11 out of the 71 listed countries with quarterly GDP
data (Poland, Slovakia, Moldova, India, China, South Korea, Indonesia, Australia, Uruguay,
Colombia and Bolivia) escaped a recession in this time period.
The few recessions appearing early in 2006-07 are commonly never associated to be part of
the Great Recession, which is illustrated by the fact that only two countries (Iceland and
Jamaica) were in recession in Q4-2007.
One year before the maximum, in Q1-2008, only six countries were in recession (Iceland,
Sweden, Finland, Ireland, Portugal and New Zealand). The number of countries in recession
was 25 in Q2-2008, 39 in Q3-2008 and 53 in Q4-2008. At the steepest part of the Great
Recession in Q1-2009, a total of 59 out of 71 countries were simultaneously in recession. The
number of countries in recession was 37 in Q2-2009, 13 in Q3-2009 and 11 in Q4-2009. One
year after the maximum, in Q1-2010, only seven countries were in recession (Greece,
Croatia, Romania, Iceland, Jamaica, Venezuela and Belize).
The recession data for the overall G20-zone (representing 85% of all GWP), depict that the
Great Recession existed as a global recession throughout Q3-2008 until Q1-2009.
Subsequent follow-up recessions in 2010-2013 were confined to Belize, El Salvador,
Paraguay, Jamaica, Japan, Taiwan, New Zealand and 24 out of 50 European countries
(including Greece). As of October 2014, only five out of the 71 countries with available
quarterly data (Cyprus, Italy, Croatia, Belize and El Salvador), were still in ongoing
recessions. The many follow-up recessions hitting the European countries, are commonly
referred to as being direct repercussions of the European sovereign-debt crisis.

24

Recession

period(s)

during

2006-2013

(measured by quarter-on-quarter changes of seasonally

Country

adjusted

real

GDP,

as per the latest revised Q3-2013 data from 10 January

2014)

Albania

Q1-2007

until

Q2-2007

(6

months)

Q3-2009

until

Q4-2009

(6

months)

Q4-2011 until Q1-2012 (6 months)

Argentina

Q4-2008 until Q2-2009 (9 months)

Australia

None

Austria

Belgium

Belize

Q2-2008

until

Q2-2009

(15

months)

(9

months)

Q3-2011 until Q4-2011 (6 months)

Q3-2008

until

Q1-2009

Q2-2012 until Q1-2013 (12 months)

Q1-2006

until

Q2-2006

(6

months)

Q1-2007

until

Q3-2007

(9

months)

Q4-2008

until

Q1-2009

(6

months)

Q4-2009

until

Q1-2010

(6

months)

Q1-2011

until

Q2-2011

(6

months)

Q2-2013 until Ongoing (6 months)

Bolivia

None

Brazil

Q4-2008 until Q1-2009 (6 months)

Bulgaria

Q1-2009 until Q2-2009 (6 months)

Canada

Q4-2008 until Q2-2009 (9 months)

Chile

Q2-2008 until Q1-2009 (12 months)

China

None

Colombia

None

Costa Rica

Q2-2008 until Q1-2009 (12 months)

Croatia

Q3-2008

until

Q2-2010

(24

months)

Q3-2011

until

Q4-2012

(18

months)

25

Recession

period(s)

during

2006-2013

(measured by quarter-on-quarter changes of seasonally

Country

adjusted

real

GDP,

as per the latest revised Q3-2013 data from 10 January

2014)
Q2-2013 until Ongoing (6 months)
Q1-2009

Cyprus

until

Q4-2009

(12

months)

(9

months)

Q3-2011 until Ongoing (27 months)

Q4-2008

Czech Republic

until

Q2-2009

Q4-2011 until Q1-2013 (18 months)

Denmark

Q3-2008

until

Q2-2009

(12

months)

Q3-2011

until

Q4-2011

(6

months)

Q4-2012 until Q1-2013 (6 months)

Q4-2006

Ecuador

until

Q1-2007

(6

months)

(12

months)

Q1-2009 until Q3-2009 (9 months)

Q3-2008

El Salvador

until

Q2-2009

Q2-2013 until Ongoing (6 months)

Q3-2008

Estonia

until

Q3-2009

(15

months)

Q1-2013 until Q2-2013 (6 months)

EU (28 member states)

Q2-2008

until

Q2-2009

(15

months)

Q4-2011

until

Q2-2012

(9

months)

(15

months)

(18

months)

(15

months)

Q4-2012 until Q1-2013 (6 months)

Q2-2008

Eurozone (17 member states)

Q2-2009

Q4-2011 until Q1-2013 (18 months)

Q1-2008

Finland

until

Q2-2009

Q2-2012 until Q1-2013 (12 months)

Q2-2008

France
G20

until

until

Q2-2009

Q4-2012 until Q1-2013 (6 months)

(43

member

weighted GDP)
Germany

states,

PPP-

Q3-2008 until Q1-2009 (9 months)

Q2-2008 until Q1-2009 (12 months)

26

Recession

period(s)

during

2006-2013

(measured by quarter-on-quarter changes of seasonally

Country

adjusted

real

GDP,

as per the latest revised Q3-2013 data from 10 January

2014)

Greece

Q3-2008 until Q2-2014 (63 months)

Hong Kong

Q2-2008 until Q1-2009 (12 months)

Hungary

Q1-2007

until

Q2-2007

(6

months)

Q2-2008

until

Q3-2009

(18

months)

Q2-2011

until

Q3-2011

(6

months)

Q1-2012 until Q4-2012 (12 months)

Iceland

Q4-2007

until

Q2-2008

(9

months)

Q4-2008

until

Q1-2009

(6

months)

(6

months)

(15

months)

Q3-2009 until Q2-2010 (12 months)

India

None

Indonesia

None

Ireland
Israel
Italy

Jamaica

Q2-2007

until

Q3-2007

Q1-2008 until Q4-2009 (24 months)

Q4-2008 until Q1-2009 (6 months)
Q2-2008

until

Q2-2009

Q3-2011 until Q3 2014 (27 months)

Q3-2007

until

Q4-2007

(6

months)

Q3-2008

until

Q1-2009

(9

months)

Q4-2009

until

Q2-2010

(9

months)

Q4-2011

until

Q1-2012

(6

months)

Q4-2012 until Q1-2013 (6 months)

Japan

Q2-2008

until

Q1-2009

(12

months)

Q4-2010

until

Q2-2011

(9

months)

Q2-2012 until Q3-2012 (6 months)

Kazakhstan

Q3-2008 until Q1-2009 (9 months)

27

Recession

period(s)

during

2006-2013

(measured by quarter-on-quarter changes of seasonally

Country

adjusted

real

GDP,

as per the latest revised Q3-2013 data from 10 January

2014)

Latvia

Q2-2008 until Q3-2009 (18 months)

Lithuania

Q3-2008 until Q2-2009 (12 months)

Luxembourg

Q2-2008 until Q1-2009 (12 months)

Macedonia

Q1-2009

until

Q3-2009

(9

months)

Q1-2012

until

Q2-2012

(6

months)

(not qoq-data, but quarters compared with same quarter

of last year)

Malaysia

Q3-2008 until Q1-2009 (9 months)

Malta

Q4-2008 until Q1-2009 (6 months)

Mexico

Q3-2008 until Q2-2009 (12 months)

Moldova

None

Netherlands

Q2-2008

until

Q2-2009

(15

months)

Q2-2011

until

Q1-2012

(12

months)

(18

months)

Q3-2012 until Q2-2013 (12 months)

New Zealand

Norway

Q1-2008

until

Q2-2009

Q3-2010 until Q4-2010 (6 months)

Q1-2009

until

Q2-2009

(6

months)

Q2-2010

until

Q3-2010

(6

months)

Q1-2011 until Q2-2011 (6 months)

OECD (34 member states, PPPweighted GDP)
Paraguay
Peru

Q2-2008 until Q1-2009 (12 months)

Q3-2008

until

Q1-2009

Q2-2011 until Q3-2011 (6 months)

Q4-2008 until Q2-2009 (9 months)

(9

months)

28

Recession

period(s)

during

2006-2013

(measured by quarter-on-quarter changes of seasonally

Country

adjusted

real

GDP,

as per the latest revised Q3-2013 data from 10 January

2014)
Philippines

Q4-2008 until Q1-2009 (6 months)

Poland

None

Portugal

Q2-2007

until

Q3-2007

(6

months)

Q1-2008

until

Q1-2009

(15

months)

Q4-2010 until Q1-2013 (30 months)

Romania

Q4-2008

until

Q2-2009

(9

months)

Q4-2009

until

Q1-2010

(6

months)

Q4-2011 until Q1-2012 (6 months)

Russia

Serbia

Q3-2008 until Q2-2009 (12 months)

Q2-2008

until

Q2-2009

(15

months)

Q2-2011

until

Q1-2012

(12

months)

Q3-2012 until Q4-2012 (6 months)

Singapore

Q2-2008 until Q1-2009 (12 months)

Slovakia

None

Slovenia

Q3-2008

until

Q2-2009

Q4-2008 until Q2-2009 (9 months)

South Korea

None
Q2-2008

until

Q4-2009

Q1-2008 until Q1-2009 (15 months)

Switzerland

Q4-2008 until Q2-2009 (9 months)

Thailand

(21

months)

Q2-2011 until Q2-2013 (27 months)

Sweden

Taiwan

months)

Q3-2011 until Q4-2013 (24 months)

South Africa

Spain

(12

Q2-2008

until

Q1-2009

Q3-2011 until Q4-2011 (6 months)

Q4-2008 until Q1-2009 (6 months)

(12

months)

29

Recession

period(s)

during

2006-2013

(measured by quarter-on-quarter changes of seasonally

Country

adjusted

real

GDP,

as per the latest revised Q3-2013 data from 10 January

2014)

Turkey
Ukraine

United Kingdom

Q2-2008 until Q1-2009 (12 months)

Q2-2008

until

Q1-2009

(12

months)

(18

months)

Q3-2012 until Q4-2012 (6 months)

Q2-2008

until

Q3-2009

Q4-2011 until Q2-2012 (9 months)

United States

Q3-2008 until Q2-2009 (12 months)

Uruguay

None

Venezuela

Q1-2009 until Q1-2010 (15 months)

Treating the Recession

President Obama came into office during the worst recession since the Great Depression. It
was clear that what might have been an ordinary recession a few months earlier was taking on
ominous proportions. That day Americans learned that they had lost more than half a million
jobs in November.

30

Over January and February of last year, other countries also began to report staggering
declines in output and employment. Any hope that growth in the rest of the world might help
to cushion the decline in the United States was dashed. We were clearly facing a worldwide
contraction unlike any we had seen for more than a generation. In the United States, people
lost almost 3 million jobs between November and March.
The key source of the recession was clearly the popping of the housing bubble and the
ensuing financial crisis. In a matter of months, trillions of dollars of household wealth were
destroyed, setting off a rapid decline in consumer spending. The collapse of Lehman Brothers
and the runs on money market mutual funds and other financial institutions caused credit
spreads to skyrocket and key sources of credit to dry up. Swift action by the Federal Reserve
and the Treasury in the fall of 2008 had helped to avert an all-out panic, but throughout the
following winter, stock prices continued to fall and credit standards steadily tightened. The
entire financial system was in a state of anxiety and paralysis.
President Obama understood that this was an all-out crisis that required an all-out policy
response. Working with Congress, the Administration took several major actions within its
first few months.
Most obviously, the American Recovery and Reinvestment Act was passed. The Recovery
Act was the boldest countercyclical fiscal stimulus in American history. It included $787
billion of tax cuts and spending, with the total split roughly one-third tax cuts, one-third
government investments, and one-third aid to the people most directly harmed by the
recession and to troubled state and local governments. Already, American families have
received more than $200 billion in tax cuts and in relief payments such as unemployment
insurance. Thousands of investment projects are already underway, including everything from
roads and bridges to a smarter electrical grid and clean energy manufacturing.
The Administration worked with the Federal Reserve and the FDIC to help repair the
financial system. Perhaps the most important action was the stress test that gave a
comprehensive evaluation of the health of the 19 largest financial institutions. This careful
scrubbing of the books, together with the governments pledge to fill any identified capital
shortfalls that the institutions couldnt fill by raising private capital, helped to restore
confidence in the financial system. It also led to a spurt of private capital-raising that put our
financial institutions on a much more secure footing. Credit spreads decreased substantially
and stock prices recovered greatly.

31

The Administration also worked to stabilize the housing market and stem the rising tide of
foreclosures. The Treasury worked with the Federal Reserve to help reduce mortgage interest
rates, resulting in lower payments for the millions of Americans who refinanced their homes.
We also set up a program that helped responsible homeowners facing foreclosure get more
manageable mortgage payments.
These policy actions complemented the Federal Reserves actions. Monetary policymakers
quickly reduced the policy interest rate to nearly zero. They also undertook large-scale
purchases of government bonds and mortgage-backed securities to further reduce longer-term
interest rates. And, they created programs that successfully restarted some of the securitized
lending that had evaporated following the crisis.
This all-out policy response has made a huge difference.
Now, the economy still has a very long way to go. The loss of output and jobs in the recession
has been so severe that it will take a number of quarters of robust growth and job creation to
restore the economy to full health and full employment. The policy response is a big part of
the reason that we are on the road to recovery.
The Council of Economic Advisers was charged by Congress with reporting each quarter on
the economic impact of the Recovery Act. It is a responsibility that we take very seriously.
Over the past year we have analyzed the impact of various components of the Act--including
the state fiscal relief, the clean energy provisions, and the tax cuts and income-support
payments. Each in-depth analysis has shown strong impacts on growth and jobs.
The most recent report estimated that the Recovery Act has saved or created roughly 2
million jobs. That means 2 million people are employed today who wouldnt have been
without the Act. The estimates are based on two different approaches and are similar to those
of private forecasters and the nonpartisan Congressional Budget Office. They are also
consistent with the direct recipient reporting data. Recipients of about 15 percent of Recovery
Act funds file a form each quarter about the number of jobs funded by the Act. The newest
reports for this small subset of Recovery Act funding identified almost 700,000 directly
funded jobs.
But perhaps the best way to see the impact of the Recovery Act is not in our overall jobs
estimates or even the aggregate economic statistics. It is to take stock of what it is doing on
the ground, in states like Ohio.

32

The Act has provided over $2 billion in state fiscal relief to Ohio. This funding has saved
thousands of teacher jobs and allowed the state to deal with the devastating impact of the
recession on its budget without significant tax increases. The Act is also supporting more than
400 transportation projects in Ohio and over 2000 loans to Ohio small businesses. This is
spurring job creation and long-term public and private investments that are turning the Ohio
economy around and will make it even stronger in the future.
Equally important, the Act has provided $2 billion of tax relief to 4 million working
families in Ohio, another $2 billion of aid to almost a million unemployed workers and
others in the front lines of the recession here, and half a billion dollars of one-time payments
to 2 million Ohio seniors and veterans. This tax relief and income support is not only helping
families get through hard times. By putting money in peoples pockets, it is supporting
demand, and so making the recession less severe and the recovery stronger than they
otherwise would be.

What More Needs to Be Done?

Because of the actions taken, the economy is decidedly better--the treatment is working. With
an overall unemployment rate of 9.7 percent, it is clear that while the economy may be
recovering, it has not yet recovered.

33

Fundamentally, the economy is still suffering from a deficiency of demand. Recessions occur
when, for reasons such as a financial crisis or a decline in wealth, consumers and firms stop
buying. Producers respond to this falloff in demand by producing less and laying off workers.
The resulting unemployment further reduces demand.
Recoveries happen when spending begins to rebound. And that is exactly what has been
happening.
But, even though demand is growing again, its level is below where it was when the recession
started, and far below where it would be if we had grown normally over the past two years.
The Congressional Budget Office estimates that demand (and hence output) is at least 6
percent below its trend path.
For example, while business investment in equipment and software is growing again, it is
starting from a painfully low level, and so is still low in an absolute sense. And business
investment in structures--that is, the building of factories, office buildings, and shopping
malls--is continuing to fall. Likewise, consumers are spending more, but housing construction
remains low and actually fell again in the first quarter. So an important traditional source of
demand and employment remains in the doldrums.
Finally, at the same time that Federal government spending is increasing demand, state and
local governments are retrenching. The recession has had a devastating impact on state and
local revenues, and governments are being forced to cut back on essential services. Projected
budget shortfalls for state and local governments are roughly $300 billion over the next two
fiscal years. If these shortfalls are closed by tax increases, the negative impact on consumer
spending could be substantial. If they are closed by laying off teachers and first responders, as
many reports suggest is likely to happen, the impact on education and public safety could be
terrible.
Todays painfully high unemployment rate is a direct consequence of the shortfall of demand.
Unemployment is not high because of structural changes or because workers arent trying to
find jobs. It is high because we are not producing at anywhere near a normal level.
What all of this means is that it is essential that policymakers continue to take steps to help
generate private demand and growth. It is not enough that output and employment are
growing. We need to spur robust growth that will speed the return of output and employment
to normal. That is why the President has been working with Congress to pass a small business

34

jobs bill. One key piece of this package is a lending fund that will help small businesses get
the credit they need to grow. Another piece eliminates capital gains taxes for people who
invest in small businesses.
The President is also continuing to work with Congress to further jump-start the
transformation to clean energy. One program in the Recovery Act, the clean energy
manufacturing tax credit, has been very successful in helping American firms establish
themselves as producers of clean energy products such as wind turbines and solar panels.
This program was greatly oversubscribed. Further investments in this area would be good for
job creation and the long-run health of the economy.
More aid to state and local governments would also be incredibly helpful. The dire condition
of state and local budgets is one of the most difficult headwinds the U.S. economy faces on
the road to recovery. Finding the funds to keep teachers in the classroom and to maintain
essential services is one of the most effective things we could do to support families,
communities, and local businesses.
The additional actions we are talking about are very well targeted. We have looked for
programs with the very highest bang for the buck. We are all very aware of our large long-run
fiscal challenges and the need to begin to take steps to get our fiscal house in order. The
President is absolutely committed to dealing with the budget deficit as the economy recovers.
But, it would be penny-wise and pound-foolish to try to deal with our long-run problem by
tightening fiscal policy immediately or foregoing additional emergency spending to reduce
unemployment. Immediate fiscal contraction would inevitably nip the nascent economic
recovery in the bud--just as fiscal and monetary contraction in 1936 and 1937 led to a second
severe recession before the recovery from the Great Depression was complete. And nothing
would be more damaging to our fiscal future than a protracted recession that eventually led to
permanently higher unemployment. Responsible, targeted actions today that help the private
sector come back more strongly is the right policy both for people and for the long-term
health of the economy.

35

Preventing Future Crises through Financial Regulatory Reform

In addition to doing more on jobs, the President has another key item on the legislative
agenda: financial regulatory reform. Compared with steps to deal with our immediate
jobs problem, financial reform may seem to be something that matters only inside the
beltway and on Wall Street. Nothing could be further from the truth. It was an inadequate
financial regulatory and monetary framework that led to the stock market crash of 1929 and
to the catastrophic waves of bank failures starting in 1930, and so to the Great Depression.
And it was the failure to update our regulatory system in response to decades of financial

36

innovation that led to the excesses of the early part of the past decade and to the disastrous
near-meltdown of the financial system in 2008 and 2009, and so to the Great Recession.
Thus, putting in place sensible new rules of the road that will help prevent the next crisis is
important to all Americans.
This is something that should not wait. Memories are short and already we see some willing
to put off necessary reforms. An earlier generation put in place a regulatory framework that
kept their children and grandchildren safe from financial panics for 75 years. We need to
follow their example and take the challenges of the moment and channel them into
modernizing that regulatory framework to ensure that our children and grandchildren remain
safe for at least another 75 years.
How will the new rules help to prevent financial crises?
Improving Regulation. A central feature of the legislation is more thorough regulation and
appropriate capital requirements. One thing that we learned from the crisis is that some very
important financial institutions whose failure could threaten the entire system had managed to
slip through the regulatory cracks. That cant happen again. In the proposals, any financial
institution that is large enough or interconnected enough with other institutions that its failure
would threaten the whole system is regulated by the Federal Reserve. It doesnt matter
whether the institution calls itself a bank, a hedge fund, or an insurance conglomerate like
AIG.
This way, one regulator will be in charge and will be held accountable for thorough
monitoring of these institutions.
For the first time, key regulators will be required to consider not only the safety and
soundness of the particular institution, but the stability of the entire system. A council of
regulators will be on the lookout for new risks developing, and individual regulatory agencies
will ensure that they are adjusting standards to protect the system.
The best way for regulators to ensure that financial institutions dont fail, and that they dont
gamble on the assumption that the government will save them if things go sour, is to require
them to have serious skin in the game. That is why capital requirements will be a central tool
of regulation. Capital provides the key buffer between bad outcomes and default for a
financial institution. And, because it means that the institutions own money is on the line, it
provides incentives not to take unreasonable risks. By setting appropriate capital

37

requirements, and by setting them higher for the largest, most interconnected institutions, we
build stability into the system. That is what the legislation will require regulators to do.
Eliminating Bailouts. Another way to ensure that financial institutions are prudent and to
protect taxpayers is to make it very clear that institutions will not be bailed out. One thing we
saw in the crisis is that under the current system, when a large financial institution is on the
verge of default, policymakers are faced with a choice between two very bad options. They
can let the institution go into conventional bankruptcy. But, as we saw with Lehman Brothers,
the slowness and uncertainty of standard bankruptcy make it likely that one failure may
trigger runs on other institutions, threatening to bring down the whole system and causing
enormous damage to the economy. Or policymakers can hold their noses and bail the
institution out. But, as we saw with AIG, this has the effect of putting taxpayer money on the
line and softening the costs of the very behavior that caused the problem.
The way to prevent the need for bailouts is to create a third option. That is what resolution
authority is all about. Resolution authority is a sensible mechanism to wind down a deeply
troubled financial institution. In the proposed legislation, the shareholders are wiped out and
the management is fired. The government then sets up a bridge to wind down the institutions
other obligations. If there are costs beyond those that can be covered by the sale of the
institutions assets in the orderly wind down, the legislation calls for a fee to be placed on all
large financial institutions to ensure that there are no costs to the taxpayer. The legislation
puts an end to bailouts. Shareholders and management are held responsible if their institution
gets into trouble, and the system as a whole pays for any costs.
The existence of a sensible resolution regime means that we have a way to deal with a large
troubled institution without generating a system-wide panic or bailing out shareholders.
Indeed, at its best, the presence of a good resolution regime could mean that management and
shareholders know they wont be bailed out, and so they would have strong incentives to
monitor risk and behave responsibly--with the result that the resolution authority wouldnt
have to be used.
Regulating Derivatives. Another essential part of the proposed reform is that it requires much
more transparency for derivatives. These financial products whose payoffs are derived from
other assets have a useful role in hedging risk. For example, farmers may want to protect
themselves from the uncertainty about the prices they will receive for their crops, and firms
that buy inputs from abroad may want to protect themselves against big swings in exchange

38

rates. But what was once a minor sideshow to asset markets has grown to be a multi-trilliondollar market of its own. An important source of trouble revealed during the crisis is that
regulators and market participants had little knowledge of the risk exposure of key financial
institutions.
The legislation brings derivatives out of the shadows. By requiring many derivatives to be
traded on exchanges, the new rules of the road ensure that prices are set by market forces in a
transparent way. Requiring many contracts to be put in clearinghouses allows the various
transactions to net out and ensures that margin payments are proportional to risk. This will
prevent us from waking up again to the terrifying realization that a single firm such as AIG
held billion of dollars of net exposure to derivatives, and that its failure would spiral through
the system.
As with the other pieces of the proposed regulatory framework, the new rules on derivatives
are designed to maintain what is good about the financial system while making it safer. A
well-functioning financial system is essential to mobilizing savings into productive
investment and to spreading risk. The rules we are proposing and Congress is working to pass
are carefully designed to maintain efficiency while giving much stronger incentives for safety
and stability.
The Administration is also actively working to harmonize financial regulations across
countries. It would be terrible if financial firms fled countries with responsible regulations for
unregulated countries. The United States is playing a major leadership role in working toward
better regulations, capital requirements, and resolution mechanisms worldwide. This is
essential, because, as we learned in the crisis, our financial markets are intimately linked with
others throughout the world. We are each safer when other countries are also imposing
sensible rules.
Protecting Consumers. A final key feature of financial regulatory reform is the creation of a
consumer financial protection agency with independent rule-making and enforcement
authority. There needs to be a single agency whose only mandate is to watch out for the
consumers of financial products. Too often in recent years, sophisticated financial institutions
have taken advantage of consumers through financial products that were too complicated,
deceptive, or flat-out fraudulent.

39

Often all that is needed is greater transparency--terms and conditions for products such as
mortgages and credit cards that are easy to read and easy for a lay person to understand. With
greater clarity, American families and small business owners will have better information to
help them make the financial decisions that work best for them. But sometimes what is
needed is for regulators to identify and limit practices that are deceitful, harmful, or aim to
take advantage of consumers.
A consumer financial protection agency will not only even the playing field between
consumers and sophisticated financial experts, but also increase the stability of the system.
Though many factors played a role in generating the bubble and bust in the housing market,
questionable lending practices and unconventional mortgages that only made sense in an
ever-rising market were contributing factors. Transparency and more focus on consumer
understanding and fair dealing will surely help facilitate sounder behavior.
Importance of Reform. In making the case for the importance of regulatory reform to
families, policymakers often focus on the consumer financial protection agency. And it is
unquestionably important. But while capital requirements, resolution authority, and
derivatives may sound far removed from everyday life, they are also essential. The central
goal of regulatory reform is to prevent future crises and their attendant fallout on tens of
millions of workers, homeowners, and businesses. Thus, all of regulatory reform is about
protecting ordinary Americans.
Preventing future financial crises is something we owe to ourselves and future generations. If
there is anything the last two years has taught us, it is that a well-functioning financial system
is important to us all. When the financial system melts down, as it did in the fall of 2008, it is
not just Wall Street bankers who feel the pain. Firms cant get loans to buy materials or cover
payroll. As a result, production grinds to a halt and workers are laid off.
Families cant get credit to buy cars, houses, or a college education for their children. As a
result, auto sales plummet, construction ceases, and dreams are put on hold. We have lost
more than 8 million jobs largely because of the fallout from the financial crisis. None of us
ever wants to live through this ever again.
To prevent it, we need sensible rules of the road that encourage responsible behavior, protect
consumers, increase transparency, and build in mechanisms for keeping pace with financial
innovation. That is what the President is working with Congress to craft.

40

As the Senate begins to debate financial regulatory reform, there will surely be many twists
and turns in the legislative process. The Administration will work with lawmakers to hold the
line on preventing loopholes and ensuring that the bill prevents both irresponsible practices
and bailouts. The President will insist on genuine reform that holds financial firms
accountable. He will also not hesitate to stand up against changes to the plan that may sound
tough at first, but in fact leave the system even more vulnerable than it is now. He will take
the heat, if it means we end up with a better bill. Because at the end of the day, what matters
is that we create a new regulatory framework that makes the financial system safer.

Conclusion
In describing the economy, I have the feeling of a doctor looking at a once-deathly-ill patient
with a new sense of hope. The patient is weak to be sure--but clearly recovering. The
economy is going to make it. This means that our short-term focus can shift from crisis
management to working to do all that we can to make the recovery as speedy as possible.
It also means that its time to start looking forward to prevention. Just as with a patient who is
coming back from a heart attack, we need to not only do our best to hasten the recovery; we

41

need to make important lifestyle changes that will keep us healthy in the future. The trauma
of the past years has shown us just how horrible the fallout from a financial crisis can be. We
need to put in place good financial regulatory reform to safeguard us against a repeat. We
must take what we have learned and channel it into a stronger and more secure financial
system, and a better future for us all.

BIBLIOGRAPHY

http://ftp.iza.org/dp4934.pdf
https://en.wikipedia.org/wiki/Great_Recession
http://www.nber.org/papers/w16407
http://www.nber.org/papers/w16407
http://www.russellsage.org/research/chartbook/great-recession
http://www.russellsage.org/research/social-effects-great-recession-description

42

http://study.com/academy/lesson/what-was-the-great-recession-timeline-facts-causes-

effects.html
www.bea.gov.
www.bls.gov
https://muddywatermacro.wustl.edu/node/95
https://www.whitehouse.gov/administration/eop/cea/speeches-

testimony/treatment_and_prevention
https://www.economy.com/mark-zandi/documents/End-of-Great-Recession.pdf