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Report On
Global Financial Crisis: Recovery and Challenges
“In the perspective of United States of America”

Course Details:
Fin603: Financial Institutions & Market
Section: 01

Submitted to:
Dr. Salehuddin Ahmed
Professor
BRAC Business School
BRAC University

Submitted by: Group- 5
|SL. |Name |ID No. |Signature |
|1 |Mohammad Ishtiaque Hossain |14164090 | |
|2 |Kazi Golam Faisal |14364071 | |
|3 |Nurshia Jahan |13264009 | |

Submission Date: November 17, 2015
LETTER OF TRANSMITTAL

November 17, 2015

Dr. Salehuddin Ahmed
Professor
BRAC Business School
BRAC University

Subject: Submission of the report paper on ‘Global Financial Crisis: Recovery and Challenges’

Dear Sir,

I hereby submitting the final version of the term paper on behalf of my group on ‘Global Financial Crisis: Recovery and Challenges’ that you asked us to submit on November 17, 2015 as our report paper. The paper is a part of the course Fin 603: Financial Institutions & Market under MBA program. The main purpose of this paper was to determine the theoretical aspects of global financial crisis and recovery and challenges analysis on the selected country named United States of America. This course gave us both academic and practical exposures, we have learned about the great recession and international financial markets and the term paper gave us the opportunity to develop the practical experience.
We have tried our level best to complete this term paper with respect to the desired requirements. We request you to excuse us for any mistake that may occur in the report despite of our best effort. We would really appreciate it if you enlighten us with your thoughts and views regarding the report.

Thank you again for your support and patience.

Sincerely Yours

-----------------------------
Mohammad Ishtiaque Hossain
Table of Contents

Executive Summary

1. Introduction …………………………………………………………………………………01

2. Background ………………………………………………………………………………….02

3. The Crisis Scenario: USA …………………………………………………………………..04

4. Impact of Global Financial Crisis on America ……………………………………………..08

1. GDP in Long Run …………………………………………………………………..08

2. Export and Import ………………………………………………………………….10

3. Boom and Collapse of the Shadow Banking System ………………………………10

4. Impact on Housing Sector ………………………………………………………….12

5. Consumer Spending ………………………………………………………………..12

6. Impact Stock Market ……………………………………………………………….14

7. Impact on Debt Burden or Overleveraging ………………………………………...14

8. Commercial Real Estate Bust ……………………………………………………....15

9. Impact on Commodity Prices ………………………………………………………16

10. Impact on wealth growth and unemployment …………………………………17

11. The effect of the Financial Crisis on the US Labor Market …………………...17

5. Recovery and Challenges ………………………………………………………………….26

6. Concluding Remarks ………………………………………………………………………27

References

Executive Summary

The purpose of this paper is to gather important information about the global financial crisis that took place in the period of 2007-08. The effects of the financial crisis in America and how it recovered from this crisis situation and the challenges that had to be overcome in order to regain a stable conditions are briefly discussed to gather knowledge and to understand the financial crisis situation that had affect the world.

The paper starts with a brief introduction about the financial crisis, than followed by the background of the crisis situation which mainly states how the crisis evolved and the reasons behind it. Than a brief description of the crisis scenario have been presented on the perspective of the United States of America.

Following the discussion on the impact of the global financial crisis on America and effort was given to discuss some factors and sectors that had a direct impact over the course of the crisis. Important aspects like GDP, export and import, shadow banking system, consumer spending, commodity price and other factors are elaborately discussed with various figures and charts for better understandings of the situation. Than followed by the recovery phase that USA has to go through and the challenges that come between the path of recovery. At last the paper was concluded with a ending remarks.

1.0 Introduction
The financial crisis of 2007–08, also known as the Global Financial Crisis and 2008 financial crisis, is considered by many economists to have been the worst financial crisis since the Great Depression of the 1930s. It threatened the collapse of large financial institutions, which was prevented by the bailout of banks by national governments, but stock markets still dropped worldwide. In many areas, the housing market also suffered, resulting in evictions, foreclosures and prolonged unemployment. The crisis played a significant role in the failure of key businesses, declines in consumer wealth estimated in trillions of U.S. dollars, and a downturn in economic activity leading to the 2008–2012 global recession and contributing to the European sovereign-debt crisis. The active phase of the crisis, which manifested as a liquidity crisis, can be dated from August 9, 2007, when BNP Paribas terminated withdrawals from three hedge funds citing a complete evaporation of liquidity.
The bursting of the U.S. (United States) housing bubble, which peaked in 2004, caused the values of securities tied to U.S. real estate pricing to plummet, damaging financial institutions globally. The financial crisis was triggered by a complex interplay of policies that encouraged home ownership, providing easier access to loans for (lending) borrowers, overvaluation of bundled subprime mortgages based on the theory that housing prices would continue to escalate, questionable trading practices on behalf of both buyers and sellers, compensation structures that prioritize short-term deal flow over long-term value creation, and a lack of adequate capital holdings from banks and insurance companies to back the financial commitments they were making. Questions regarding bank solvency, declines in credit availability and damaged investor confidence had an impact on global stock markets, where securities suffered large losses during 2008 and early 2009. Economies worldwide slowed during this period, as credit tightened and international trade declined. Governments and central banks responded with unprecedented fiscal stimulus, monetary policy expansion and institutional bailouts. In the U.S., Congress passed the American Recovery and Reinvestment Act of 2009.
Many causes for the financial crisis have been suggested, with varying weight assigned by experts. The U.S. Senate's Levin–Coburn Report concluded that the crisis was the result of high risk, complex financial products; undisclosed conflicts of interest; the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.
The Financial Crisis Inquiry Commission concluded that the financial crisis was avoidable and was caused by widespread failures in financial regulation and supervision, dramatic failures of corporate governance and risk management at many systemically important financial institutions, a combination of excessive borrowing, risky investments, and lack of transparency" by financial institutions, ill preparation and inconsistent action by government that added to the uncertainty and panic, a systemic breakdown in accountability and ethics, collapsing mortgage-lending standards and the mortgage securitization pipeline, deregulation of over-the-counter derivatives, especially credit default swaps, and "the failures of credit rating agencies" to correctly price risk. The 1999 repeal of the Glass-Steagall Act effectively removed the separation between investment banks and depository banks in the United States. Critics argued that credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their regulatory practices to address 21st-century financial markets. Research into the causes of the financial crisis has also focused on the role of interest rate spreads.
In the immediate aftermath of the financial crisis palliative fiscal and monetary policies were adopted to lessen the shock to the economy. In July 2010, the Dodd–Frank regulatory reforms were enacted in the U.S. to lessen the chance of a recurrence.

2.0 Background
The immediate cause or trigger of the crisis was the bursting of the U.S. (United States) housing bubble, which peaked in 2004. Already-rising default rates on subprime and adjustable-rate mortgages (ARM) began to increase quickly thereafter. As banks began to give out more loans to potential home owners, housing prices began to rise.
Easy availability of credit in the U.S., fueled by large inflows of foreign funds after the Russian debt crisis and Asian financial crisis of the 1997–1998 periods, led to a housing construction boom and facilitated debt-financed consumer spending. Lax lending standards and rising real estate prices also contributed to the real estate bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.
As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses.
Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.
While the housing and credit bubbles were building, a series of factors caused the financial system to both expand and become increasingly fragile, a process called financialisation. U.S. Government policy from the 1970s onward has emphasized deregulation to encourage business, which resulted in less oversight of activities and less disclosure of information about new activities undertaken by banks and other evolving financial institutions. Thus, policymakers did not immediately recognize the increasingly important role played by financial institutions such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same regulations.
These institutions, as well as certain regulated banks, had also assumed significant debt burdens while providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or MBS losses. These losses impacted the ability of financial institutions to lend, slowing economic activity. Concerns regarding the stability of key financial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions and implemented economic stimulus programs, assuming significant additional financial commitments.
The U.S. Financial Crisis Inquiry Commission reported its findings in January 2011. It concluded that "the crisis was avoidable and was caused by: widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; an explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels".

3.0 The Crisis Scenario: USA
The housing bubble started to burst in 2006, and the decline accelerated in 2007 and 2008. Housing prices stopped increasing in 2006, started to decrease in 2007, and have fallen about 25 percent from the peak so far. The decline in prices meant that homeowners could no longer refinance when their mortgage rates were reset, which caused delinquencies and defaults of mortgages to increase sharply, especially among subprime borrowers. From the first quarter of 2006 to the third quarter of 2008, the percentage of mortgages in foreclosure tripled, from 1 percent to 3 percent, and the percentage of mortgages in foreclosure or at least thirty days delinquent more than doubled, from 4.5 percent to 10 percent. These foreclosure and delinquency rates are the highest since the Great Depression; the previous peak for the delinquency rate was 6.8 percent in 1984 and 2002. And the worst is yet to come. The American dream of owning your own home is turning into an American nightmare for millions of families.
Early estimates of the total number of foreclosures that will result from this crisis in the years to come ranged from 3 million (Goldman Sachs, International Monetary Fund) to 8 million (Nuriel Roubini, a New York University economics professor whose forecasts carry some weight because he was one of the first to predict several years ago the bursting of the housing bubble and the current recession). So far (as of January 2009), there have already been almost 3 million mortgage foreclosures. Another 1 million mortgages are ninety days delinquent (foreclosure notices usually go out after ninety days), and another 2 million were thirty days delinquent. Therefore, a total of about 6 million mortgages either have already been foreclosed, are in foreclosure, or are close to foreclosure. Six million mortgages are about 12 percent of all the mortgages in the United States. The situation could get a lot worse in the months ahead, due to the worsening recession and lost jobs and income, unless the government adopts stronger policies to reduce foreclosures.
Defaults and foreclosures on mortgages mean losses for lenders. Estimates of losses on mortgages keep increasing, and many are now predicting losses of $1 trillion or more. In addition to losses on mortgages, there will also be losses on other types of loans, due to the weakness of the economy, in the months ahead: consumer loans (credit cards, etc.), commercial real estate, corporate junk bonds, and other types of loans (e.g. credit default swaps).
Estimate of losses on these other types of loans range up to another trillion dollars. Therefore, total losses for the financial sector as a whole could be as high as $2 trillion. It is further estimated that banks will suffer about half of the total losses of the financial sector. The rest of the losses will be borne by non-bank financial institutions (hedge funds, pension funds, etc.). Therefore, dividing the total losses for the financial sector as a whole in the previous paragraph by two, the losses for the banking sector could be as high as $1 trillion. Since the total bank capital in the U.S. is approximately $1.5 trillion, losses of this magnitude would wipe out two-thirds of the total capital in U.S. banks! This would obviously be a severe blow, not just to the banks, but also to the U.S. economy as a whole.
The blow to the rest of the economy would happen because the rest of the economy is dependent on banks for loans—businesses for investment loans, and households for mortgages and consumer loans. Bank losses result in a reduction in bank capital, which in turn requires a reduction in bank lending (a credit crunch), in order to maintain acceptable loan to capital ratios. Assuming a loan to capital ratio of 10:1 (this conservative assumption was made in a recent study by Goldman Sachs), every $100 billion loss and reduction of bank capital would normally result in a $1 trillion reduction in bank lending and corresponding reductions in business investment and consumer spending. According to this rule of thumb, even the low estimate of bank losses of $1 trillion would result in a reduction of bank lending of $10 trillion! This would be a severe blow to the economy and would cause a severe recession.
Bank losses may be offset to some extent by “recapitalization,” i.e., by new capital being invested in banks from other sources. If bank capital can be at least partially restored, then the reduction in bank lending does not have to be so significant and traumatic. So far, banks have lost about $500 billion and have raised about $400 billion in new capital, most of it coming from “sovereign wealth funds” financed by the governments of Asian and Middle Eastern countries. So ironically, U.S. banks may be “saved” (in part) by increasing foreign ownership. U.S. bankers are now figuratively on their knees before these foreign investors offering discounted prices and pleading for help. It is also an important indication of the decline of U.S. economic hegemony as a result of this crisis. However, it is becoming more difficult for banks to raise new capital from foreign investors, because their prior investments have already suffered significant losses.
In addition to the credit crunch, consumer spending will be further depressed in the months ahead due to the following factors: decreasing household wealth; the end of mortgage equity withdrawals (which were very significant in the recent boom); and declining jobs and incomes. All in all, it is shaping up to be a very severe recession.
The persistent high unemployment remained as of December 2012, along with low consumer confidence, the continuing decline in home values and increase in foreclosures and personal bankruptcies, an increasing federal debt, inflation, and rising petroleum and food prices. A 2011 poll found that more than half of all Americans thought that the U.S. was still in recession or even depression, although economic data showed a historically modest recovery.[90] This could have been because both private and public levels of debt were at historic highs in the U.S. and in many other countries. • Real gross domestic product (GDP) began contracting in the third quarter of 2008 and did not return to growth until Q1 2010. CBO estimated in February 2013 that real U.S. GDP remained only a little over 4.5 percent above its previous peak, or about $850 billion. CBO projected that GDP would not return to its potential level until 2017. In 2009 the U.S GDP was at $14.4 trillion. By the final quarter of 2014, the US GDP had grown by 18.6%, equal to $17.7 trillion. Canada, the United States' largest trading partner by then, had a GDP of $1.37 trillion in 2009, but by 2014 reached $2 trillion, growing by over 31%. Both countries now have the fastest growing economies within the G8 and G20, and both countries has increased daily trade with each other from $1.5 Billion in 2011, to $4 Billion in 2014, equating to over $1.3 trillion in annual trade. • The unemployment rate rose from 5% in 2008 pre-crisis to 10% by late 2009, and then steadily declined to 7.3% by March 2013. The number of unemployed rose from approximately 7 million in 2008 pre-crisis to 15 million by 2009, then declined to 12 million by early 2013. • Residential private investment (mainly housing) fell from its 2006 pre-crisis peak of $800 billion, to $400 billion by mid-2009 and has remained depressed at that level. Non-residential investment (mainly business purchases of capital equipment) peaked at $1,700 billion in 2008 pre-crisis and fell to $1,300 billion in 2010, but by early 2013 had nearly recovered to this peak. • Housing prices fell approximately 30% on average from their mid-2006 peak to mid-2009 and remained at approximately that level as of March 2013. • Stock market prices, as measured by the S&P 500 index, fell 57% from their October 2007 peak of 1,565 to a trough of 676 in March 2009. Stock prices began a steady climb thereafter and returned to record levels by April 2013. • The net worth of U.S. households and non-profit organizations fell from a peak of approximately $67 trillion in 2007 to a trough of $52 trillion in 2009, a decline of $15 trillion or 22%. It began to recover thereafter and was $66 trillion by Q3 2012. • U.S. total national debt rose from 66% GDP in 2008 pre-crisis to over 103% by the end of 2012. • For the majority, income levels have dropped substantially with the median male worker making $32,137 in 2010, and an inflation-adjusted income of $32,844 in 1968. The recession of 2007–2009 is considered to be the worst economic downturn since the Great Depression and the subsequent economic recovery one of the weakest. The weak economic performance since 2000 has seen the percentage of working age adults actually employed drop from 64% to 58% (a number last seen in 1984), with most of that drop occurring since 2007 • Approximately 5.4 million people have been added to federal disability rolls as discouraged workers give up looking for work and take advantage of the federal program. • The United States has seen an increasing concentration of wealth to the detriment of the middle class and the poor with the younger generations being especially affected. The middle class dropped from 61% of the population in 1971 to 51% in 2011 as the upper class increased its stake of the national income from 29% in 1970 to 46% in 2010. The share for the middle class dropped to 45%, down from 62% while total income for the poor dropped to 9% from 10%. Since the number of poor increased during this period the smaller piece of the pie (down to 9% from 10%) is spread over a greater portion of the population. The portion of national wealth owned by the middle class and poor has also dropped as their portion of the national income has dropped, making it more difficult to accumulate wealth. The younger generation, which would be just starting their wealth accumulation, has been the hardest hit. Those under 35 are 68% less wealthy than they were in 1984, while those over 55 are 10% wealthier. Much of this concentration has happened since the start of the Great Recession. In 2009, the wealthiest 20% of households controlled 87.2% of all wealth, up from 85.0% in 2007. The top 1% controlled 35.6% of all wealth, up from 34.6% in 2007. The share of the bottom 80% fell from 15% to 12.8%, dropping 15%. • Inflation-adjusted median household income in the United States peaked in 1999 at $53,252 (at the peak of the Internet stock bubble), dropped to $51,174 in 2004, went up to 52,823 in 2007 (at the peak of the housing bubble), and has since trended downward to $49,445 in 2010. The last time median household income was at this level was in 1996 at $49,112, indicating that the recession of the early 2000s and the 2008–2012 global recession wiped out all middle class income gains for the last 15 years.[111] This income drop has caused a dramatic [ rise in people living under the poverty level and has hit suburbia particularly hard. Between 2000 and 2010, the number of suburban households below the poverty line increased by 53 percent, compared to a 23 percent increase in poor households in urban areas.
4.0 Impact of Global Financial Crisis on America
4.1 GDP in the Long Run:
Real gross domestic product (GDP) began contracting in the third quarter of 2008 and did not return to growth until Q1 2010. CBO estimated in February 2013 that real U.S. GDP remained only a little over 4.5 percent above its previous peak, or about $850 billion. CBO projected that GDP would not return to its potential level until 2017. In 2009 the U.S GDP was at $14.4 trillion. By the final quarter of 2014, the US GDP had grown by 18.6%, equal to $17.7 trillion. Canada, the United States' largest trading partner by then, had a GDP of $1.37 trillion in 2009, but by 2014 reached $2 trillion, growing by over 31%. Both countries now have the fastest growing economies within the G8 and G20, and both countries has increased daily trade with each other from $1.5 Billion in 2011, to $4 Billion in 2014, equating to over $1.3 trillion in annual trade.

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Clearly, the slowdown in the United States has had a ripple effect, contributing to a dramatic drop in economic growth virtually everywhere.

4.2 Export and Import:

The graph below shows the growth in U.S. exports of goods and services to the rest of the world and the growth in U.S. imports of goods and services from the rest of the world in recent years. The data are shown in “real” terms, meaning they have been adjusted for price changes so that we can focus only on changes in the physical volume of trade.

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4.3 Boom and Collapse of the Shadow Banking System:

The securitization markets also remain impaired, as investors anticipate more loan losses. Investors are also uncertain about coming legal and accounting rule changes and regulatory reforms. Private bond issuance of residential and commercial mortgage-backed securities, asset-backed securities, and CDOs peaked in 2006 at close to $2 trillion (Figure 4). In 2009, private issuance was less than $150 billion, and almost all of it was asset-backed issuance supported by the Federal Reserve's TALF program to aid credit card, auto and small-business lenders. Issuance of residential and commercial mortgage-backed securities and CDOs remains dormant. Banks and other financial institutions packaged various types of loans (including mortgages) into securities and sold them to global investors. This is called securitization. In exchange for purchasing the investment, the investor receives a right to the cash flows from the underlying loans specified for the security. The chart shows how this financing source dried-up, meaning that non-prime mortgages and other types of loans could not be originated and sold to investors.

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Figure 4: Securitization Market Activity

Residential private investment (mainly housing) fell from its 2006 pre-crisis peak of $800 billion, to $400 billion by mid-2009 and has remained depressed at that level. Non-residential investment (mainly business purchases of capital equipment) peaked at $1,700 billion in 2008 pre-crisis and fell to $1,300 billion in 2010, but by early 2013 had nearly recovered to this peak.
For the majority, income levels have dropped substantially with the median male worker making $32,137 in 2010, and an inflation-adjusted income of $32,844 in 1968. The recession of 2007–2009 is considered to be the worst economic downturn since the Great Depression and the subsequent economic recovery one of the weakest. The weak economic performance since 2000 has seen the percentage of working age adults actually employed drop from 64% to 58%, with most of that drop occurring since 2007

4.4 Impact on Housing Sector:
Housing prices fell approximately 30% on average from their mid-2006 peak to mid-2009 and remained at approximately that level as of March 2013.
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By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak. As prices declined, borrowers with adjustable-rate mortgages could not refinance to avoid the higher payments associated with rising interest rates and began to default.
During 2007, lenders began foreclosure proceedings on nearly 1.3 million properties, a 79% increase over 2006. This increased to 2.3 million in 2008, an 81% increase vs. 2007. By August 2008, 9.2% of all U.S. mortgages outstanding were either delinquent or in foreclosure. By September 2009, this had risen to 14.4%.
4.5 Consumer Spending:
The loss of household wealth remains a heavy weight on consumer spending. From the peak in mid-2007 to the low point in early 2009, household net worth—the difference between what households own and what they owe—had fallen by some $17.5 trillion, or more than 25%.xvii Given firmer stock and house prices since then, net worth has recovered somewhat, but it is still down $12.5 trillion from its peak (Figure 6).
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Figure 6: Consumer Spending
The impact of the loss of wealth on consumer spending is evident in the increase in the personal saving rate. When net worth was at its highest in the summer of 2007, the personal saving rate was close to an alltime low of 2%. The saving rate in recent quarters has been closer to 5%. If the historical relationship between wealth and saving holds true—every dollar lost in wealth cuts approximately 5 cents from consumer spending—the saving rate will eventually rise to closer to 8%.

4.6 Impact on Stock Market:
Stock market prices, as measured by the S&P 500 index, fell 57% from their October 2007 peak of 1,565 to a trough of 676 in March 2009. Stock prices began a steady climb thereafter and returned to record levels by April 2013.
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4.7 Impact on Debt Burden or Overleveraging

U.S. households and financial institutions became increasingly indebted or overleveraged during the years preceding the crisis. This increased their vulnerability to the collapse of the housing bubble and worsened the ensuing economic downturn.
Free cash used by consumers from home equity extraction doubled from $627 billion in 2001 to $1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion over the period, contributing to economic growth worldwide. U.S. home mortgage debt relative to GDP increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion.
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From 2004 to 2007, the top five U.S. investment banks each significantly increased their financial leverage (see diagram), which increased their vulnerability to a financial shock. Changes in capital requirements, intended to keep U.S. banks competitive with their European counterparts, allowed lower risk weightings for AAA securities. These five institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007.
4.8 Commercial Real Estate Bust:
The earlier boom and current bust in the commercial real estate market also poses a serious problem for the recovery. With absorption of commercial space still falling and vacancy rates rising, rents and property prices are under severe pressure. The near doubling in commercial real estate prices during the first half of this decade was even greater than the increase in house prices, and the subsequent bust more severe. Prices are down more than 35% from their peak two years ago.
Even property owners with substantial equity, solid tenants, and positive cash flow are unable to refinance mortgages as they come due. Most commercial mortgages have maturities of around five years, meaning that loans originated during the boom will come due in the next several years. Unfortunately, the commercial mortgage securities market remains closed, and traditional portfolio lenders, including banks, insurance companies and pension funds, are not offering to refinance because of heightened risks and the lenders' desire to reduce exposure to commercial real estate.
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Even property owners with substantial equity, solid tenants, and positive cash flow are unable to refinance mortgages as they come due. Most commercial mortgages have maturities of around five years, meaning that loans originated during the boom will come due in the next several years. Unfortunately, the commercial mortgage securities market remains closed, and traditional portfolio lenders, including banks, insurance companies and pension funds, are not offering to refinance because of heightened risks and the lenders' desire to reduce exposure to commercial real estate.
4.9 Impact on Commodity Prices:
Rapid increases in a number of commodity prices followed the collapse in the housing bubble. The price of oil nearly tripled from $50 to $147 from early 2007 to 2008, before plunging as the financial crisis began to take hold in late 2008. A pattern of spiking instability in the price of oil over the decade leading up to the price high of 2008 has been recently identified.
Copper prices increased at the same time as the oil prices. Copper traded at about $2,500 per ton from 1990 until 1999, when it fell to about $1,600. The price slump lasted until 2004 which saw a price surge that had copper reaching $7,040 per ton in 2008.
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4.10 Impact on Wealth growth and Unemployment:
Distribution of wealth in the US:
Typical American families did not fare as well, nor did those "wealthy-but-not wealthiest" families just beneath the pyramid's top. On the other hand, half of the poorest families did not have wealth declines at all during the crisis. The Federal Reserve surveyed 4,000 households between 2007 and 2009, and found that the total wealth of 63 percent of all Americans declined in that period. 77 percent of the richest families had a decrease in total wealth, while only 50 percent of those on the bottom of the pyramid suffered a decrease.
4.11 The Effect of the Financial Crisis on the US Labor Market:
The financial crisis will also do significant longer-term damage to the labor market. Under the best of circumstances, unemployment is likely to remain uncomfortably high for a number of years. Payroll employment is expected to fall by 8.25 million jobs from its peak in December 2007 to its trough in the next few months, and not return to its previous peak until the very end of 2012.
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The unemployment rate is expected to peak between 10.5% and 11% this fall and not return to a rate consistent with full employment until 2013 .The full-employment unemployment rate is rising as more workers face longer periods of joblessness, undermining their skills and marketability. Structural unemployment is also increasing due to weakening in labor force mobility, a function of the large number of homeowners whose mortgages are underwater. Historically, people who lose jobs in one part of the country could readily move to take jobs in other regions. This is much more difficult with a home that requires more equity in order to sell. The full-employment unemployment rate has already risen from below 5% before the Great Recession to an estimated 5.4% currently. Under the best of circumstances, it is expected to rise to nearly 6% over the next couple of years.
The Federal Reserve surveyed the 39 industries covered in this study, the actual job losses that occurred from August 2007 until September 2008. In the last two columns of below Table, the part of the job losses that can be explained by the financial crisis and the sectors financial dependence are listed. We always present first the absolute numbers and then changes in percent of the August 2007 level of employment.
Overall, of the total decline in employment of 2.72% since the start of the financial crisis, 1.86 percentage points (over two thirds) can be attributed to the effect of the financial crisis on the higher cost of obtaining external finance. When looking at absolute values, the financial crisis seems to explain nearly the entire decrease in employment (1,439,000 of 1,558,800 total decrease in employment), but this is driven by two very large sectors (“Administrative and Waste Services” as well as “Administrative and Support Services”). When excluding these two sectors, 608,000 out 965,000 layoffs can be explained, i.e., again around two thirds.
|No |Industry name |Actual change in employment |in percent of |Change in emp. |in percent of |
| | |08/2007-09/2008 |08/2007 |attributed to crisis |08/2007 |
| | | | |08/2007-09/2008 | |
|1 |Logging |100 |0.2% |3,046 |5.1% |
|2 |Specialty trade contractors |-271,100 |-5.7% |-122,907 |-2.5% |
|3 |Wood products |-55,200 |-11.3% |101 |0.0% |
|4 |Nonmetallic mineral products |-27,800 |-5.7% |-12,689 |-2.5% |
|5 |Primary metals |-9,200 |-2.1% |-11,461 |-2.5% |
|6 |Fabricated metal products |-35,700 |-2.3% |-38,622 |-2.5% |
|7 |Machinery |-1,200 |0.1% |-9,060 |-0.8% |
|8 |Computer and electronic products |-16,600 |-1.3% |-32,041 |-2.5% |
|9 |Computer and peripheral equipment |100 |0.1% |-4,712 |-2.5% |
|10 |Communications equipment |2,500 |1.9% |-3,253 |-2.5% |
|11 |Semiconductors and electronic components |-14,700 |-3.4% |-11,137 |-2.5% |
|12 |Electronic instruments |2,300 |0.5% |-11,203 |-2.5% |
|13 |Electrical equipment and appliances |-9,700 |-2.3% |-17,938 |-4.2% |
|14 |Transportations equipment |-130,100 |-7.9% |-71,807 |-4.2% |
|15 |Motor vehicles and parts |-141,600 |-15.4% |-41,728 |-4.2% |
|16 |Furniture and related products |-49,500 |-9.7% |-9,082 |-1.7% |
|17 |Miscellaneous manufacturing |-7,700 |-1.2% |-4,390 |-0.7% |
|18 |Food manufacturing |-4,800 |-0.3% |-10,626 |-0.7% |
|19 |Beverages and tobacco products |-5,100 |-2.6% |-3,732 |-1.9% |
|20 |Textile mills |-17,400 |-11.0% |-3,735 |-2.2% |
|21 |Textile product mills |-8,800 |-5.8% |-191 |-0.1% |
|22 |Apparel |-16,500 |-8.1% |-853 |-0.4% |
|23 |Leather and applied products |1,800 |5.3% |867 |2.6% |
|24 |Paper and paper products |-9,700 |-2.1% |-11,346 |-2.5% |
|25 |Printing and related support activities |-24,400 |-4.0% |-26,143 |-4.2% |
|26 |Petroleum and coal products |1,200 |1.1% |-3,401 |-3.0% |
|27 |Chemicals |-12,200 |-1.4% |-5,887 |-0.7% |
|28 |Plastics and rubber products |-27,900 |-3.8% |8,987 |1.2% |
|39 |Motor vehicle and parts dealers |-69,300 |-3.7% |-48,475 |-2.5% |
|30 |Miscellaneous store retailers |-12,200 |-1.4% |-22,018 |-2.5% |
|31 |Support activities for transportation |6,100 |1.0% |-14,778 |-2.5% |
|32 |Publishing activities |-28,200 |-3.2% |-22,710 |-2.5% |
|33 |Motion picture and sound recording |4,400 |1.2% |-9,527 |-2.5% |
| |industries | | | | |
|34 |Admin. and waste services |-306,500 |-3.7% |-355,365 |-4.2% |
|35 |Admin. and support services |-316,100 |-4.0% |-475,947 |-5.9% |
|36 |Waste management and remediation services |9,600 |2.6% |-9,061 |-2.5% |
|37 |Arts |13,900 |0.7% |19,819 |1.0% |
|38 |Performing arts and spectator sports |19,800 |4.7% |4,116 |1.0% |
|39 |Repair and maintenance |-23,000 |-1.8% |-50,111 |-4.0% |
|Total (percentages are unweight) |-1,588,000 |-2.72% |-1,439,000 |-1.86% |
|Total excluding sectors 34 & 35 |-965,400 |-2.66% |-607,688 |-1.69% |

Sources: Bureau of Labor Statistics, own calculations.
5.0 Recovery and Challenges:

Ironically, the legacy of the crisis has been to continue and even double down on the deviations from good policy that led to the crisis. In many ways the policies resemble the policies that got USA into this mess with the uncertainty, the unpredictability, the unprecedented nature, and the failure to follow rules and a basic strategy. The crisis itself has given more rationale to “throw out the rule book,” to do special, unusual things. To illustrate this in the case of monetary policy, consider Figure 5 which deserves careful study in analyzing the causes and effects of policy. Figure 5 shows reserve balances held by banks (deposits of the banks at the Federal Bank). It is a measure of liquidity provided by the Federal Bank. The first part of the chart illustrates what represents good monetary policy before the crisis. There is a small blip around 9/11/2001 in the chart. With the physical damage in lower Manhattan, the Federal Bank provided what was then an amazing $60 billion of liquidity to the financial markets. There is another expansion of liquidity during the panic of the fall of 2008; again, this largely represents good lender-of-last-resort policy, including the swaps with foreign central banks and loans to US financial institutions. When the panic subsided in late 2008 this lender of last resort policy began to wind down as it should have.

But as shown in the picture, the liquidity increases didn’t end. Instead there was a massive expansion of liquidity with QE1, QE2, and QE3. It has been completely unprecedented. There’s really no way for such a massive policy to be predictable or rules-based. In the year since QE3 started, long term Treasuries and mortgage backed securities have risen rather than fallen at the Federal Bank predicted with this policy.

The suggestion by the Federal Bank that there would a tapering of QE3 is also illustrated in the chart. The anticipations of a difficult exit are part of the reason why this unconventional monetary policy has not been effective. And now we’re back to a seemingly never ending QE3 as originally implemented with a great deal of uncertainty about when it will slow down and end. How it’s going to be unwound, we still don’t know. Figure 5 also serves as a reminder that the magnitudes of quantitative easing are very large, and that this is a very unusual policy. Indeed, the magnitudes on that graph are completely unprecedented.

So, America is facing a very interventionist, unconventional, unpredictable policy. After good lender of last resort policies during the panic of 2008, the Federal Bank has doubled down since 2009 on the interventionist policies of 2003-2007 and this has raised questions about its independence and credibility. In this sense the impact of the crisis has not been good for the future of monetary policy. Figure 5 also is an illustration that when referring to unconventional monetary policy it is important to distinguish between these massive asset purchase programs from 2009 onwards, and the liquidity operations during the panic of 2008.

[pic]

Figure 5: Shifting from liquidity operations to unconventional monetary policy

A further challenge is that existing micro-prudential regulation, by and large, did not identify the nature and size of accumulating financial and systemic risks and impose appropriate remedial actions. Even though some analysts and institutions were sounding alarms before the crisis erupted, there were few regulatory tools available to cope with the accumulation of risk in the system as a whole or the risks being imposed by other firms either in the same or different sectors. There also seemed to be insufficient response to these risks either by market participants or by the authorities responsible for the oversight of individual financial institutions or specific market segments.
Under a free-enterprise system, a fundamental assumption is that markets will self-correct, and that individuals, in pursuing their own financial interests, like an “invisible hand,” tend also to promote the good of the global community. If losses occur, investors and institutions naturally become more prudent in the future. A complex challenge remains to determine how much further regulation and oversight is necessary to moderate behavior by institutions that may be in their own financial interest but may pose excessive risk to the system as a whole. Also, how can supervisory authorities preclude a repeat of the same mistakes in the future as personnel and firms change and as memories of financial crises become distant? Also, how the system should be improved to fill gaps in information and technical expertise in order to compensate for faulty or incomplete methods of modeling risk or to provide more resilience in the system to offset human error?
For other nations of the world, what has become clear from the crisis is that U.S. financial ailments can be highly contagious. Foreign financial institutions are not immune to ill health in American banks, brokerage houses, and insurance companies. The financial services industry links together investors and financial institutions in disparate countries around the world.
Investors seek higher risk-adjusted returns in any market. In financial markets, moreover, innovations in one market quickly spread to another, and sellers in one country often seek buyers in another. AIG insurance, for example, appears to have been brought down primarily by its Financial Products subsidiary based in London, an operation that engaged heavily in credit default swaps. The revolution in communications, moreover, works both ways. It allows for instant access to information and remote access to market activity, but it also feeds the herd instinct and is susceptible to being used to spread biased or incomplete information.
The linking of economies also transcends financial networks. Flows of international trade both in goods and services are affected directly by macroeconomic conditions in the countries involved. In the second phase of the financial crisis, markets all over the world have been experiencing historic declines. Precipitous drops in stock market values have been mirrored in currency and commodity markets.
Another issue is the mismatch between regulators and those being regulated. The policymakers can be divided between those of national governments and, to an extent, those of international institutions, but the resulting policy implementation, oversight, and regulation almost all rest in national governments (as well as sub-national governments such as states, e.g. New York, for insurance regulation). Yet many of the financial and other institutions that are the object of new oversight or regulatory activity may themselves be international in presence. They tend to operate in all major markets and congregate around world financial centers (i.e., London, New York, Zurich, Hong Kong, Singapore, Tokyo, and Shanghai) where client portfolios often are based and where institutions and qualified professionals exist to support their activities. The major market for derivatives, for example, is London, even though a sizable proportion of the derivatives, themselves, may be issued by U.S. companies based on U.S. assets.
A further issue is to what extent the U.S. government and Federal Reserve as “domestic lenders of last resort” should intervene in the day-to-day activities of corporations that have received federal support funds. Traditionally, financial regulations have been aimed at ensuring financial stability, transparency, and equity. Financial institutions have traded the promise of a governmental safety net for government rules that attempt to ensure that a safety net is not necessary. Issues such as executive compensation and bonuses or, in the case of General Motors, whether executives travel by private jet, traditionally have not been subject to regulation. Yet once the government provides public support for companies, public pressure rises to intervene in such matters. A fundamental issue deals with the nature of regulation and supervision. Banking regulation tends to be specific and detailed and places requirements and limits on bank behavior. Federal securities regulation, however, is based primarily on disclosure. Registration with the Securities and Exchange Commission is required, but that registration does not imply that an investment is safe, only that the risks have been fully disclosed. The SEC has no authority to prevent excessive risk taking. Likewise, derivatives trading are supervised by the Commodity Futures Trading Commission, but the futures exchanges and the over-the-counter markets on which they trade are largely unregulated.

6.0 Concluding Remarks:

The U.S. economy is currently experiencing its worst crisis since the Great Depression. The crisis started in the home mortgage market, especially the market for so-called “subprime” mortgages, and is now spreading beyond subprime to prime mortgages, commercial real estate, corporate junk bonds, and other forms of debt. Total losses of U.S. banks could reach as high as one-third of the total bank capital. The crisis has led to a sharp reduction in bank lending, which in turn is causing a severe recession in the U.S. economy.

One course of action the Federal Reserve can take to minimize the negative impact that a financial crisis could have on the economy is to be innovative. The Fed must leave room for itself to be more “fluid” and be able to adapt to changes as they come. Following strict guidelines and procedures that have been in place for years does not lend itself well to unprecedented circumstances. The Fed must be able to make changes and adapt to circumstances and being rigid does not allow for this. We think that this course of action is supported by history. The Fed was very innovative in dealing with the financial crisis of 2008 and it is one of the main reasons U.S. economy was able to recover, not to mention why they did not slip into an even greater crisis.

Referances

• Financial Crisis of 2007-08, Available from [14 November 2015]

• International Monetary Fund, 2009 Global Financial Stability Report: Responding to the Financial Crisis and Measuring systemic Risks, Summary Version, Washington, DC, April 2009, p. 1ff.

• Koller, Cynthia A. (2012). White Collar Crime in Housing: Mortgage Fraud in the United States. El Paso, TX: LFB Scholarly.

• "Brookings Institution – U.S. Financial and Economic Crisis June 2009 PDF Page 14". Brookings.edu. Retrieved January 2, 2011

• Clinton T. Brass et al, CRS Report R40537, American Recovery and Reinvestment Act of 2009 (P.L. 111-5): Summary and Legislative History

• Cautious Moves on Foreclosures Haunting Obama". The New York Times. Retrieved August 20, 2012.

• Taylor, P 2013, “Causes of the Financial Crisis and the Slow Recovery: A 10-Year Perspective” SIEPR Discussion Paper N0. 13026, Available from: The Stanford Institute for Economic Policy Research Centre Course Material Online [14 November 2015]