Recession 2007 to 2009

Beginning in 2007 and through 2009, the world economy was in turmoil. In this lesson, you'll learn about the Great Recession; why it happened, the events that made it worse, and what it meant to the United States and the world.

The Lead-Up

Over the past century, the setup for recessions in the United States has been largely based on the economic cycle of growth and contraction. After a few years of a robust and flourishing economy, the wheels of industry take a brief rest. When the economy slows, the Federal Reserve can set interest rates lower, making money cheaper and thus encouraging growth. Once the economy is growing again, the Fed quietly backs out and carefully observes.

This strategy, one that was used for nearly 100 years before the financial crisis of 2007-2008, has been used plenty of times before. Alan Greenspan, Chair of the Federal Reserve, used it again to help push along a slowing economy still suffering from 9/11. But, there was a slight difference this time that would end up leading to financial disaster, and, for some countries, financial ruin. No one bothered to turn off the faucets of cheap money (low interest rates).

Low interest rates make the economy grow because it means money is easier to borrow. Interest is the cost of money, so just like any asset, when the price goes down, demand goes up. Businesses could borrow cheap money to expand their capacity and consumers could borrow cheap money to buy things from those businesses. This meant more production, more jobs, and more credit-worthy citizens. This is the sign of a healthy economy, except for one small detail - much of the money that was paying for the growth in the economy after 9/11 was borrowed.

After years of record profits for banks, homebuilders, and all kinds of companies - reflected by all-time high levels in financial markets - it came time to pay the piper. Investors weren't the only ones hit; homeowners had created demand that had inflated asset prices (home prices) to unsustainable levels. Suddenly, no bank was willing to be the one that took the next bit of risk. Everyone (individuals and companies) seemed so leveraged that no one wanted to lend. No lending meant no buying. No buying meant no production. No production meant no jobs. No jobs meant defaults on loans. In 2007, the cycle began.

Timeline of the Great Recession

A recession is when a country experiences two or more quarters of contraction in their economy. GDP in the United States had averaged around 1% per quarter prior to 2007, but beginning in the fourth quarter, those numbers started to shrink. In the fourth quarter of 2007 and the first quarter of 2008, the United States hit a recession. Technically, the recession ended in the second quarter of 2009 after four quarters of negative GDP growth, but because of the severity of the recession, it took longer for many parts of the economy to turn around.

As discussed earlier, years of cheap money, excessive spending, and negative savings rates led to the recession, but the ultimate trigger for the recession was the uncertainty surrounding the financial industry. By the fall of 2008, four major mortgage providers had declared bankruptcy, and in September 2008, three of the largest financial institutions in the country, with roots back as much as 100 years, declared bankruptcy. When AIG, Lehman Brothers, and Bear Sterns all collapsed, everyday Americans were faced with the question, 'If the smartest minds in finance couldn't get their money, can I?'