Recession 2007-2009

Global Financial Crisis There were a number of causes to the global financial crisis of 2007-2009. Baily, Litan and Johnson (2008) argue that there were numerous contributing factors, including the perception of a low risk U.S. housing market, securitization of the housing market, credit rating agencies, and the spread of these securities to financial institutions around the world. The primary contagion came from the United States, beginning in 2007, but there were contributing factors in many European countries as well. housing market entered a bubble state, with rapidly increasing prices.

This was the result of changes to the way that mortgages were financed, bringing more and riskier consumers into the housing market. This in turn fuelled speculators. Banks were able to securitize risk from the housing marketing. In complex transactions they were able to offload much of the risk onto other financial institutions around the world. Credit rating agencies, lacking a clear understanding of the products, rated them as secure investments.

These "secure" investments offered returns much higher than investments of similar "security," but of course they were not as secure as their ratings suggested. However, they had become popular investment items for banks around the world as the result of their apparent security. This is what made the crisis global in nature, rather than just an American problem -- banks all over the world were buying these securities. Baily et al. (2008) noted that risk management was poor.

In countries where banks exercise proper risk management -- Australia and Canada notably -- the economic crisis was nowhere near as intense. Tridico (2012) explains what happened next. With uneven income distribution, the increase in consumer credit represented by the new mortgage market in the U.S. was unsustainable, and inevitably it began to collapse shortly after the U.S. Federal Reserve increased interest rates -- most mortgages were on floating terms with low introductory rates. This resulted in a dramatic increase in mortgage defaults, threatening the supposedly secure mortgage-backed securities.

Banks heavily invested in these securities, such as Lehman Brothers, went bankrupt, causing a mass crisis of confidence in the entire financial system, and this crisis of confidence extended to all countries where banks were invested in these assets (The Economist, 2013). The banking crisis spawned a credit crunch. Around much of the developed world, financial institutions were either unable to lend to business or unwilling. This caused economic contraction.

Compounding the problem, governments bailed out their bankers, leading to public budget crises in several places, notably around the perimeter of Europe. Weak action from the U.S. government -- half the government was essentially calling for a do-nothing solution, watering down the public funding available to assist the economy -- and the ongoing crisis in Europe suppressed global economic growth for several years. Inept leadership in so many Western nations exacerbated the crisis, making short-run recover that much more difficult (Elliott, 2011).

The result is that even today the effects of the crisis represent a drag on global economic growth. Most nations have been forced to try to spur growth using monetary policy, that is to say offering money at a very low cost from the central bank to their banking systems in an effort to spur investment again. This is the case in Australia, and many other nations as well. Thus, we have persistent low interest rates because global economic growth is not strong.