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Chapter 24: Problem 3

Briefly discuss the factors that caused the recession of \(2007-2009 .\)

Short Answer

Expert verified
The recession of 2007-2009 was primarily caused by the bursting of the housing bubble, risky financial practices and instruments, and the resultant credit freeze.

Step by step solution

01

Housing Bubble and its Bursting

One of the main causes of the recession was the bursting of the housing bubble. Banks were lending to individuals who could not afford mortgages, causing a surge in house prices. When these individuals defaulted on their loans, house prices fell drastically, leading to a crisis in the mortgage industry and a sharp decline in the value of mortgage-backed securities held by many financial institutions.
02

Financial Instruments and Practices

Banks and other financial institutions had been engaged in the practice of securitization, turning mortgages and other debts into securities that could be sold to investors. Additionally, many financial institutions had taken on too much risk with complex financial products like collateralized debt obligations (CDOs) and credit default swaps (CDSs). When the housing market collapsed, the value of these securities plummeted, leading to huge losses.
03

Credit Freeze

As a result of massive losses on bad loans and risky securities, many financial institutions faced potential insolvency. This led to a freeze in lending (credit crunch), which further deepened the recession. Companies found it difficult to borrow money, resulting in cutbacks and layoffs.

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Most popular questions from this chapter

Why does the short-run aggregate supply curve slope upward?

What variables cause the short-run aggregate supply curve to shift? For each variable, identify whether an increase in that variable will cause the short- run aggregate supply curve to shift to the right or to the left.

From August 2009 to May \(2017,\) the Standard \(\&\) Poor's Index of 500 stock prices increased by more than 135 percent, while the consumer price index increased by less than 15 percent. Briefly explain what effect, if any, these changes had on the aggregate demand curve.

Briefly explain how each of the following events would affect the long-run aggregate supply curve. a. A higher price level b. An increase in the labor force c. An increase in the quantity of capital goods d. Technological change

What is "stagflation"? Why might a supply shock result in it?
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