What caused the worst economic crisis since the Great Depression? 

Overview

  • The Great Recession of 2007-2009 was the worst global economic crisis since the Great Depression in the 1930s.
  • The recession resulted from a combination of tax cuts, spending increases, and the devastating effects of a banking crisis in the subprime mortgage market.
  • The recession contributed to rising income inequality and prompted a debate about the role of the federal government in regulating private industry.

George W. Bush’s economic policies

Upon taking office in 2001, US President George W. Bush implemented a series of economic measures that substantially raised the federal budget deficit while almost doubling the federal debt. The Bush administration increased federal spending, most dramatically in the areas of Medicare and defense spending, while the wars in Afghanistan and Iraq consumed vast financial resources.start superscript, 1, end superscript
Meanwhile, the Bush administration enacted some of the largest tax cuts in US history. All marginal tax rates were lowered, while certain tax credits, such as the child tax credit, became more generous. Critics of what became known as the “Bush Tax Cuts” argued that they contributed to increased income inequality by unfairly benefiting the upper class. Others have attributed rising inequality to technological advances, free trade policies, and the declining power of labor unions. While economists will continue to debate the causes and effects of income inequality, what remains certain is that the average American family is now worse off than it was a quarter-century ago.start superscript, 2, end superscript
Graph depicting the income limits of each fifth and the top five percent of families between 1947 and 2007, in 2007 dollars. The 20th, 40th, 60th and 80th percentiles have seen small increases over this time period, while the earnings of the top five percent have nearly quadrupled.
US income distribution for each fifth and the top five percent of families between 1947 and 2007, in 2007 dollars. Graph courtesy Wikimedia Commons. Source: US Census Bureau Historical Income Tables.

The recession of 2007-2008

The US economy was already tipping into recession by 2007. Consumer spending was down, unemployment was up, and the financial markets were unstable. But it was the September 2008 collapse of Lehman Brothers, a major Wall Street investment firm, that ushered in the worst banking crisis the country had experienced since the Great Depression.start superscript, 3, end superscript Both the boom-and-bust dynamic associated with free-market capitalism and the monetary policies enacted by the Federal Reserve played a role in creating the crisis.start superscript, 4, end superscript
The Federal Reserve (the US central banking system) had implemented monetary policies aimed at increasing rates of homeownership. Excessive home building, combined with the loosening of credit and the extension of high-risk mortgages, served to create a housing bubble. When that bubble burst, many homeowners were unable to pay their mortgages, while the value of their homes tanked, leaving them with a debt burden that was greater than what their homes were worth.

Bailing out the banks

In order to prevent what Federal Reserve Chairman Ben Bernanke referred to as a “global financial meltdown,” the Bush administration authorized a massive federal intervention to mitigate the worst effects of the crisis.start superscript, 5, end superscript In February 2008, President Bush authorized a $168 billion economic stimulus package, which consisted largely of income tax rebates. The Emergency Economic Stabilization Act of 2008 included $700 billion to fund the Troubled Assets Relief Program (TARP), which provided loans to troubled banks.
Several of the nation’s largest financial institutions were either taken over by other companies or bailed out by the federal government. The bailouts involved the direct transfer of taxpayer money to the banks. In February 2009, US President Barack Obama authorized a $787 billion economic stimulus package composed of spending increases and tax cuts. The US national debt rose by $6 trillion from 2008 to 2012, while unemployment peaked at 10 percent in 2009 and then declined.
Graph depicting the net change in US employment per month from 2009 to 2016. Unemployment peak at ten percent in 2009, and has since steadily dropped to about five percent.
Graph depicting the net change in US employment per month from 2009 to 2016. Unemployment peaked at ten percent in 2009. Graph courtesy Wikimedia Commons.
In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed. The law attempted to address some of the key causes of the banking crisis but stopped short of breaking up the largest banks, which had become even bigger due to the wave of mergers and acquisitions that ensued in the wake of the housing market collapse.

What do you think?

What caused the Great Recession?
What responsibility does the federal government have to regulate private industry?
Were the relief measures enacted by the Bush and Obama administrations effective?
Article written by Dr. Kimberly Kutz Elliott. This article is licensed under a CC-BY-NC-SA 4.0 license.
Notes
  1. See Joseph E. Stiglitz and Linda J. Bilmes, The Three Trillion Dollar War: The True Cost of the Iraq Conflict (New York: W.W. Norton & Company, 2008).
  2. Joseph E. Stiglitz, The Great Divide: Unequal Societies and What We Can Do About Them (New York: W.W. Norton & Company, 2015), xvi.
  3. See Miles Kahler and David A. Lake, eds. Politics in the New Hard Times: The Great Recession in Comparative Perspective (Ithaca, NY: Cornell University Press, 2013).
  4. See Robert L. Hetzel, The Great Recession: Market Failure or Policy Failure? (New York: Cambridge University Press, 2012).
  5. Ben Bernanke, quoted in Alan S. Blinder, After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead (New York: Penguin Books, 2013), 5.