Causes of the 2007-2008 US Recession

The assignment examines the factors contributing to the 2007-2008 US recession. It argues that a housing market bubble, fueled by government encouragement of credit activities, was a core driver of the crisis. Other factors, such as stock market crashes, credit defaults, low interest rates, and Chinese dumping, also played significant roles. The analysis emphasizes the lasting economic impact of this period, including a sluggish recovery.

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GREAT RECESSION IN USA: ITS CAUSES
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1GREAT RECESSION IN USA: ITS CAUSES
Executive summary
This report aims to focus on causes behind the recession that broke during 2007 to 2008
in USA and report shows why US economy was largely influenced due to recession. Study also
considered GDP and Unemployment rate of USA to assess the effect of recession on the
economy. The results found in the study shows that elements like housing market bubble, stock
market crash, credit default, low interest rate dumping from china are the main reasons behind
financial crisis.

2GREAT RECESSION IN USA: ITS CAUSES
Table of Contents
Introduction......................................................................................................................................4
Discussion........................................................................................................................................4
Role of Business Cycle to understand the recession...................................................................5
Causes of Recession in USA.......................................................................................................6
House market bubble...............................................................................................................6
Stock market Crash..................................................................................................................8
Credit default Swap situation...................................................................................................9
Excessive debt at private level...............................................................................................10
Dumping from China.............................................................................................................11
USA GDP affected due to recession..........................................................................................12
USA Unemployment rate due to recession................................................................................13
Conclusion.....................................................................................................................................13
References......................................................................................................................................15

3GREAT RECESSION IN USA: ITS CAUSES
Introduction
Financial crisis is a situation which is outcome of several factors, it mainly shows huge
loss that is faced by an economy or country. The global financial crisis of 2007 to 2008 is
marked as one of the contraction period of the world and this situation affected many countries.
The main reasons behind any financial crisis are crashes of stock market, bursting of financial
bubbles, devaluation of currencies and credit defaulters. Countries which are affected by
financial crisis of 2007 to 2008 took a huge time to recover its losses and have recorded even
negative growth during that period. The recession which was observed during this period of
global financial crisis was very large and affected all the sectors of the economy and as a result
of this country that are affected by global financial crisis suffered a large extent of loss.
Among the countries that were affected by recession during 2007 to 2008, USA stands in
a visible position. The extent of loss suffered by US economy was very large and all the
economic indicators of the country was affected as a result of this recession. During this period
US economy recorded negative growth and economy even showed sluggish growth after the
recovery from this period.
The main aim of this report is to explore the reasons that are liable for occurring of the
great recession in USA during 2007 to 2008. Paper focused on the core causes and their effect on
economy. The effect of recession economic indicators are also considered in this report.
Discussion
Recession shows a significant decline of economic activities across the economy. It is
mainly observable when an economy records negative growth in two consecutive quarters. In

4GREAT RECESSION IN USA: ITS CAUSES
order to understand recession in a clear way , business cycle can be used. Business cycle mainly
shows the phases through which an economy passes through.
Role of Business Cycle to understand the recession
Occurrence of recession can be understood by considering business cycle. Business cycle
mainly shows a cyclical pattern which every economy faces during its process of development.
Business cycle consists of four phases and these are: expansion of economy, peak of the
economy, contraction in an economy and finally the trough situation faced by an economy.
National Bureau of Economic Research determine the business cycle of an economy and they
mainly uses the quarterly GDP growth rates; economic indicators like unemployment rate , trade
balance, inflation rate, exchange rates are also used (McClelland and Rust, 2016).
Figure 1: Four phases of business cycle
The above figure shows different phases attained by an economy over time. It shows that
the economy starts from the trough or depression phase and this phase shows low economic
growth. The second phase attained by the economy is expansion, the third phase is the peak
phase and finally the last phase is the contraction phase. A reduction in overall economic activity
is the main reason behind the contraction phase and this phase deals with the recession phase of
Real GDP
Time

5GREAT RECESSION IN USA: ITS CAUSES
the economy. The main features of recession are- increase of unemployment, slumping sales,
business failures increase, lower income level and expansion in underemployment.
Considering business cycle, recession that occurred in USA economy can be shown. US
economy in 2008, contracted to 2.7 percent in the first quarter of 2008. Second quarter shows
that the economy rebounded to 2 percent and during this period another contraction took place
which recorded 1.9 percent in the third quarter finally in the fourth quarter the economy reached
to 8.2 percent.
Causes of Recession in USA
The global financial crisis of 2007 to 2008 evolved from the middle of 2007. This period
created history since several events took place at one time, the most visible ones were crash of
stock market, collapse of financial institution, rise in unemployment rate and vulnerable position
of trade. In order to rescue economy from the grasp of global financial crisis several economies
adopted several measures. US economy was largely affected by the recession period during 2007
to 2008, country’s all economic indicators have shown low level of development even negative
results were recorded. In order to explore the main reasons of recession that broke out during this
period several aspects are to be considered, these aspects are discussed below in an detailed
manner.
House market bubble
US government provided housing loans post 19th century and these loans were easily
available to most of the citizens. During this period government basically provided loan to the
citizens with a view to generate wealth and this conception crop up within government because
national median home prices increased from 2.9 to 3.1 percent in 2001 and 4 percent to 4.6

6GREAT RECESSION IN USA: ITS CAUSES
percent in 2006. This is the reason government provided easy credit and it was expected by the
government that housing prices will appreciate and government may earn more revenue from
this process of appreciation (Cheng, Raina and Xion, 2014). Government encouraged subprime
borrowers to attain adjustable rate mortgages and these borrowers were entitled to give below
market interest rate. However, this expectation of government was hampered since later in 2007
the housing market crashed and this was due to decline in the price of the houses. This affected
the borrowers who were encouraged to obtain loans and this was due to the borrowers were
unable to pay high monthly payments (Fligstein and Goldstein, 2015). Thus refinancing became
difficult as housing prices fall. In 2007 credit market of USA froze and the situation deteriorated.
Subprime credit stopped and federal fund rate for credits of other borrowings increased.
Figure 2: Number of houses sold
Source: (U.S Census)

7GREAT RECESSION IN USA: ITS CAUSES
The above figure shows that during the period from 2002 onwards the housing prices was
very high and this high price grabbed the attention of US government to encourage borrowers to
obtain loans for buying houses and government encouraged to increase its wealth . The period
2005 have recorded maximum sale of houses and this was due to credits that were easily
available by the Banks. But post 2006, as housing prices began to fall due to its increase in
demand, the sale of houses decreased and this was due to increase in number of borrowers who
were unable to repay the interest amount and this affected the overall economy resulting in
recession (Kivedal, 2013).
Stock market Crash
A sudden decline of stock market prices is defined as stock market crisis and this mainly
results in loss of paper wealth. The reasons behind this stock market crash are: extended period
of rising stock prices, economic optimism in an extreme level, when ratio of price equity ratio
increases than long term averages and lastly extreme usage of margin debt and leverage.
Massive failure of financial institutions in USA in 2008 occurred mainly due to exposure
to packaged subprime loans and swaps of credit defaults that were issued to cover these loans
and the issuers (Bates, 2012).

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Figure 3: USA bear market
Source: (Commons.wikimedia.org, 2017)
The figure above shows that US stock market peaked in 2007 and then it began to fall.
Dow Jones Industrial Average closed at low level. DJIA dropped 18 percent with a decline of
points. The S & P also fell by 20 percent. Finally NYSE volume fell during this period (Lleo and
Ziemba, 2012).
Credit default Swap situation
Credit default is a financial swap agreement that a broker of CDS will pay return to the
buyer in the incident of a loan or other credit event.
In 2007 -2008 subprime securities market crisis in US economy was a threat as this
market decreased the market value heavily. This was because financial institutions heavily
invested in mortgage securities but this investment resulted to crumble. Many of the failing

9GREAT RECESSION IN USA: ITS CAUSES
institutions owned credit default swap on their subprime securities. Credit crunch mainly caused
freezing of exchange of money and this affected the entire economy. Since CDS are intangible in
nature here source of capital is difficult to be recognized to payout the CDS exactly. Thus this
created situation in USA more vulnerable (Eichengreen, 2012).
CDS thus contributed significantly to financial crisis in 2007. However, market tried to
rectify the market by making the market for CDS fairly liquid. Market also handled large
defaults like Lehman brothers. Lehman brothers is one of the large firm that collapsed during the
financial crisis but however were merely protected by CDS.
Excessive debt at private level
In 2007, Federal Reserve eased the credit availability , this was mainly due to the crash of
stock market and the subsequent slowdown of economic growth which was faced by the
economy and for this reason the interest rate level was decreased . This low interest rate initiated
the growth of debt and among private debt mainly and this as result resulted in more purchase of
housing. These high levels of debt have been identified as causal factor behind the recessions
(Summers, 2014). Most of the housing debt was in turn caused by the credit default swap,
mortgage security and collateralized debt obligation sectors of the industry, who were offering
low interest rate and when the value of assets began to fall, debt consumers were unable to pay
off the industry. In USA, the ratio of household debt to income increased from 39 percent to 138
percent.

10GREAT RECESSION IN USA: ITS CAUSES
Figure 4: Household debt to disposable income
Source: (US, Federal Reserve)
Dumping from China
Dumping means the General Agreement on Tariffs and Trade and it shows product
opening of one country into the commerce of another country accessible at below normal value
of the products. China’s name comes first when dumping is considered.
As a result dumping from China in 2007, US firms incurred losses at a higher level and
this resulted in financial crisis in USA . Chinese industries dumped US industries to a large
extent. Steel industry was mainly affected due to dumping (Shen and Fu, 2014).

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Figure 5: Dumping
Source: (IIT policies)
The above figure shows the before and after scenario, case of anti dumping. After the
imposition of anti dumping policies share of production is stabilized.
USA GDP affected due to recession
2005 2006 2007 2008 2009
-4
-3
-2
-1
0
1
2
3
4
USA (GDP)
Figure 6: USA GDP
Source: (OECD)

12GREAT RECESSION IN USA: ITS CAUSES
The figure shows that period of financial crisis recorded negative growth in USA and all
these was due to events that negatively affected the economy.
USA Unemployment rate due to recession
Figure 7: Unemployment rate
Source: (US Bureau of labor statistics)
The rate is considered from 2006 to 2009 in the above figure. The rate began to increase
post 2007 and it increased at a high level.
Conclusion
The conclusions drawn from report consist of various aspects of recession. . USA being a
developed country was affected by recession in a large scale and the main causes behind this are:
housing market bubble which can be considered as core element of driving the recession within
the economy. Although, the main reason behind this housing bubble market is Government itself

13GREAT RECESSION IN USA: ITS CAUSES
because they encouraged citizens to engage in credit activities with the view to increase the
wealth . Other causes such as stock market crash, credit default, low interest rate and dumping
from China also played important role behind creation of recession.
Thus period of recession from 2007 to 2008 is a remarkable one for USA, as the
economy faced severe problems during this period and the growth of the economy post the
period of financial crisis was also sluggish one as it took time for the economy to recover its
losses at the cost of things.

14GREAT RECESSION IN USA: ITS CAUSES
References
Bates, D.S., 2012. US stock market crash risk, 1926–2010. Journal of Financial
Economics, 105(2), pp.229-259.
Bls.gov. (2017). U.S. Bureau of Labor Statistics. [online] Available at: https://www.bls.gov/
Cheng, I.H., Raina, S. and Xiong, W., 2014. Wall Street and the housing bubble. The American
Economic Review, 104(9), pp.2797-2829.
Commons.wikimedia.org. (2017). File:2007-2009 Bear Market.png - Wikimedia Commons.
[online] Available at: https://commons.wikimedia.org/wiki/File:2007-2009_Bear_Market.png
Eichengreen, B., Mody, A., Nedeljkovic, M. and Sarno, L., 2012. How the subprime crisis went
global: evidence from bank credit default swap spreads. Journal of International Money and
Finance, 31(5), pp.1299-1318.
Fligstein, N. and Goldstein, A., 2015. The emergence of a finance culture in American
households, 1989–2007. Socio-Economic Review, 13(3), pp.575-601.
Kivedal, B.K., 2013. Testing for rational bubbles in the US housing market. Journal of
Macroeconomics, 38, pp.369-381.
Lleo, S. and Ziemba, W.T., 2012. Stock market crashes in 2007–2009: were we able to predict
them?. Quantitative Finance, 12(8), pp.1161-1187.

15GREAT RECESSION IN USA: ITS CAUSES
McClelland, J. and Rust, J., 2016. Gains from investment timing over the business cycle:
Machine replacement in the US rental industry.
Shen, G. and Fu, X., 2014. The Trade Effects of US Anti‐dumping Actions against China Post‐
WTO Entry. The World Economy, 37(1), pp.86-105.
Summers, L.H., 2014. US economic prospects: Secular stagnation, hysteresis, and the zero lower
bound. Business Economics, 49(2), pp.65-73.
The OECD. (2017). United States - OECD Data. [online] Available at:
https://data.oecd.org/united-states.htm.