page_title: Causes of the Great Recession
section_title: Excessive private debt levels
hierarchical_section_title: Causes of the Great Recession / Excessive private debt levels
caption_attribution_description: English: U.S. Household Debt Relative to Disposable Income and GDP 1980-2011
context_page_description: Many factors directly and indirectly caused the Great Recession that started in 2008 with the US subprime mortgage crisis. The major causes of the initial subprime mortgage crisis and following recession include the Federal Reserve lowering the Federal funds rate and creating a flood of liquidity in the economy, international trade imbalances, and lax lending standards contributing to high levels of developed country household debt and real-estate bubbles that have since burst; U.S. government housing policies; and limited regulation of non-depository financial institutions. Once the recession began, various responses were attempted with different degrees of success. These included fiscal policies of governments; monetary policies of central banks; measures designed to help indebted consumers refinance their mortgage debt; and inconsistent approaches used by nations to bail out troubled banking industries and private bondholders, assuming private debt burdens or socializing losses.
context_section_description: To counter the 2000 Stock Market Crash and subsequent economic slowdown, the Federal Reserve eased credit availability and drove interest rates down to lows not seen in many decades. These low interest rates facilitated the growth of debt at all levels of the economy, chief among them private debt to purchase more expensive housing. High levels of debt have long been recognized as a causative factor for recessions. Any debt default has the possibility of causing the lender to also default, if the lender is itself in a weak financial condition and has too much debt. This second default in turn can lead to still further defaults through a domino effect. The chances of these follow-up defaults is increased at high levels of debt. Attempts to prevent this domino effect by bailing out Wall Street lenders such as AIG, Fannie Mae, and Freddie Mac have had mixed success. The takeover is another example of attempts to stop the dominoes from falling.There was a real irony in the recent intervention by the Federal Reserve System to provide the money that enabled the firm of JPMorgan Chase to buy Bear Stearns before it went bankrupt. The point was to try to prevent a domino effect of panic in the financial markets that could lead to a downturn in the economy.
  Excessive consumer housing debt was in turn caused by the mortgage-backed security, credit default swap, and collateralized debt obligation sub-sectors of the finance industry, which were offering irrationally low interest rates and irrationally high levels of approval to subprime mortgage consumers because they were calculating aggregate risk using gaussian copula formulas that strictly assumed the independence of individual component mortgages, when in fact the credit-worthiness almost every new subprime mortgage was highly correlated with that of any other because of linkages through consumer spending levels which fell sharply when property values began to fall during the initial wave of mortgage defaults. Debt consumers were acting in their rational self-interest, because they were unable to audit the finance industry's opaque faulty risk pricing methodology.
  According to M.S. Eccles, who was appointed chairman of the Federal Reserve by FDR and held that position until 1948, excessive debt levels were not a source cause of the Great Depression. Increasing debt levels were caused by a concentration of wealth during the 1920s, causing the middle and poorer classes, which saw a relative and/or actual decrease in wealth, to go increasingly into debt in an attempt to maintain or improve their living standards. According to Eccles this concentration of wealth was the source cause of the Great Depression. The ever-increasing debt levels eventually became unpayable, and therefore unsustainable, leading to debt defaults and the financial panics of the 1930s. The concentration of wealth in the modern era parallels that of the 1920s and has had similar effects. Some of the causes of wealth concentration in the modern era are lower tax rates for the rich, such as Warren Buffett paying taxes at a lower rate than the people working for him, policies such as propping up the stock market, which benefit the stock owning rich more than the middle or poorer classes who own little or no stock, and bailouts which funnel tax money collected largely from the middle class to bail out large corporations largely owned by the rich.
  The International Monetary Fund (IMF) reported in April 2012: "Household debt soared in the years leading up to the Great Recession. In advanced economies, during the five years preceding 2007, the ratio of household debt to income rose by an average of 39 percentage points, to 138 percent. In Denmark, Iceland, Ireland, the Netherlands, and Norway, debt peaked at more than 200 percent of household income. A surge in household debt to historic highs also occurred in emerging economies such as Estonia, Hungary, Latvia, and Lithuania. The concurrent boom in both house prices and the stock market meant that household debt relative to assets held broadly stable, which masked ho
caption: U.S. household debt relative to disposable income and GDP.
exif: {}