Economic Catastrophe: Where Things Went Wrong

Submitted By ap3866a
Words: 2011
Pages: 9

Economic Catastrophe: Where things went wrong

The 2008 economic crisis was one of the most destructive economic crisis in history. Notoriously known as the “Great Recession”, after it became nearly as disastrous as the Great Depression itself. According to Arthur MacEwan and John Miller, the core of financial crisis of 2008 was led by income inequality. As this Income inequality increased, earnings of the middle class become sluggish. Lower Interest rates on loans and lower taxes on labor and capital income increased the gap between the rich and poor. This inequality made consumer demand sluggish. Non-sensible investments created by income inequality, generated ill-advised loans to lower class borrowers who could not afford them. The main factors that brought the crisis to a head were the housing market bubble, increased debt in the economy and the lack of regulation in the economy. The catalyst of the financial crisis of 2007-2008 was the collapse of the housing market. From 1997 to 2006 the value of homes rose by 85%, an increase in value never before seen in history. (83) Buyers were willing to pay higher prices for homes and take out larger mortgages because they thought the values of the homes would continue to rise even after they purchased a home. Homeowners were willing to take on more and more debt and banks were increasingly willing to give out more and more loans. Unfortunately, only works as long as the housing bubble inflated. All the blame cannot be placed on home buyers though because banks were just as ignorant to the situation. Many of the loans made by these banks undertook subprime lending, where banks made loans to people who were in positions where they would struggle to repay the money the borrowed. Banks were willing to do this because they could sell them subprime mortgages that would make them more money through their higher interest rates. The increase in household debt among home owners after the housing market bubble popped is essentially what light the powder keg which was this financial crisis. This borrowing took place both because banks had abandoned any notion of sound lending and because everyone assumed that house prices would never fall.
The expansion of people using loans rapidly increased leading into the crisis. The expansion of debt affected both the demand and supply of credit in the economy. From 1980 to 2005 the average amount of income going to the bottom 60% of people decreased from 35% to 29%. (89) Statistically, while it seemed average incomes were increasing, the spread of income between those who are at the top of the economic ladder and those at the bottom was widening with incomes at the top skewing the numbers. The low cost of credit allowed many people to rely on credit for everything “from food to fuel”. (89) The supply of this credit in the economy was made so readily available because of the low interest rates set by the Federal Reserve. This resulted in weak consumer demand, which led to slower economic growth. By keeping interest rates low, the Federal Reserve had a direct impact on the mortgage rates of ARMs (adjustable rate mortgages), the kind that were widely given out during the housing bubble. The increased reliance of U.S. consumers on credit was a response to the growing income inequality among classes.
As a result of these loans, the debt that home owners had accrued then began holding back the economy. This reduced activity in the economy because less cash was being given to other people. Since a person’s income is another person’s spending, less money was being distributed in the economy. A majority of people’s incomes was spent on repaying loans rather than spent on activities or goods that puts money in other people’s pockets. Most people with these loans generally had no money to put in their savings. This phenomenon perpetuated the crisis that was to come further because people lost any defense against economic shock. Once the value of