According to The State of Working America (2015), The Great Recession of the new millennium started with the burst of the $8 trillion housing bubble. Between 2005 and 2006 subprime loans made up 20 percent of all new loans. The loans were adjustable rate and other exotic loans as brokers took advantage of the relaxed mortgage standards made possible by mortgage securitization (Carr, 2008; Fishbein & Woodall, 2006). Neighborhood values were rapidly increasing and lender offered creative loan options in the form of larger loans for borrowers to purchase larger, more expensive homes (Edimiston & Zalneraitis, 2007, Immergluck, 2009).
Prospective homeowners purchased expensive homes, made affordable through the subprime market offerings. Unfortunately, rather than increase, housing prices began to decline. Due to these subprime loans, which often did not require large down payments, when housing prices declined, and the adjustable rates for borrows fluctuated up, homeowners became unable to pay their mortgages (Fishbein & Woodall, 2006). The more homeowner who fell into foreclosure, the more housing prices declined, the more property values fell, affecting others and making it impossible to refinance due to the lack of equity in the home. The implosion of a Bear Sterns billion-dollar hedge fund in 2007 was the straw that broke the camel’s back for the housing market (Morgenson, 2007).
According to the Federal Reserve Bank of Atlanta (2015), nations experience recession with the gross domestic product or GDP growth is negative for a minimum of two consecutive quarters. Gross domestic product, a value of all the products and services a country produces annually, is considered a significant gauge of the activity or robustness of a country’s economic health (Federal Reserve Bank of Atlanta, 2015). When economic activity falls, and does not rebound, economies are said to be in a recession (Gustman, Steinmeier, & Tabatabai, 2015). In addition to reductions is GDP output, income, employment, manufacturing, and retail sales also contribute to recession. The Great Recessive is evidenced with four consecutive quarters of decline in economic activity from 2008 to 2009 (Gustman, Steinmeier, & Tabatabai, 2015).
When the economy declines, the nation’s central bank, the Federal Reserve Bank, influences the amount of money and credit in the economy in order to revive performance. The Federal Reserve Bank’s Monetary Policy works to stabilize prices, stabilize long-term interest rates, and maximize employment (Federal Reserve Education, 2015). The Fed has three tools in its monetary policy arsenal; open market operations, discount rate, and reserve requirements. Effective monetary policies allow the Federal Reserve Bank to stabilize prices, creating the right conditions for increased employment and long-term economic growth. The key is to create conditions were money and credit slowly increase, as too rapid increases result in inflation.
The Great Recession of 2008 represented the largest decline in U.S. GDP since the Great Depression of 1929 (Carvalho, Eusepi, & Grisse, 2012). The Great Recession was not merely an American problem, but affected most emerging and developed nations. With such an immense impact, which was felt across the world, the economic projection of recovery produced vast uncertainty. Due to the expanse of the Great Recession, standard fiscal policies relying on automatic stabilizers and interest rate deductions were not enough to begin to turn around this financial crisis. More aggressive policies were needed to impact this sever of a decline. The Fed had to expand its balance sheets to help the economy recovery.
The Federal Reserve Bank added four alternative balance sheet policies to spark economic recovery. First, exchange rate-related policy allowed for the purchase of foreign currency, which not only expanded the balance sheet, but also boosted export demand due to currency appreciation limitations and minimization of currency depreciation, thereby averting inflation declines (Carvalho, Eusepi, & Grisse, 2012). Second, the Fed implanted expansion designed to lower the fees associated with borrowing money (Carvalho, Eusepi, & Grisse, 2012). The Quasi-Debt Management Policy, the second balance sheet expansion, changed the gain on government securities in the private sector which impacts the cost of funding and asset prices in a more general way (Borio & Disyatat, 2009). The Credit Policy, the third Fed expansion, worked to alter private sector balance sheet structure through the modification of collateral, loan maturity through private loans or the acquisition of private sector claims (Borio & Disyatat, 2009). Credit policy has the goal of priming credit conditions for the private sector so that people and business will increase their spending.
The final Fed policy expansion implemented in response to the Great Recession of 2008 was bank reserves policy. While the other tools expanded the balance sheets, the bank reserves policy allowed the Fed to boosts its supply of money and credit in order to raise the growth rate (Carvalho, Eusepi, & Grisse, 2012). Asset prices and credit supply are affected by quantitative easing, which asset prices exchanged with reserves, increased available funds for loans (Borio & Disyatat, 2009). Credit Companies and individuals are more likely to spend when their assets grow, are able to obtain loans easier, and have more money in their reserves (Carvalho, Eusepi, & Grisse, 2012). In addition to increases in government spending, numerous tax cuts in between 2008 and 2009 were also implement to help stimulate and stabilize the economy (Carvalho, Eusepi, & Grisse, 2012).