A Recap of the 2008 Financial Crisis: Aftermath
By: Larry Zhang, Senior Editor
The 2008 financial crisis left millions unemployed and trillions of potential dollars wasted.
The impact of the recession was particularly disastrous for the United States, with American corporations taking some of the hardest blows. For example, instead of risking the extinction of General Motors and Chrysler, President Bush spent $17 billion in loans to keep the two auto giants above water. The Treasury also invested $5 billion with GM’s financing company, GMAC, and granted it another $1 billion in loans. By the end of 2008, all of the world’s major players saw their economies either drowning under the weight of the recession, or barely staying afloat. In the last quarter of 2008 alone, the U.S. lost nearly 2 million jobs, skyrocketed to a 7.2% unemployment rate (up from a recent low of 4.4% in March), and shrank in output by 0.5% in just the third quarter. With layoffs all around the country and sharp declines in consumer spending, these numbers only worsened. By one Federal Reserve estimate, the U.S. lost about a year’s worth of economic activity between 2007-2009, or $14 trillion.
What did such chaos mean for America’s citizens? Well for starters, states cut back on spending immensely, and were forced to shrink the public workforce. While the private sector saw wage increases of 1.7%, state and local government wages grew by only 1.2% during the same period in 2012. In addition, labor changes were inevitable, with health and retirement cuts, pay freezes, salary cuts, and furlough days all enacted without much choice. For businesses, expansion was no longer in the foreseeable future, workers were laid off, and worker compensation underwent major changes. For the individual, the recession meant a delayed future, with home purchases flooring downwards from previous years.
Such devastation was especially problematic because real estate markets served as the backbone of economic growth, and homes were long-term investments that ushered Americans into an opportunity for middle-class life. Because of the recession, the housing bubble finally burst and collapsed the real estate market, leaving millions of Americans in the face of foreclosure and millions of others struggling with their livelihoods. Home prices plummeted, but home ownership rates fell, too. In fact, home ownership rates of households with children under 18 declined 15% between 2005-2011, according to the Census Bureau. For years after the recession, the housing market was an obstacle all too difficult to surmount for many Americans, with lending regulations having tightened in an effort to prevent the same mistakes, such as predatory lending, which contributed to the housing bubble in the first place. And with new legislation such as the Dodd-Frank Act, designed so that consumer exploitation never occurred on such a level again, potential homeowners were having a tougher time than ever as they searched for homes. The challenge for such legislation, then, is to fairly assess potential homeowners who were victims of the crisis themselves.
Job growth was also bleak, and in some cases, negative. The economy lost 8.7 million jobs between December 2007 and early 2010. In addition, the Economic Policy Institute estimates that inflation-adjusted wages for U.S. workers grew by only 1.5% between 2000-2007, though wages declined for the bottom 70% of workers during the five years after, reversing any modest gains in compensation. And at the state level, mass reductions in state budgets spelled other problems indirectly related to the workforce. In the 2012-2013 school year, 35 states had K-12 inflation-adjusted funding amounts that were below pre-2008 levels, according to the Center on Budget and Policy Priorities. Summer and after-school programs were often the first to be neglected with the decreased funding, and bigger class sizes were all but inevitable. Higher education was also affected, with states having cut spending on each college student by estimates of more than 28% between 2008-2013. For those pursuing higher education, this meant tuition skyrocketing to new levels.
Tragedy did not stop at the national level, however. While the largest corporate and financial institutions were enveloped in their own fair share of chaos in America, matters outside the U.S. were in some ways just as tragic. In the U.K., the government had to spend $88 billion to bail out banks, and guaranteed another $438 billion in bank loans. In Iceland, the nation’s three largest private banks collapsed, whose assets were worth more than eleven times the nation’s own GDP. Because of how large its financial system was in comparison to the actual country itself, Iceland and its central bank was unable to act as a lender of last resort, leading to the banks defaulting after trouble with refinancing their short-term debt. The sheer magnitude of the Nordic country’s banks was a major problem unto itself, and with their collapse, streams of economic problems and political unrest followed.
With Europe as a whole, its largest economy, Germany, for instance, saw economic output falling at annual rates of 0.4% and 0.5% in the second and third quarters of the crisis, respectively. Since the euro’s debut in 1999, total output in the fifteen Eurozone countries shrank by 0.2% during each of the second and third quarters of ‘08. It wasn’t until late fourth quarter that major policies were put into play, with the European Central Bank responding by implementing rate cuts for both the Bank of England and Sweden’s Riksbank. The Swiss followed suit a week later by slashing its benchmark rate to a range of 0-1%. Concurrently, the EU governments engineered mass public-spending programs designed to pump as much money into their economies as they could reasonably hold. The French government, for one, stated that they would dedicate $33 billion worth of spending to fiscal policy over the next two years. Other EU countries undertook similar actions, but one key player, Germany, had called for fiscal restraint.
In Asia, China and Japan, two of the regions largest exporters, suffered blows from falling consumer demand. In the second quarter of ’08, Japan’s output fell by 3.7%, with major exports having fallen an annual total of 27%, come November. Japan responded in a similar fashion to that of the EU, pledging a total of $300 billion in government spending by December of the fourth quarter. Meanwhile, China saw its economy continue to grow, though not at the monstrous double-digit rates of earlier years. Nonetheless, the government was forced to dedicate $586 billion to a stimulus plan, and cut interest rates repeatedly.
In terms of recovery, there is still a long way to go before the U.S. economy (and the world’s) fully distances itself from the effects of the meltdown. But while it does, we should be both cautious and understanding of the legislature and policies that have and haven’t been implemented, or have and haven’t been championed forward, in the name of regulating and saving our economy. Take, for example, the idea that the government further worsened the crisis, and should have just let the markets save themselves. This idea is wrong when examining the failures of big banks such as Lehman Brothers and Wachovia, and all the other banks nearing collapse. When Lehman was allowed to fail in 2008, its demise shut down short-term money markets, choking the flow of money. Instead, the Fed and the government had to supply $14 trillion to stop the ensuing panic after Lehman’s fall.
In addition, it’s important to understand that the Volcker Rule, at least in its current state, will not save us. The Volcker Rule, which is designed so that banks can’t make risky trading bets with taxpayer money, still allows for banks to invest billions through hedge funds, which are exempt from current law. In addition, differentiating between market making in terms of securities transactions and banks speculating for their own accounts is near impossible. If the Volcker Rule is to be kept, its hedge fund loophole should at least be closed. This is exactly the solution that Tom Hoenig, former head of the Kansas City Fed and current acting vice chairman of the FDIC, proposes. Under Hoenig, big banks should not be broken up by size, but rather by function, with the importance of eliminating banks’ ability to trade and hedge highlighted as a step to reduce high-risk banking activity. Banks would still be allowed to engage in activities such as underwriting bonds and stocks, and not pressured to return to Glass-Steagall rules of the Depression-era.
Speaking of Glass-Steagall, reinstating such rules would be vastly ineffective. Activities would have continued with or without Glass-Steagall, such as mass investment in notoriously bad mortgage loans. By reinstating Glass-Steagall and expecting it to prevent another financial apocalypse, we can also expect firms such as Bear, Lehman, Merrill, Fannie Mae, Freddie Mac, AIG, and other such firms at the center of the crisis to remain totally unaffected in their practices. And the notion of breaking up big banks is no better, either. Size limits on banks would make the U.S. uncompetitive in financial services, and imposing costs on U.S. banks would in turn impose costs on U.S. businesses and consumers. Furthermore, many of the players at the heart of the crisis could not even be categorized as “too big too fail,” as Bear Stearns nor Lehman Brothers was in the top 15 of banks in 2008. And when we look to the past, we see that small banks are no guarantee of stability either, as from the Great Depression Era. So it’s important to set one thing straight: big banks are not the problem. The problem is overleveraged banks making highly questionable bets with borrowed money. Instead, we should turn to Hoenig’s insights and strengthen the Dodd-Frank Act and similar legislature, and seek to limit leverage by forcing banks to hold more capital.