Annals of the Great Recession XIV.

To review, the presidents from 1981 to 2017 were Ronald Reagan (1981-1989), George H.W. Bush (1989-1993), Bill Clinton (1993-2001), George W. Bush (2001-1009), and Barack Obama (2007-2017).  The chair-people of the Federal Reserve Bank were Alan Greenspan (1987-2006), Ben Bernanke (2006-2014), and Janet Yellin (2014-2018).  So, those are the people upon whose watch various things happened.[1]

Between 1997 and 2006 the government eased regulations on lending and encouraged home-ownership among new groups.[2]  Mortgage originators—banks or mortgage companies—did what they were allowed and even encouraged to do: they issued mortgages (loans) to “sub-prime” borrowers.[3]  These amounted to hundreds of billions of dollars of risky loans.  Rather than hold these dangerous loans on their own books, the loan originators re-packaged the mortgages as collateralized debt obligations (CDOs) and mortgage-backed securities (MBS), then sold these packages to investors.[4]  With many previously-excluded buyers seeking a limited stock of housing, housing prices rose by a national average of 124 percent.  The value of the CDOs and MBSs also rose.  Prices for both exceeded their real value.[5]

Then, in 2007 and 2008, it became apparent why sub-prime borrowers had previously had trouble getting loans.  The number of defaults started to rise sharply.  The MBSs and CDOs dropped toward their real value.  Financial institutions that had purchased these “instruments” suddenly found immense sums wiped off the asset side of their ledgers without their liabilities (what they owed other people) being reduced.  Bankruptcy loomed for the banks unless they could get rid of these dogs in a hurry and replace them with more valuable assets.  First Bear, Sterns, and then Lehman Brothers failed.  Seeking to stop the bleeding, banks pulled in the reins on all lending, including for productive investment.  The whole economy rapidly slowed during 2008.  The Dow Jones Industrial Average fell by 50 percent.  This reduced the values of many assets held by the upper and middle-classes, causing them to cut spending in order to reduce their own debts.  With consumption spending and investment both falling, the unemployment rate jumped to 10 percent by late 2009.

Acting quickly, the George W. Bush administration pushed through a Troubled Asset Relief Program (TARP) that bought $700 billion worth of bad debt from the banks.  The Obama administration launched a mini-Keynes stimulus program of $757 billion.  The Federal Reserve Bank cut interest rates to near zero and held them there for a long time.

[1] “The long shadow of the financial crisis,” The Week, 13 April 2018, p. 11.

[2] In part, this seems to have had a worthy purpose.  Houses are a key middle-class asset, but “red-lining” by banks had long restricted access to home purchases by African-Americans and other groups.  See: https://en.wikipedia.org/wiki/Redlining

[3] Sub-prime borrowers are ones with poor credit-worthiness.  For an explanation of how credit-worthiness is determined, see: https://www.investopedia.com/terms/f/ficoscore.asp  Very often, these are referred to in public discourse as “sub-prime loans,” as if the problem existed only with “predatory” lenders.  This seems to me to resemble referring to illegal immigrants as “un-documented immigrants,” as if the only problem is a bureaucratic foul-up with issuing them some documents.

[4] Apparently, it was possible for the purchasers to discern that the CDOs and MBSs were very risky—and possibly worthless—investments.  Most people did not do so.  A few did.  See: Gregory Zuckerman, The Greatest Trade Ever (2009) and Michael Lewis, The Big Short (2010).  The bets against the housing buble were called credit default swaps.

[5] This is called a “bubble.”

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