History of Economic Recessions – Financial Crisis of 2008 7/7

Financial Crisis of 2008

Oft referred to as a “credit crunch,” the financial crisis of 2008 refers to the so-called recession beginning with the collapse of subprime loans and a loss of confidence in available securitized mortgages and their ratings.

Whether the financial crisis and associated collapse is truly a recession or not is still in heated debate by economists, with many believing that a market correction cannot be considered contractionary in this context. That said, a clear reduction in consumer spending has been noted, and imports have fallen by over 4 per cent since 2007, down from a growth of 12 per cent between 2006 and 2007. Petroleum imports are by far the biggest loser, at nearly 30 per cent reduction; correlating with the automotive crisis, and increase in oil prices.

In September, when the stock market finally crashed, indicating the failure of these asset packages, and lack of available liquidity to American businesses, the government stepped in and increased the cash injection program. Internationally, stock prices began to collapse, possibly indicative of the rise of globalization in financial markets.

A number of large financial institutions – including Lehman Brothers, Merrill Lynch, Washington Mutual and Wachovia Inc. – found themselves insolvent due to the de-leveraging effect of the shrinking money supply, resulting in either government managed takeovers in the form of cash injections, or corporate buyouts.

An important result of the government intervention in protecting financial institutions was the provision of bailout money to firms such as A.I.G., where the liquidity crisis, combined with alleged poor management and irresponsible spending, resulted in downgrading of their debt ratings, and the risk of absolute insolvency in one of the largest insurers in the world. The Federal Reserve Bank provided a $85 billion dollar credit facility to A.I.G. in exchange for 79.9 per cent of the equity.

“We can’t keep doing this, both because we at the Fed don’t have the necessary resources and for reasons of democratic legitimacy, it’s important that the Congress come in and take control of the situation,” appealed current Chairman of the Federal Reserve, Ben Bernanke, at a Congress meeting; leading Congress to establish a bill to provide bailout funding to the banking industry, later to be somewhat redirected to the failing automotive industry.

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