All of us, at some point in life, have come across the term ‘The Great Recession’. The calamity of ‘08 has, in a way or the other, affected every human on the planet. Yet, due to financial complexities and intensely intertwined business behaviour, only a few people grasp the mere gist of the Great Recession.

This article will take into account the causes, the mannerism and the impacts of the Great Recession, which quite possibly could have triggered the end of the world as we know it.

What caused The Great Recession?

The origins can be traced back to the early 2000s with the rise of American housing. The American housing was FLOURISHING – mainly due to two primary reasons – 1. The dot-com bubble (deflation in the stock market, emphasis on tech companies) and 2. The American Banks.

One is bound to ponder; how did the dot-com bubble lay the foundation of the Great Recession? The answer is simple, the investor’s behaviour. Following the dot-com bubble, Wall Street witnessed dark days, the trust in the stock markets was low. Thus, investors sought investment that would yield a dividend (profit capital) with low risk. Their pursuit leads them to invest in real estate, which at that period, fulfilled their desires.

Arguably the bigger cause, the American Banks and their greed led to great suffering. As a product of the first cause, the housing business was booming. This resulted in two sentiments – the first being related to the people, the thought of buying a house was more popular than ever due to the lucrative investment. It was clear that the value was increasing due to the booming market. The second sentiment was related to the banks – they made it easier than ever to buy a house, with attractive loans and greatly undermining the credit score. The mortgages which were based on such credit scores were called subprime mortgages. This gave the people, who previously could not buy a house, the opportunity to do so. This was their chance at completing the American Dream, whose crux is a house.

How did it happen?

Now that the origins have been established, it is time to shed light on the issues. One needs to understand the fact that to buy houses, people borrow money from the bank, as a mortgage. So, what is a mortgage? A mortgage is a loan issued by a bank to a person so that they can buy a house. In return, the banks receive a deposit+interest from the loanee and if the loanee fails to do so, they are categorized as a defaulter, the proprietorship of the defaulter’s house is given to the bank. Now, an interesting finding is that the banks also issued collective mortgage bonds aka Collateralized Debt Obligation (CDO) as mortgage debt investments. The investors were not normal people, but large investment firms and top dogs, which had influence over the market.

These investors were unsure though, because after all, they were investing massive sums in a non-volatile variable. So, by their greedy nature, the bank partnered with insurance firms to issue insurance on these investments. These insurance policies were referred to as Credit Default Swap, which means a swap to a defaulting credit, which was largely a product of subprime mortgages. The greatest insurance company involved in this was also the biggest company in the United States as well as the biggest insurer in the world – American International Group. The massive problem in this was that AIG or any other credible insurance company should have that capital to pay the insurance but AIG, rather than having that capital, was under the impression that the capital will come to them as the housing market gradually increases. To their great despair, the market crashed. The irony being that it crashed due to their greedy partners, the banks. You see, the banks issued the great subprime mortgage, which resulted in issuing loans to people who have no way to repay it. Thus, the bank takes their real estate and sells it. The problem here was that so many people had subprime mortgages, that the bank had to sell a GREAT number of real estate homes, and NO ONE could buy them. And as the rule of commerce goes, an increase in supply and a decrease in demand results in deflation, due to which the prices go down and eventually, the markets crash.

What was the impact?

This affected millions of Americans – 8 million Americans lost their jobs; 4 million homes were getting foreclosed each year and 2.5 million businesses closed down. AIG declared bankruptcy, on September 8, 2008, a few hours after one of the oldest and biggest banks in the States – Lehman Brothers, did the same.

Now how could this affect the nature of the world?

Firstly, the American economy and the American banks have a massive influence on the world – thousands of international commercial and state bodies depend on these banks and their economy. The turmoil in America, unfortunately, meant turmoil in most of the world. Furthermore, since AIG was the biggest insurer in the world, its clients were major economic powerhouses from all over the world. If AIG would have sunk, it would have taken the jobs of hundreds of millions with it and definitely would have plundered the economy and the state of the world. As former FBI Chairman Alan Greenspan had declared, ‘if they’re too big to fail, they’re too big.’

Who to blame and who to give credit to?

The Great Recession is largely accepted as a result of failures in-between the financiers of America, who were driven by their ignorance, incompetence and blinded by their greed. It must be stated that the lack of transparency in finance powerhouses, such as the banks and AIG, was utterly depressing. However, it is also a mistake on the State’s part. How could they NOT see this? Why did they not regulate adequately? Such questions often strike one’s mind when thinking of their role in this. But it is also the State, that saved the world. The day AIG and Lehman Brothers declared bankruptcy, the State decided to initiate state-sponsored buyouts. Before that day, the State, represented by the Chair of Federal Reserve, Ben Bernanke, had their firm stance against state buyouts to teach the Bulls. On September 16, 2008, the Treasury Secretary, Henry Paulson bailed out AIG, due to its plausible ramifications. The Federal Reserve took charge of an 80% equity stake of AIG for $85 billion. They then appointed a new CEO – Edward Liddy, for a salary of $1 to undo the complex finance maze. AIG also gave $165 millions worth of executing incentives for the same. There were several challenges encountered by AIG thereafter. A lawsuit which settled at them paying out nearly a billion-dollar people who were misled. It recorded the greatest loss in the corporate history of $61.7 billion. Due to all of this, AIG had to half its number of employees by 2016, just to retain their profit. After dealing with all the mishaps, AIG became gradually stable and astonishingly in 2012, Federal Reserve sold their stake for a $22 billion profit. It took another five years until all their stature was reduced to dust and their authority ceased to exist. Only God knows what would have happened if the bubble never busted or the State did not decide to bail out AIG.

What did we learn?

With a better understanding of what led us there, people need to be more responsible and should not take mortgages which they know they cannot possibly afford. The investors also need to be cognizant of the fact that they should not be blinded by over-the-top incentives. Lastly, the State should regulate efficiently to avoid landing in such situations.