After more than two-year financial malaise, signs of recovery finally emerged in 2009 as the economy expanded for the first time in a year in October and stock markets surged above 50% from their the bottom in March. A major challenge to a full recovery is the struggling labor market with a 10.2% unemployment rate.
Housing bubble burst and subprime mortgage disaster in 2006 led to a series of stunning financial closures. They changed the face of Wall Street forever, turned the United States economic to the most serious crisis since the Great Depression, and eventually sent the global financial system into turmoil in the fourth quarter 2008.
Precursors: Housing bubble build-up The precursors of this crisis went back as early as 2000 when the tech bubble burst, followed by the Fed’s lowering interest rates to stem the recession. Lower interest created the housing boom, ensued by the period of careless mortgage lending and the complex financial instruments to slice up and resell the mortgage-backed securities intended to spread risk.
As the quality of the mortgages went down, subprime mortgage and loans default and delinquency rate began to rise in 2006.
2007: The crisis began with subprime mortgage bubble burstAs a result of the rising number of foreclosures and mortgage backed securities defaults, in June 2007 two Bear Stearns hedge funds that had invested heavily in the subprime market collapsed.
More banks found that securities they thought were safe were tainted and became toxic mortgages. At the same time, the number of prime mortgages in default increased, and the rising number of foreclosures facilitated speed of the fall of housing prices.
For the first time in over a year, the Fed cut the Federal Funds rate by 50bp to 4.75% to prevent a steep housing slump and turbulent financial markets from triggering a recession.
2008: Gloomy year for U.S. and world economyAs Wall Street’s losses mounted, in March 2008 the Fed staved off a Bear Stearns bankruptcy by assuming $30 billion in liabilities and engineering a sale to JPMorgan Chase. The government-engineered sale of Bear set off a new phase of financial turmoil and Wall Street’s meltdown.
In the fall of 2008, problem is the credit markets ballooned into Wall Street’s biggest crisis since the Great Depression. The financial turmoil began to accelerate in September 2008 and eventually turned into a full-blown global financial crisis.
During this biggest financial crisis since the Great Depression, the U.S. government had to rescue the nation’s two largest mortgage finance companies, Fannie Mae and Feddie Mac, and bailed the troubled insurance giant A.I.G. out. Lehman Brothers went bankrupt and Merrill Lynch was sold to Bank of America. The Lehman Brothers bankruptcy marked the largest bankruptcy in U.S. history, with more than $600 billion of debt.
Mighty investment banks that once ruled high finance crumbled or reinvented themselves as humdrum commercial banks, which is subject to tighter regulation, in exchange for more access to the Federal Reserve's lending facilities. The channels of credit, the arteries of the global financial system, constricted, cutting off crucial funds to consumers and businesses small and large.
As global stock markets plummeted and economies shrank, many currencies sank. The unemployment rate jumped as million of jobs evaporated. America and Europe reacted to the crisis by unveiling broad bail-out packages for the financial system. The U.S. government passed a $700 billion financial bailout package and the Fed made unprecedented market interventions, such as buying large amounts of short-term debt issued to companies to enable day-to-day financing and to rejuvenate a reeling economy.
Most central banks slashed interest rates. By the end of 2008, the Fed had cut its target for the overnight federal funds rate to near zero (range of zero to 0.25 percent) and brought the U.S. to the zero-rate policies.
In December 2008 America was officially declared to have been in recession since December 2007; and Japan and the euro area fell into recession (using the definition of two quarters of negative growth). The IMF, World Bank and OECD snipped their projections for economic growth next year.
At the end of 2008 authorities arrested money manager Bernard Madoff, a onetime Wall Street legend. He was charged with running the largest Ponzi scheme in financial history, a $50 billion fraud that wiped out many investors.
Over the last 12 months that were ruled by negative economic indicators and widespread fear, the S&P Index decreased about 40 percent, for a loss of more than $6 trillion.
(Read “A kaleidoscope of the critical events in 2008”)2009: Year of recovery In the beginning of 2009, the U.S. government adopted a $787 billion economic stimulus measure to beef up the ailing economy. As the unemployment rate surged to 8.1 percent, stock markets hit the bottom in March.
At the end of second quarter, ten big banks began to exit bailout program by repaying federal aid that had sustained them through the worst of the economic crisis.
Signs of a recovery began to emerge in August. Positive economic data across the globe offered a hint that the worst of the financial crisis had passed, though many cautioned that the after-effects were likely to persist for quite some time.
The third quarter probably marked the end of the longest recession since World War II, with the economy expanding at an annual rate of 2.8 percent for the first time in a year. The report does not mark the official end of the recession, though. That determination will be made by the National Bureau of Economic Research, likely sometime in 2010 once all the various economic readings have had their final revisions.
As the economy emerges from its deep recession, labor market continues to struggle with the U.S. unemployment surged to 10.2%, its highest level in more than 26 years, as employers cut more jobs in October.
(Read “A kaleidoscope of the critical events in 2009”)