What Caused the Great Recession?

By Mike DuBose with Blake DuBose

 

It’s a question that Nobel Prize-winning economists, university scholars, think tanks, Congressional committees, and financial experts still debate to this day: “What brought about the ‘Great Recession,’ the period of economic difficulty we experienced in the late 2000s?” The correlating (and equally difficult) question is usually, “What brought us out of it?”

The truth is that there’s no easy answer. The origins of the Great Recession are complicated and intertwined with other problems of the time. However, our experiences as business owners during difficult economic times, research we have conducted, interviews we have held with bankers, and meetings we have had with those involved in solving the Great Recession (such as former Federal Reserve chairman Ben Bernanke) have combined to give us some understanding of the source of the problem, which we will attempt to describe in understandable terms. As Bernanke explained during a meeting we attended in October 2014, the American economy in 2008 was on the verge of a Great Depression similar to the one experienced in 1929-1939, where unemployment peaked at nearly 25%! Therefore, it’s in the best interest of future generations—and our own—to understand the reasons behind the Great Recession and avoid repeating these mistakes.

 

What is a recession?

A recession is an economic slump, particularly when a nation’s economy fails to grow (or experiences negative growth) within two consecutive quarters of any year. Usually, recessions last between six and 24 months and are often characterized by fear, panic, and reduced business and consumer spending. When demand for products and services falls, retail, wholesale, and manufacturing companies reduce production. Revenue decreases, banks tighten up on access to credit, and companies without strong cash reserves cannot sustain the profits required to stay in business. In an attempt to maintain their companies’ financial health, leaders often cut back on their buying, reduce expenses, and lay off employees. When employees are laid off, they lose health insurance coverage, don’t pay taxes, and sometimes cannot pay their bills. This leads to a rise in the number of people declaring bankruptcy or seeking government services such as welfare and unemployment benefits—all at a time when government tax revenue is decreasing.

The United States economy has experienced several recessions in the past few decades, culminating in the Great Recession, which took place between 2007 and 2009 (according to the National Bureau of Economic Research). The first began in 1981 and lasted through 1982. This recession followed the high interest rates (20%) under President Carter’s administration, the Iranian Hostage Crisis, steep increases in gasoline prices, and inflation rates that significantly increased the price of goods. It grew in strength when President Reagan implemented steep cuts in domestic and federal government spending while the price of OPEC-controlled fossil fuels continued to grow. Many businesses went under at this time, including our retail and wholesale computer businesses. (It was a painful experience, but it gave us a stellar education on how to effectively run a business, which we applied to create a new group of companies in 1985 that are still going strong today.)

A second recession began in 2001. In the late 1990s, booming computer sales inspired many to invest heavily in technology companies, but many of these companies went bust, resulting in devastating stock losses and heavy layoffs. The September 11, 2001 terrorist attacks on the World Trade Center spread fear within the American public, consumer spending sharply decreased, and several stock market crashes occurred. The wars in Afghanistan and Iraq that followed wiped out the balanced budget that President Clinton and the Republican Congress had left behind when President Bush assumed office.

Then, in the late 2000s, came the Great Recession, the most severe financial downturn our country has seen since the Great Depression! Although it officially ended in 2009, the negative impact of the Great Recession continues to haunt the economy, individuals, families, and businesses years later. In fact, we are still feeling the effects in 2015, as many of the jobs that were wiped out during the recession have not yet been replaced. There may also be a shortage of skilled workers in the future—as Stewart Mungo, one of South Carolina’s largest builders, informed us, many older, highly skilled workers such as housing framers retired or found other work during the recession, but didn’t train apprentices because jobs were so hard to come by. Therefore, once housing needs increase again, there will be fewer people with the skills needed to meet those needs.

Historically, South Carolina has always been about a year “behind” when it comes to recessions. In fact, while 2008 was a horrible year for most US businesses, it was one of the best financial years ever for our companies! We falsely believed that if we could weather “the worst” in 2008, our future looked bright, but the nightmare caught up with us in 2009. Thankfully, we had built the family of companies on a solid foundation: the DuBose family motto, “Hope for the best and plan for the worst!”

 

What caused the Great Recession?

The beginnings of the Great Recession can be traced back to the administration of President George W. Bush and the Federal Reserve at that time. Instead of raising borrowing rates in 2004, the Federal Reserve under Alan Greenspan kept interest rates low. This led to many individuals buying houses they could not afford because they believed that housing prices would continue to skyrocket. “Irrational exuberance” also encouraged some people to buy homes with plans of reselling them for a profit.

The beginning of the end emerged when the “interest only” loans began to surface. In fact, I knew that trouble would be coming when I saw home loans advertised for little to no money down. Some mortgage companies were even providing loans at 120% of houses’ already inflated value—not only giving the new owners enough money to purchase their home, but also an additional 20% to spend!

Banks, governed by only weak regulations and limited oversight, began to aggressively buy and sell mortgages to make a profit. A person might take out a home mortgage with one financial institution, only to learn that another owned it six months later. Stock investors began to invest heavily in both banks and stock portfolios that featured large amounts of housing loans and real estate-backed securities. Many countries began to invest in US stocks and bonds, as did many US-based investment firms, and banks around the world were lending money to each other. Thus, international financial institutions began a “global connection” of cross investments. Because they were all linked together, if one economy failed, it could impair other nations as well.

One major cause of the Great Recession was lack of oversight. As Nobel Laureate Paul Krugman noted in a New York Times article, “Regulation did not keep up with the system.” Stock traders and executives at financial firms greedily took on excessive risks, tempted by the possibility of extraordinary returns; companies were also expanding far too quickly (and for similar reasons). People were rewarded handsomely for making short-term gains, and leaders did not take the long view of what could happen down the road. “Greed” and “risk” were the two terms that popped up most frequently in our research. When the crisis began, even US Treasury leaders did not recognize the seriousness of the problem and didn’t move to implement quick solutions.

As worldwide confidence in the American economic system eroded, the value of the dollar also fell, which limited US companies’ desire to invest overseas. Many decided instead to divert their liquid assets into hard assets like real estate, which later plunged in value. To make matters worse, during the period of 2004 to 2007, the price of gasoline doubled, increasing transportation costs and raising the prices of many goods.

In 2005, the number of new houses being built started to decline. A year later, the housing bubble (where the value of homes was escalating at a rapid pace) burst, resulting in a $7 trillion dollar loss. For example, homes that were valued at $200,000 (and had been bought with a loan of $210,000) suddenly dropped in value to $140,000. This caught both lending institutions and consumers off guard. As the housing troubles escalated, home builders cut back on building new homes and many workers were laid off. It wasn’t just the laborers who built the homes who suffered—skilled technicians like plumbers, electricians, and heating and air conditioning technicians, as well as wholesalers, vendors, and their staffs, were also impacted. The need for supplies to build the homes dropped, and manufacturers of these materials reduced their inventory and laid off thousands of workers.

Consumers who had taken out mortgages that they could not afford now could not pay their bills. Banks began to rapidly foreclose on loans, stoking panic amongst many bankers and hedge fund investors who had bought mortgaged-backed securities and were being faced with huge losses. Their once-healthy balance sheets suddenly dropped by one-third to one-half. Credit rating agencies such as Moody and Standard and Poor’s misjudged the seriousness of the problem and often gave higher-than-deserved credit ratings to banks, mortgage companies, and investment firms. (In fact, many banks were mistakenly considered “too big to fail!”) Some financial institutions also lacked transparency in their activities and hid or downplayed their risks.

In 2007, banks tightened loans and were afraid to lend to each other because they didn’t want these toxic loans secured by over-inflated mortgages as collateral. To obtain a line of credit during the Great Recession, you basically had to prove to the banks that you did not need a loan! One banking officer we spoke to said that he had turned down loans to millionaires who were real estate wealthy, but had little cash. He explained, “We were simply not interested in owning real estate in the case that the person could not pay back a loan.” Businesses found it so difficult to borrow money and keep enough liquid cash on hand to pay their bills that they often had to lay off more employees in an attempt to stay afloat. Many failed anyway. About 170,000 small businesses closed their doors between 2008 and 2010, according to a 2012 Huffington Post article by Bonnie Karoussi. Looking at a wider span of years (2008-2015), other researchers have put the number of failed businesses closer to 200,000.

In 2008, the 85-year-old lending institution Bear Sterns was on the verge of collapse. Although it possessed $46 billion in mortgage-backed and other “questionable” securities, the organization on was cash poor. With the backing of the Federal Reserve, JP Morgan bought Bear Sterns…but nearly one-half of its employees—7,000 people—lost their jobs! A few months later, another huge financial institution, Lehman Brothers, filed for bankruptcy. This turned out to be one of the largest US bankruptcies in history, resulting in 23,000 employees being laid off.

When the American government refused to bail out Lehman Brothers, which had strong ties to international banks, fear spread to other countries. Banks worldwide began their own march toward recession as the US economy faltered and dragged other countries with it. The media inflamed public and corporate pessimism by constantly bombarding the airwaves with fear, negativity, and panic, speculating that the United States was headed for a depression. Consumer confidence shrank, and people cut back spending. Many fearful and insecure Baby Boomers, remembering horrific stories about the Great Depression told to them by their grandparents, also withdrew their money from banks. With so much real estate debt and inadequate cash to sustain their operations, 465 US banks failed during the Great Recession. One was Columbia, SC-based Bank Meridian, where we were significant investors. Many innocent people lost a great deal of money when the banking system failed and their stock became worthless!

The Great Recession claimed nearly 9 million jobs, and the US unemployment rate hit a peak of 11% (not to mention the numerous employees at US-connected companies overseas who were also laid off). Just 25 companies eliminated more than 700,000 employees (examples include General Motors, which laid off 107,000; Citigroup, 73,000; Hewlett-Packard, 47,500; Starbucks, 21,000; and AT&T, 18,000). State governments, facing dramatic shortfalls in tax revenue, also slashed their budgets by up to one-third and laid off thousands of workers. (South Carolina was no exception.) The remaining staffs were forced to take on the responsibilities of those who left, fostering a stressful work environment with decreased job satisfaction.

According to the US Financial Crisis Inquiry Commission’s 2011 report, the causes of the Great Recession were: “Widespread failures in financial regulation, including the Federal Reserve’s failure to stem the tide of toxic mortgages; dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; an explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; and systemic breaches in accountability and ethics at all levels.” All of the aforementioned factors combined in a “perfect storm” of mistakes, greed, and fear, resulting a Great Recession from which we are still recovering today.

While our economy is once again picking up steam, there are still rocky roads ahead. The stock market will doubtlessly experience corrections, and beginning in the last quarter of this year, interest rates will most likely begin to rise. Since 1981, our family of companies have experienced three recessions, most of which could have been prevented or at least been less painful. Who knows when the next recession will occur?

 

The bottom line: George Santayana once said, “Those who cannot remember the past are doomed to repeat it.” All of us—individuals, families, businesses, and governments—must learn the lessons taught by the Great Recession and live within our means, control our greed, and “hope for the best” while we “plan for the worst!” I often tell people that one of the greatest factors leading to failure is success: when your business is rapidly growing, that is the time you need to be most keenly alert. Thus, instead of seeking unsustainable growth, our family of companies have chosen to do few things very well, leading to a more secure future with happier customers and staff members. For those who choose otherwise, like Enron, greed and the love of money will surely bring them back down to earth!

 

Our next article will address what Ben Bernanke and others did to bring us out of the Great Recession. Many thanks to my friend Hal Xheraj of World of Business Ideas (wobi.com), for enabling me to meet Ben Bernanke!

 

About the Authors: Our corporate and personal purpose is to “create opportunities to improve lives” by sharing our knowledge, research, experiences, successes, and mistakes. You can e-mail us at [email protected].

Mike DuBose, a University of South Carolina graduate, is the author of The Art of Building a Great Business and is a field instructor with USC’s graduate school. He has been in business since 1981 and is the owner of four debt-free corporations, including Columbia Conference Center, Research Associates, The Evaluation Group, and DuBose Fitness Center. Visit his nonprofit website www.mikedubose.com for a free copy of his book and additional business, travel, health, and personal published articles.

Blake DuBose graduated from Newberry College’s Schools of Business and Psychology and is president of DuBose Web Group (www.duboseweb.com).

Katie Beck serves as Director of Communications for the DuBose family of companies. She graduated from the USC School of Journalism and Honors College.

 

© Copyright 2015 by Mike DuBose—All Rights Reserved. You have permission and we encourage you to forward the full article to friends or colleagues and/or distribute it as part of personal or professional use, providing that the authors are credited. However, no part of this article may be altered or published in any other manner without the written consent of the authors. If you would like written approval to post this information on an appropriate website or to publish this information, please contact Katie Beck at [email protected] and briefly explain how the article will be used; we will respond promptly. Thank you for honoring our hard work!

 

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