Great Recession

economics [2007–2009]

WRITTEN BY
Brian Duignan

Great Recession, economic recession that was precipitated in

the United States by the financial crisis of 2007–08 and quickly
spread to other countries. Beginning in late 2007 and lasting until
mid-2009, it was the longest and deepest economic downturn in many
countries, including the United States, since the Great
Depression (1929–c. 1939).

The financial crisis, a severe contraction of liquidity in global financial

markets, began in 2007 as a result of the bursting of the U.S. housing
bubble. From 2001 successive decreases in the prime rate (the interest
rate that banks charge their “prime,” or low-risk, customers) had
enabled banks to issue mortgage loans at lower interest rates to
millions of customers who normally would not have qualified for them
(see subprime mortgage; subprime lending), and the ensuing
purchases greatly increased demand for new housing, pushing home
prices ever higher. When interest rates finally began to climb in 2005,
demand for housing, even among well-qualified borrowers, declined,
causing home prices to fall. Partly because of the higher interest rates,
most subprime borrowers, the great majority of whom
held adjustable-rate mortgages (ARMs), could no longer afford their
loan payments. Nor could they save themselves, as they formerly
could, by borrowing against the increased value of their homes or by
selling their homes at a profit. (Indeed, many borrowers, both prime
and subprime, found themselves “underwater,” meaning that they
owed more on their mortgage loans than their homes were worth.) As
the number of foreclosures increased, banks ceased lending to
subprime customers, which further reduced demand and prices.
As the subprime mortgage market collapsed, many banks found
themselves in serious trouble, because a significant portion of their
assets had taken the form of subprime loans or bonds created from
subprime loans together with less-risky forms of consumer debt
(see mortgage-backed security; MBS). In part because the underlying
subprime loans in any given MBS were difficult to track, even for the
institution that owned them, banks began to doubt each other’s
solvency, leading to an interbank credit freeze, which impaired the
ability of any bank to extend credit even to financially healthy
customers, including businesses. Accordingly, businesses were forced
to reduce their expenses and investments, leading to widespread job
losses, which predictably reduced demand for their products, because
many of their former customers were now unemployed or
underemployed. As the portfolios of even prestigious banks and
investment firms were revealed to be largely fictional, based on nearly
worthless (“toxic”) assets, many such institutions applied for
government bailouts, sought mergers with healthier firms, or
declared bankruptcy. Other major businesses whose products were
generally sold with consumer loans suffered significant losses. The car
companies General Motors and Chrysler, for example, declared
bankruptcy in 2009 and were forced to accept partial government
ownership through bailout programs. During all of this, consumer
confidence in the economy was understandably reduced, leading most
Americans to curtail their spending in anticipation of harder times
ahead, a trend that dealt another blow to business health. All these
factors combined to produce and prolong a deep recession in the
United States. From the beginning of the recession in December 2007
to its official end in June 2009, real gross domestic product (GDP)—
i.e., GDP as adjusted for inflation or deflation—declined by 4.3
percent, and unemployment increased from 5 percent to 9.5 percent,
peaking at 10 percent in October 2009.

As millions of people lost their homes, jobs, and savings,

the poverty rate in the United States increased, from 12.5 percent in
2007 to more than 15 percent in 2010. In the opinion of some experts,
a greater increase in poverty was averted only by federal legislation,
the 2009 American Recovery and Reinvestment Act (ARRA), which
provided funds to create and preserve jobs and to extend or
expand unemployment insurance and other safety net programs,
including food stamps. Notwithstanding those measures, during
2007–10 poverty among both children and young adults (those aged
18–24) reached about 22 percent, representing increases of 4 percent
and 4.7 percent, respectively. Much wealth was lost as U.S. stock
prices—represented by the S&P 500 index—fell by 57 percent between
2007 and 2009 (by 2013 the S&P had recovered that loss, and it soon
greatly exceeded its 2007 peak). Altogether, between late 2007 and
early 2009, American households lost an estimated $16 trillion in net
worth; one quarter of households lost at least 75 percent of their net
worth, and more than half lost at least 25 percent. Households headed
by younger adults, particularly by persons born in the 1980s, lost the
most wealth, measured as a percentage of what had been accumulated
by earlier generations in similar age groups. They also took the longest
time to recover, and some of them still had not recovered even 10
years after the end of the recession. In 2010 the wealth of the median
household headed by a person born in the 1980s was nearly 25 percent
below what earlier generations of the same age group had
accumulated; the shortfall increased to 41 percent in 2013 and
remained at more than 34 percent as late as 2016. Those setbacks led
some economists to speak of a “lost generation” of young persons who,
because of the Great Recession, would remain poorer than earlier
generations for the rest of their lives.

Losses of wealth and speed of recovery also varied considerably by

socioeconomic class prior to the downturn, with the wealthiest groups
suffering the least (in percentage terms) and recovering the soonest.
For such reasons, it is generally agreed that the Great Recession
worsened inequality of wealth in the United States, which had already
been significant. According to one study, during the first two years
after the official end of the recession, from 2009 to 2011,
the aggregate net worth of the richest 7 percent of households
increased by 28 percent while that of the lower 93 percent declined by
4 percent. The richest 7 percent thus increased their share of the
nation’s total wealth from 56 percent to 63 percent. Another study
found that between 2010 and 2013 the aggregate net worth of the
richest 1 percent of Americans increased by 7.8 percent, representing
an increase of 1.4 percent in their share of the nation’s total wealth
(from 33.9 percent to 35.3 percent).

As the financial crisis spread from the United States to other

countries, particularly in western Europe (where several major banks
had invested heavily in American MBSs), so too did the recession.
Most industrialized countries experienced economic slowdowns of
varying severity (notable exceptions were China, India, and
Indonesia), and many responded with stimulus packages similar to the
ARRA. In some countries the recession had serious
political repercussions. In Iceland, which was particularly hard-hit by
the financial crisis and suffered a severe recession, the government
collapsed, and the country’s three largest banks were nationalized.
In Latvia, which, along with the other Baltic countries, was also
affected by the financial crisis, the country’s GDP shrank by more than
25 percent in 2008–09, and unemployment reached 22 percent
during the same period. Meanwhile, Spain, Greece, Ireland, Italy,
and Portugal suffered sovereign debt crises that required intervention
by the European Union, the European Central Bank, and
the International Monetary Fund (IMF) and resulted in the imposition
of painful austerity measures. In all the countries affected by the Great
Recession, recovery was slow and uneven, and the broader social
consequences of the downturn—including, in the United States,
lower fertility rates, historically high levels of student debt, and
diminished job prospects among young adults—were expected to
linger for many years.