2008 Global Economic Crisis: Causes, Effects, and Household Impact

Introduction: The 2008 Financial Crisis and Its Global Reach

Throughout the history of the United States and the world at large, financial crises and the resultant economic recessions have occurred with troubling regularity. The phenomenon has become so common that some regard such crises as inherent features of the economic systems of major world powers. The most recent example is the 2008 financial crisis, which brought about a global economic recession. The recession resulted in over $4.1 trillion in losses, increased poverty, and unemployment numbers climbing to over 10% in the United States and considerably higher in major European economies. Major banks collapsed and several stock markets crashed. American investors alone lost over forty percent of their savings value. Housing prices dropped sharply from the highs recorded in 2006. The 2008 crisis also resulted in a decline in manufacturing, a reduction in world trade, a decrease in consumer spending, and many other negative effects.

Because of the central importance of finance to most major dimensions of globalization, matters such as trade, migration, human rights, ethnic conflicts, inequality, crime, disease, democracy, and the environment were all affected. Moreover, the latest financial crisis affected some nations more than others, creating power shifts among nations—particularly between the United States and China. The European Union debated the degree to which member governments should bail out banks and what remedial measures were needed in their financial systems. These political, economic, financial, and social differences continue to be felt to this day, as evidenced by issues such as the Greek debt crisis. In the United States, citizens protested against financial inequality, resulting in movements such as "Occupy Wall Street" gaining popularity in the latter years of the financial crisis (Claessens & Kose, 2013).

The global impact of the 2008–2009 financial crisis demonstrates the importance of having a comprehensive understanding of what causes such crises, what their effects are, and what can be done to prevent them or at least mitigate their consequences. The latest crisis resulted in shifts in financial and economic policy, prompting experts to pursue new research to find the best responses, as the effects of the crisis continued to be felt worldwide years after the initial event (Tcherneva, 2012; Arestis, Charles & Fontana, 2013).

Background: Understanding Global Economic Crises

The causes of economic crises are as complicated as the crises themselves and the actors behind them. Since the early 17th century, approximately 60 financial crises have been recorded. People have always been driven by greed and an obsession with wealth, giving rise to both legal and illegal methods of accumulating it. Moreover, just as many individuals spend more than they earn, governments too operate with large deficits, resulting in substantial debts that destabilize financial systems. Since it is not possible to identify the precise causes of world economic crises with certainty, we can only examine the most plausible explanations behind the latest one. These include: (1) very low interest rates; (2) subprime loans, particularly in the mortgage market; (3) housing boom speculation; (4) large executive compensation packages; (5) the advent of complex financial innovations associated with rapid changes in the information and communications technology industry; and (6) deregulation of financial markets (Claessens & Kose, 2013; Tcherneva, 2012). A number of financial crises have followed periods of credit and asset booms. Several theories and observations support this pattern. However, explanations from governments and financial regulators for why they do not intervene before credit booms or asset bubbles become unsustainable have generally been unsatisfactory (Pfeffer, Danziger & Schoeni, 2013).

There are two broad types of financial crises. The first type is classified using strictly quantitative definitions and includes sudden stop and currency crises. The second type is defined through judgmental or qualitative analysis and includes banking and debt crises. The integration of the global economy means that the effects of financial crises spread quickly around the world and are felt across many different sectors. For instance, Aluko (2008) noted that the debt crisis in the United States during the recent economic downturn caused a significant reduction in foreign direct investment and other capital flows from Americans to both developing and developed countries. The economic downturn also contributed to the collapse of stock markets around the world (Olaniyi & Olabisi, 2011).

Methodology

The sharp stock market decline in the second quarter of the 2008–2009 financial year marked the first point of data collection. A survey designed to cover a wide range of issues—including life satisfaction, health metrics, employment status, retirement realities and expectations, housing, stock ownership, recent transactions and declines in value, expectations about future returns, and future plans for asset accumulation—was administered to the American Life Panel (ALP) in November 2008. This survey was followed up in February 2009 with a longitudinal interview addressing the same issues (Hurd & Rohwedder, 2010).

In the first survey, 73% of households reported that they had cut spending because of the financial crisis. The spending cuts by households are of both scientific and policy interest, and there is important value in carefully measuring the extent of such cuts—for example, the effects of the financial crisis on social welfare are partially dependent on consumption levels. The scale of spending cuts prompted a reorientation of the survey to include the collection of detailed data on spending (Hurd & Rohwedder, 2010; Claessens & Kose, 2013).

Beginning with the second interview, a monthly interview schedule was established to reduce the risk of recall error on spending and to gather high-frequency data on issues such as expectations, employment, satisfaction, mood, and affect. The goal was to allow detailed assessment of events and their implications. During each interview, participants were asked about their spending in the preceding 30 days across 25 categories, which together accounted for approximately 70% of total spending. After every quarter, questions were also asked about 11 additional categories. Measures from the quarterly and monthly surveys together captured total spending from February through May (Pfeffer et al., 2013). The quarterly surveys continued until April 2010.

The monthly panel design allowed researchers to observe the immediate effects of the financial crisis in a way that could not be captured by low-frequency retrospective studies (Claessens & Kose, 2013; Tcherneva, 2012). Monthly measurements of total spending also reduced recall bias around high-frequency purchases. The repeated surveys also elicited high-frequency subjective probabilities and measures of mood that tend to respond in tandem with financial events (Tcherneva, 2012).

A total of 2,693 respondents participated in at least one of the 14 interviews conducted. Retention was strong: over 73% of respondents participated in at least 10 of the interviews, and 40% participated in all of them. The high retention rate was partly attributable to interviewers actively encouraging respondents to continue participating even if they had missed some intervening interviews (Pfeffer et al., 2013; Arestis et al., 2013).

Conclusion

The financial problems that eventually culminated in the 2008 recession began when the housing bubble in the United States burst and Wall Street crashed. These financial problems escalated into a full-fledged economic crisis. Immediately following the significant declines in stock market values near the end of 2008, unemployment—though rising—still stood at a relatively modest 6.9%. However, even as the mortgage market stabilized and stock prices partially recovered, unemployment continued to rise, reaching a high of 10.1% in October 2009 (Hurd & Rohwedder, 2010).

As unemployment increased, the economic crisis deepened into the Great Recession, bringing the United States close to a government shutdown. Survey data indicated that approximately 40% of households had been affected by at least one indicator of financial distress: mortgage payment arrears, negative home equity, or unemployment. Financial planning for retirement was also undoubtedly disrupted, though difficult to measure precisely. Most individuals between 50 and 59 years of age lost significant value in their retirement accounts. Some older workers became unexpectedly unemployed due to job losses and will therefore have far less in savings than they had anticipated (Hurd & Rohwedder, 2010).

Short-term expectations regarding housing value gains and stock price increases had somewhat recovered by the end of the study period, but long-term expectations had not. Expectations about unemployment had also modestly improved; however, projections still suggested that approximately 18% of the American workforce would be unemployed in the following year. The global economic crisis thus offers several important lessons. The first is that investing in property booms or stock market bubbles frequently ends in sharp corrections. The second is that sustained spending beyond one's means results in financial vulnerability and an insufficient safety net during periods of economic turmoil.

References

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