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The Story of the Recession

Prof. Henry Chappell

University of South Carolina

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Introduction

Motivation! What happened? What caused the recession? Were government policies appropriate? Why is the recovery slow?

House Prices, 2000 - 2011

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Housing Starts

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Real Residential Investment, 1994 - 2010

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Real GDP, 1970 - 2011

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Real Fixed Investment

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Real Consumer Durables

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Real Personal Consumption, 1994-2011

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Employment/Population

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Core CPI Inflation

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Productivity

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AD and AS

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AD

SRAS

*Y

0P

LRAS

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What Causes Fluctuations?

Shocks to: Spending and Taxes Money Wealth/Expectations/Animal spirits Technology/Productivity

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Housing and Financial Markets

Institutions and History “Old-fashioned mortgages” Specialization Securitization Slicing and dicing: CDOs Leverage and the Shadow Banking System Boom and Bust

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Panic!

What Happened and When? 2006 Home prices peak 2007 Losses related to subprime mortgages

UBS, Bear-Stearns, BNP Paribas, Countrywide, Northern Rock

2008 Premonitions: Bear-Stearns bailout Emergency loans to Fannie and Freddie

2008 September Panic Fannie, Freddie, Lehman, AIG, WaMu, Wachovia Fed intervenes under Article 13.3, then TARP

Stock Market Collapse

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Market Failures

How housing and financial markets went wrong Principle-agent problems Moral hazard problems

Mortgage market actors Banking panics/bank runs

Leverage as an amplifier Asymmetric information Bigger moral hazard problems

Financial institutions and government

Why Now?

What was special about the period leading up to the panic? Easy money Global savings glut Government support for housing Lax regulation Self-reinforcing expectations

Unfortunate coincidence?

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Policy Responses

Multiple governmental responses Conventional monetary and fiscal policy

responses Special lending/purchase programs and bailouts Quantitative easing Regulatory reform

Have policies worked? What about the government debt?

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Why is the Recovery so Slow?

Recovery is slow because: Balance sheet repair Overhang in housing and consumer durables Damage to the functioning of intermediation Zero lower bound on nominal interest rates

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The End