The Bursting of the Housing Bubble and Its Consequences on the US Economy

The Great Recession was a significant economic downturn that started in the United States in 2006. The housing market bubble burst, leading to a sharp decline in housing prices and a subsequent crash of the stock market. This had severe consequences for the economy, including high levels of unemployment, foreclosure, and bank failures. The recession led to a loss of $16 trillion, resulting in widespread job losses and economic instability. The government and Federal Reserve intervened to stabilize the economy, but it took years to recover from the effects of the Great Recession.

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Economics for Managers
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Introduction
An economy, by nature is expected to be dynamic and deals with the mutual interactions
of the demand and the supply forces existing in the framework. The dynamic stability of any
economy depends on the dynamics of these two forces and how they come in agreement to reach
an equilibrium state, in the short run as well as in the long run. However, apart from these two
forces, there are other variables, which can cause fluctuations in the economy, giving rise to
special conditions in the economy for the time being. One such abnormal economic condition is
known as recession (Eaton et al 2016). By the term recession, a temporary economic decline is
meant, when the general economic activities are reduced and the implications are seen in the
reduced GDP and GDP growth rate of the concerned economy for that particular period.
Recession, however, depending upon the nature and magnitude, can have long term implications
(mostly negative) on the concerned economy (Rabie 2013). The essay tries to analyze the
phenomenon of Great Recession, which occurred in the United States of America, during the
time period of 2007-2008 and had huge implications on the economy of the country and in the
global economic scenario as a whole. The essay emphasizes on discussing the causes of this
Great Recession and analyzing these causes in terms of economic theories and concepts.
What is a recession?
The term recession, in terms of economics, means an overall slowdown of the economy
in terms of the productive, trading and industrial activities, due to a loss of the confidence from
the consumer as well as producer sides over the economy. This in turn, leads to an overall
reduction in aggregated demand, which results in a lowered supply, low wages, employment and

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low standard of living of the residents of the concerned economy. The negative performance of
the country in the different economic aspects can be clearly seen in the unimpressive GDP
statistics of the country at that period. However, the declining GDP is the effect of recession and
should not be taken to be one of the factors contributing to it, as is confused to be, because GDP
is generally recorded after the initiation of the event (Auerbach and Gorodnichenko 2012).
Often, recession, due to its nature of creating negative events in cyclical manner, leads to the
creation of a viscous cycle, which spirally takes the economy towards the path of economic
downturn. The process goes on if the governing bodies and the monetary authorities of the
economy do not intervene and take abrupt actions to reduce the effects of this economic
phenomenon (Allen 2016).
In general, there may be many factors, which cumulatively contribute to the initiation of
recessionary situations in an economy. Few of the important ones are as follows:
a) High interest rates prevalence- Existence of an overall high level of interest rate in the
economy encourages people to save more, which, in turn affects the demand conditions of the
economy, thereby reducing the supply side activities of the economy eventually and taking the
economy on the path of initiation of recession in the future periods.
b) Crash in the stock market- Recession can also be caused by a sudden loss of confidence of the
investors, which may result in draining away of capital from the market, slowing down the
economy (Cynamon, Fazzari and Setterfield 2013).
c) House market irregularities- A sudden and long term fall in the prices of the residential assets
can also trigger recession as housings are also seen as a type of asset building. If the prices of
these assets start to decline, the customers start losing out confidence over the market, thereby

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leading to foreclosures and an overall slowdown of the investing activities. The problem
becomes even more acute in the populous developed countries as a significant share of the total
investment amount of these countries is comprised of residential investments, which poses as an
avenue of channelizing investment and building up of assets (Danziger, Chavez and
Cumberworth 2012).
Apart from the above mentioned factors, recession can also be caused in a country, due to
factors like wage controls, asset bubbles, crunches in the credit markets and abnormal
phenomenon like slowdown due to state of war or huge natural or man-made catastrophe.
The Great Recession of the USA:
The economy of the United States of America, has been and still is considered to be one
of the strongest economies in the global scenario. The country has significant influence on the
global economy as much of the global conditions depend on the economic strategies taken by the
country. However, the more or less stable economy of the country has had its share of turmoil
and fluctuations, two of which are of immense implications on the economy. One of these events
is the Great Depression of 1930s and the other one is the Great Recession, which the country
faced from 2007 to 2009-2010 (Jenkins et al 2012).
According to the data provided by the National Bureau of Economic Research, the USA
started experiencing the initiation of this recessionary situation from the last quarter (specifically
from December) of the year 2007. The recession led to a tremendous backlash in the economy,
with the GDP statistics of the country stooping to new lows. The GDP of the country contracted
by 51% during that period of time, the rates being the worst the country had experienced since

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the Great Depression of the 1930s (O'higgins 2012). Apart from the GDP, the employment
scenario of the country also decreased to a huge extent during that period, as can be seen in the
following graph:
Figure 1: Employment Population Ratio of USA 1900-2016
(Source: Bls.gov, 2017)
As can be seen from the above figure, the employment population ratio of the country,
remaining otherwise stable and having a general upward trend over time, experienced a steep
decline in the period between 2007-2009, with the rate reaching stability at a significantly lower
level, in 2010. The country slowly is gaining back in this aspect but the implication of the
recession has been huge and long term on the employment sector of the country as is evident
from the above figure (Boldrin et al 2013).

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The overall consumption demand also decreased significantly due to the fall in wage rate,
employment and an overall slowdown of the economy:
Figure 2: Personal Consumption Expenditures in USA on a quarterly basis
(Source: Bls.gov, 2017)
Figure 2 shows that the consumption expenditures, which otherwise maintain an upward
trend, in the country, had a sudden and stiff fall during the time period between 2007 and 2009.
This in turn led to the overall slowdown of the supply side activities also, thereby showing the
initiation of the Great Recession in the country. It took the economy much time to overcome the
effects of this phenomenon (Farmer 2012).

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Causes of the Great Recession
There has been significant debates regarding the factors that caused the Great Recession
in the USA and while economists differ in opinions in many aspects, almost all of them
unanimously agree on one cause. The primary factor, which caused this phenomenon in such a
great magnitude, was the irrational and abnormal exuberance in the residential investment sector
of the economy in the periods prior to the occurrence of the recession.
Housing sector bubble
After the recovery of the economy of the USA from the Great Depression in the 1930s,
the economy was doing significantly well, achieving new highs in all the economic aspects and
emerging as one of the strongest economies in the global scenario. The GDP and other indicators
of the country were showing significant growth and there was huge increase in the investment
sector of the economy. Over time residential investment came as a profitable avenue to build up
asset as there was a general notion that the housing prices in the economy will consistently grow
up with the economic boom which the country was experiencing (Cynamon and Fazzari 2015).
The overall rate in interests prevailing in the economy, during the years 2004 and 2005,
were significantly low, which thereby facilitated the increase in the investment in the residential
assets. The absence of robust monetary policy framework and lack of foresightedness on the part
of the monetary authority of the country resulted in an uncontrolled magnitude of investment in
this sector. Due to the presence of low interest rate, both the households as well as the investors
plunged into this market (Pfeffer, Danziger and Schoeni 2013). Borrowing of the household
sector increased significantly, for buying new houses. The commercial banks and different

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insurance companies came up with mortgage facilities, which required the households to make a
very small down payment as much of the amount, were lent to them by these institutions. The
introduction of the interest-only loans, in turn led many people to buy houses, which they could
not actually afford. On the other hand, the investors started investing more in this sector, as the
low interest rates on borrowing were apparently beneficial to expand their economic prospects. A
section of businesspersons prospered immensely by buying homes and selling them at higher
prices as the prices of the residential assets were consistently going up. This cumulatively
formed a bubble in the housing market and the speculations of the people in general that the
prices will always go up, along with the low interest rates, contributed even more in the
formation of this bubble (McDonald and Stokes 2013).
Bursting of the bubble in the housing market
The housing bubble, in 2006, burst, much to the shock of the residents, as the housing
prices started declining sharply, having significant implications (mostly negative) on the overall
economy of the country. The sudden fall in the prices led to huge rate of foreclosure by the
customers of the housing assets. These foreclosure activities in turn took the banks and financial
institutions to the state of panic as they faced immense losses on the mortgage backed securities
that they had on secondary markets. The banks eventually became skeptic to lend out money,
which led to bailing out of more than 700 billion dollars from the market (Kivedal 2013).
By the end quarter of 2008, many commercial investment institutions faced bankruptcy,
including the fourth largest of the investment banks of the country, the Lehman Brothers. The
share market of the country faced a crash, which was never seen before in the economy of the

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USA. The residents of the country, by the year 2009, lost an astonishing amount of 16 trillion
dollars, which made the stock market conditions even more worse and the implications were
farfetched and tremendously long term. The bubble burst, indirectly decreased the employment
of the country in a threatening way by decreasing the economic activities of the country
significantly. The country alone lost around 7.5 million jobs, which in its turn doubled the
previously existing employment rate (Kivedal 2013).
The effects of the Great Recession took substantially long time to wither out from the
economy and the government of the country along with the apex monetary institution, the
Federal Reserve, had to intervene in the market and had to adapt and implement huge reforms
before the economy again gained stability and sustainability in the long run (Farmer 2012).
Conclusion
The Great Recession, which started in the USA had hugely adverse impacts on the
country and percolated to the global economic scenario as well. The entire economy experiences
a massive slowdown in every aspect, especially in terms GDP, share market and employment
scenarios. The main cause of this huge recessionary situation was the bursting of the housing
sector bubble, which was highly unanticipated by the residents of the country. The phenomenon
came as a lesson to the governing authorities as well as the residents of the country, who were
before that, unaware of what repercussions the economy could face with an abnormal turn in the
economy. The worst sufferers were the insurance companies and the financial enterprises, who,
based on their speculations of huge expected prosperity of the housing market, started mortgage
based operating and took high risks. Many of these companies had to file bankruptcy and some

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of them even faced a permanent shut down. The lax financial regulations of the country along
with the strategy of keeping interest rates at low levels, to increase borrowing and investments,
contributed significantly to the occurrence of the Great Recession in the USA, which later,
affected many other countries, including Europe and had massive negative impact on the global
economic scenario.

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