Sunday 21 March 2010

Why was there a recession in 2008?

UK began 2010 on a happy note, having painstakingly come out of a recession which affected almost everyone in the country in one way or another. For some, it meant a lower wage than a couple of years ago, while for some, reaching up to 3 million in 2009, it meant not having a job at all. The past two years have seen so many high grossing as well as low profile businesses shut down, "bail out" of banks by national governments and downturns in stock markets around the world. So the most common question arises: why did we end up being in the position that we were in, in the first place?

As with many things in today’s world, we have to start by looking at the USA, the centrepiece around which the whole idea of global markets is based and also where the root of the problem lay. Many have blamed the US bankers, for committing horrendous mistakes when it came to lending and investment ideas. It is true to some extent that there were some reckless and unsustainable lending practices that went on within a few banks, as rising house prices were an indication of a bubble forming in the US. Despite this, banks continued to provide easy credit in terms of mortgages, credit cards, and auto credit, which combined with a low interest rate, meant that people were ready to invest in assets that would have been beyond their reach under normal circumstances. However, with an increase in the interest rate in mid 2006, and a burst in the bubble caused people to default, as housing prices failed to go up as anticipated.

As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime mortgage backed securities reported significant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The meltdown of Lehman Brothers, the major investment bank, was the spark that set off the burning down of the financial system, as panic broke out on the inter-bank loan market and more and more firms started going into administration.

However, the banks should not have to take up all the blame for the slowing down of the economy, as government intervention contributed greatly to this. The financial market had been made extremely fragile due to the work of the US government including creation of complex and opaque assets, the failure of ratings agencies to properly assess the risk of such assets, as well as the creation of cheap credit through expansionary monetary policy. These policies, dating back to Clinton’s era, were bound to lead to a boom, followed by a bust worse than ever.

What the banks did was only an accelerator of the bust that was bound to happen. The government had created such an atmosphere in the market that people panicked at the slightest lack of assurity and slowed down economic activity greatly. Together with defaults, irresponsible behaviour both by the bankers and government, resulted in a crisis which started in the powerhouse of the world economy and spread like a wild forest fire to the rest of the economies, causing similar damage. The problem is that it’s not the first time that a crisis has been caused due to these factors. These cycles keep occurring every few decades, and yet no one is ready to learn from the mistakes and instead commit them again. After all, what is the point of learning and studying historical evidence, if you’re not going to learn from it?