How the Great Recession Could Have Been Prevented

The Great Recession

The Great Recession was a dramatic economic fall that occurred near the end of the first decade of the twentieth century. In 2009, most countries afflicted by the crisis began to recover. The International Monetary Fund described the Great Recession as the worst economic slump since the Great Depression, which occurred between the two world wars (IMF 11).

Many high-income and middle-income countries had economic downturns during this period. It started in the United States with a home market decline in December 2007. This is one of the depressions where economies have been able to predict and account for in most logical terms. Though there were many warning signs and interpretations by economists, the slump seemed to get people by a surprise. The major factor that contributed to this economy was the overhyped real estate industry that saw many people invest in. This compromised the liquidity of the economy when the industry collapsed. Households, business entities and financial institutions did not have money that could fund regular consumption and thus the effect spread to other industries and eventually the whole economy (Pilkauskas et al. 409). This essay will discuss some of the possible ways that could been used to prevent this economic slump.

Preventing the Great Recession

Many developed nations were experiencing massive economic growth at the inception of the new millennium. Unemployment levels were low and people were willing to obtain highly-valued property, especially housing. Mortgage-backed securities (MBS) were being bought at exceptionally high prices. Banks started giving out large loans to property developers. The real estate market started collapsing in 2007 and the value of securities declined (Davis et al. 585). Investors were unable to retrieve their money from the real estate industry in order to pay loans. Many financial institutions in Europe and the US had very large loan to equity ratios. This jeopardized their insolvency. They could neither fund new investments or expenditure of the households. This condition would have been prevented if banks and financial institutions could have foreseen the collapse of the real estate industry and limited their lending to investors from this industry. The entities would thus have maintained their solvency despite the collapse of the real estate industry.

Individuals purchasing securities should have foreseen the likelihood of the collapse of the real estate industry. Since people were willing to purchase landed property, it created demand. The investors in the industry approached the banks with this demand in mind and convinced them to increase their loans to facilitate the creation of some sophisticated derivative products which would then be offered to the market at very high prices. The banks could then float securities. The stakeholders in this circle should have foreseen the likely consequences of increased investment in one industry (Pfeffer et al. 101). Housing is a basic human want. However, the kind of products that the money was being invested into was not basic. It is important to acknowledge that disposable income is limited. The investors did not appreciate this fact. Slowing down investments in non-basic landed properties would have prevented the great recession.

The slump can be attributed to the rise in interest rates. The high interest rates compromised liquidity because individuals and entities with savings would often give it up in order to earn interest. It was accelerated by the fact that these people associated the securities with little or no risks. Interest rates are usually controlled by central banks in most economies. The Federal Reserve Bank came in to lower interest rates and this saved many economies from further damage (Cetorelli et al. 2010). This should have been done before the depression occurred. Central banks invest in research. These institutions have experts who can predict likely trends in various industries and the economy using this data. Though the US and other western economies rely on free market, there are cases where market forces lead to inconveniences and hitches. The institutions are charged with the responsibility of regulating certain market forces to avoid these inconveniences. Central banks should have kept interest rates low. When this is done, a certain proportion of households and business entities will hold their money and invest in other enterprises. Others will continue holding it in the hope that the rates will go up. Such money is available for circulation. They will be mobile and will tend to balance between the various industries in the economy. In case one industry collapses, the effect will not be felt much in other sectors of the economy (Blinder et al. 4)

Conclusion

The recess can be blamed on the decisions of various stakeholders. Central banks should have lowered interest rates long before the recession to promote liquidity. Investors and financial institutions who funded investments in real estate should have foreseen the collapse because supply was growing at a very fast rate and it was likely that it would surpass demand. Individuals buying securities should also have foreseen the collapse of the housing industry and preferred direct investments in other industries instead. Most of the preventive strategies to the recess should have focused on promoting liquidity and insolvency of financial institutions and entities in all the industries in the economy.

Works Cited

Blinder, Alan S., and Mark M. Zandi. How the great recession was brought to an end. Moody’s Economy. com, 2010.

Davis, Steven J., R. Jason Faberman, and John C. Haltiwanger. “Recruiting intensity during and after the Great Recession: National and industry evidence.” The American Economic Review 102.3 (2012): 584-588.

International Monetary Fund. World Economic Outlook — April 2009: Crisis and Recovery“ (PDF). IMF. 24 April 2009. Web. 18 March 2017.

Pfeffer, Fabian T., Sheldon Danziger, and Robert F. Schoeni. ”Wealth Disparities before and after the Great Recession.“ The ANNALS of the American Academy of Political and Social Science 650.1 (2013): 98-123.

Pilkauskas, Natasha V., Janet M. Currie, and Irwin Garfinkel. ”The great recession, public transfers, and material hardship.“ Social Service Review 86.3 (2012): 401-427.

Cetorelli, Nicola, and Linda S. Goldberg. ”Liquidity management of US global banks: Internal capital markets in the great recession.“ Journal of International Economics 88.2 (2012): 299-311.