When 2009 dawned, no one knew whether the global financial crisis that had burst into full bloom the previous
autumn would develop into the second Great Depression. Twelve months later, what many called the Great
Recession showed signs of coming to an end, and the worst appeared to have been averted. On the whole,
private economists applauded the U.S. government’s response to the crisis at hand, but some of the remedies
enacted there and in other countries seemed poised to haunt the world economy in years to come.
Even if the financial crisis did not send the world back to the 1930s, it turned economic growth into
contraction in many countries and slowed expansion practically everywhere else. The ripple effects of the
financial crisis ranged far beyond the financial. Governments fell in Iceland and Latvia. The Chinese brushed
aside pleas for more accommodating human rights and currency valuation policies. European political union
was put under strain. Japan proposed only weak measures to combat climate change.
Most of the major industrial democracies adopted domestic government programs designed to awaken their
slumbering economies; the U.S. package, at $787 billion, was the biggest. The world’s economic outlook
brightened as the year proceeded, however, and most countries began growing again in mid-2009 after
recessions that were, for most, the deepest since the Great Depression. In a rare exception, China escaped the
slump; if anything, the global recession burnished China’s apparent ambition to challenge U.S. dominance in
the global economy. (See Special Report.)
The U.S. Leads the Way
The U.S. housing market was the domino that, when it fell, toppled many of the world’s major economies and
led the world into recession. For the first half of the decade, aggressive investing by homebuyers, mortgage
lenders, Wall Street investment houses, and insurers had driven up the median price of a single-family home
by almost 10% a year, with housing in some parts of the country escalating even faster. When home prices
headed back down in 2007, large numbers of homeowners faced rising adjustable-rate mortgage payments
and/or could no longer borrow against a rising home value to finance other expenses. By the middle of 2009,
the median home price had fallen close to its 2000 level. Those with heavy investments in housing, including
risky mortgage-backed securities, found them all but worthless. The government stepped in with a massively
expensive bailout program in late 2008 and continuing into 2009.
The devastation to the U.S. economy spread far beyond housing. The banking industry was especially hard hit.
(See Sidebar.) Altogether, 176 banks in the U.S. failed in 2009, many of them small and local. Even financially
secure banks, not trusting potential borrowers to pay them back, stopped lending. Businesses—especially small
and new businesses—could not find the credit that they needed to pay creditors or buy inventory or to pay their
own workers, much less to hire new ones. Even short-term interest rates close to zero did not fully thaw credit
markets. Businesses that relied on their customers’ ability to secure loans had a rough time. Automakers
General Motors (GM) and Chrysler, both of which reorganized after brief trips through bankruptcy in 2009,
qualified for bailout money. The overall economic slowdown sent stock prices reeling, with the benchmark
Dow Jones Industrial Average (DJIA) sinking by about 54% in the 17 months from the market high in October
2007 to the trough in March 2009.
As 2009 began, comparisons with the Great Depression were as common as foreclosed houses in Nevada, but
there was one important difference: policy makers this time had the experience of the Depression to guide
them. They identified three policy areas where they vowed not to make the same mistakes that seemed to have
prolonged the Depression: fiscal, monetary, and trade.
In the 1930s, national leaders generally pledged allegiance to fiscal policies based on balanced budgets. With
tax revenue falling in tandem with economic growth, balancing budgets meant cutting spending just when
economies needed to stimulate business expansion and job growth. This time around, however, political
leaders poured money into such projects as road construction and schools. Although some governments were
more aggressive than others, just about all countries joined the stimulus parade.
In 1929 the U.S. Federal Reserve Board (Fed), seeking to restrain a speculative rise in stock prices, instituted a
monetary policy of tight money and high interest rates. The economy predictably contracted, and the
Depression officially began that August. Nevertheless, the Fed further tightened its grip on the money supply
in 1931, adding to the squeeze on the domestic economy. Through all of 2009, however, the Fed held the Fed
Funds rate (the interest rate that banks pay each other for overnight loans) in a range of 0.0–0.25%. Most other
central banks also loosened monetary policy. The Fed and many of its foreign counterparts also injected capital
into banks and bought their shaky loans.
When economies go haywire, there is a natural tendency to close ranks by tightening trade policy and
refraining from buying foreign goods. In 1930 the U.S. Congress enacted the Smoot-Hawley import tariffs.
Many U.S. trading partners followed suit. The result was a decline in world trade volume estimated in late1932
at about 30% and still growing, an outcome almost universally seen as having fueled the Great Depression.
This time there was no such rush to protect industry at home, although worldwide trade actually dropped even
more sharply in the current financial crisis than during the beginning of the Depression. This was not the result
of new trade barriers; rather, the faltering global economy sapped demand for goods and services, whether
produced at home or abroad.
The World Follows
Enlightened decision making may have blocked another Depression, but it could not prevent a great deal of
misery. The financial crisis struck individual countries with an impact that depended heavily on two factors:
whether local institutions had ties to the U.S. financial sector and whether the local economy depended on
export sales to the West. Most of the developed countries had close financial and trade relations with the U.S.
Of the 33 countries that the International Monetary Fund considered to have “advanced economies,” only
Australia seemed likely to avoid a period of contraction.
The dynamic economies of Asia were well positioned, and three large Asian countries—India, Indonesia, and
China—escaped relatively unscathed. At least in the short run, India benefited from having isolated itself from
the crosscurrents of the global economy. Japan’s economy, the largest in the world after the U.S., was fused to
the West’s, and Japan marched alongside the West into recession. With a large economic stimulus package in
place, however, Japan pulled out of recession in the third quarter of 2009. Fearful that strict limits on
greenhouse gas emissions could cripple the economic rebound, the Japanese government proposed weaker
limits than those under discussion in Europe and the U.S.
Europe, with its close financial and trade ties to the U.S., stood in sharp contrast to Asia. Even Norway, which
had virtuously invested its North Sea oil revenue with considerable prudence while the U.K. was spending its
windfall on government programs, could not escape recession. Norway slipped into a mild slump in late 2008
and emerged early in 2009. Most of the rest of Europe fared worse. Many countries approved economic
stimulus packages to extricate themselves from recession, and many resumed economic growth, although the
U.K., Spain, and others remained in recession for the first nine months of 2009. In the fourth quarter, the U.K.
barely emerged from recession with growth of 0.1%. Reflecting fears of future inflation, the stimulus programs
in Europe were smaller than those in the U.S. Perhaps more significant, the largesse stopped at national
borders. Germany, France, and other wealthy European Union countries defeated Hungary’s request that the
EU’s Western European members give $240 billion to members in Eastern Europe to combat the slump.
Hardest hit were countries at the four “corners” of Europe: Iceland, Latvia, Greece, and Spain. Iceland became
the first country to lose its government over the financial crisis. Iceland’s three largest banks, privatized in the
early 1990s, had grown fat on securities trading, but they failed in 2008 when the financial crisis left them
unable to pay a mountain of foreign obligations. The conservative prime minister resigned in January 2009 and
was replaced by a leftist, Jóhanna Sigurðardóttir, who promptly recapitalized the banks and started the process
of taking her fiercely reclusive country into the EU.
The Great
Recession of 2008–09Roman Koksarov/APInternational trade—or the sudden lack of it—was Latvia’s
undoing. Latvia had boasted Europe’s strongest economic growth rate (10%) as recently as 2007. Then the
tables turned, and the Latvian economy shrank at double-digit rates in 2009—possibly the worst performance
in Europe, although its Baltic neighbours, Lithuania and Estonia, were not far behind. In the Latvian capital of
Riga, a street demonstration in January to protest economic decline turned violent, and a month later the prime
minister resigned.
In Greece, where the budget deficit reached nearly 13% of annual economic output (even greater than the 11%
in the U.S.), the three credit-rating services—Fitch, Moody’s, and Standard and Poor’s—downgraded the
country’s debt. At year’s end Greece had the lowest credit rating of the 16 countries in the euro zone. That
made it more expensive for Greece to finance its debt, which at 130% of economic output was nearly the
highest in Europe. A default on its debt would be a giant headache not only for Greece but also for the entire
EU. Spain, whose budget deficit was rocketing toward 11%, was on the same path as Greece, although less far
along. Standard and Poor’s also downgraded Spain, which started at a much higher level.
The fiscal problems that put Greece and Spain on a slippery slope were common across Europe, especially
among economies that had grown the most (largely on borrowed money) during the heady early years of the
decade. Ireland, heretofore an EU success story, was a typical case. The Irish government, determined not to
let the budget deficit reach 13%, proposed to raise taxes, cut benefits, and trim government workers’ pay.
The U.S. Response
In the United States, the government followed a two-pronged strategy to reverse the financial crisis: bail out
distressed financial institutions (lest they transmit their failure to their creditors) and pump government money
into the economy (to stimulate business activity when private loans were scarce). What emerged from the
bailout was an extraordinary degree of government involvement in—and sometimes even majority ownership
of—the private sector. Altogether, the government by late 2009 had provided an estimated $4 trillion to keep
the financial sector afloat. Many of the biggest bailout beneficiaries quickly paid the government back, and the
ultimate cost of the bailout to taxpayers was estimated at “only” $1.2 trillion.
The Great
Recession of 2008–09David Zalubowski/APCongress in February handed Pres. Barack Obama the first
legislative triumph of his month-old presidency when it enacted a $787 billion fiscal stimulus bill that
comprised $288 billion in tax cuts and $499 billion in spending, most of it for public-works programs such as
school construction and highway repair. Although Although Republicans groused that checks for much of the
$499 billion would be issued too late to do any good, the nonpartisan Congressional Budget Office said that
thanks to the tax measures, about three-quarters of the full $787 billion would be spent in 18 months. Obama
claimed that the bill would create or preserve 3.5 million jobs, a figure that many of his opponents called far
too optimistic.
Congress also played a role in the bailout of failing financial institutions. At the end of 2008, Congress enacted
the Troubled Asset Relief Program (TARP) authorizing the Department of the Treasury to invest up to $700
billion by buying unproductive real-estate investments or even becoming part owners by purchasing financial
company stock. The Fed, using authority that it already had, played an even bigger role. Printing more money
when not enough was available, the central bank invested heavily in foundering institutions and guaranteed the
value of their shaky assets. By the end of 2009, the government owned almost 80% of American International
Group (AIG), the country’s biggest insurer, at a cost of more than $150 billion. It also owned 60% of GM and
had a stake in some 700 banks. It initially spent $111 billion to prop up Fannie Mae and Freddie Mac, the
companies sponsored by Congress to buy mortgages from their issuers. The government promised to play no
role in managing these companies and to sell its ownership stakes as soon as practical. TARP provided the
Treasury with only a fraction of the funds used for the bailout, however. The Fed was responsible for the lion’s
share, and even the massive AIG rescue was engineered entirely outside the legislated Treasury Department
program.
Reflecting public views, members of the government expressed outrage that some of the same executives who
helped precipitate the financial crisis should make millions of dollars a year in salaries and bonuses. Treasury
Secretary Timothy Geithner appointed a “special master for executive compensation” to review the
compensation packages of top financial executives at firms that received bailouts. Many of the biggest bailout
beneficiaries balked at the proposed salary limits and strove to get out from under them by paying the
government back.
More ominously for the financial institutions, many members of Congress marched into 2010 with a
determination to regulate them more closely. The House passed a bill in 2009 that for the first time would
bring exotic financial instruments under review by federal regulators. The bill would also establish a single
agency to protect financial consumers and guarantee shareholders a chance to vote on the compensation
packages of corporate executives. The Senate planned to take up the issue in 2010.
An Uncertain Future
The Great
Recession of 2008–09Eric Gray—file/APDespite the year-end sighs of relief over the improving economy, the
economic destruction had not necessarily run its course. Many banks that survived the crisis were badly
bruised by the collapse of the housing market and remained less willing than before to provide the credit that
greases all capitalist economies. Huge government budget deficits, designed to facilitate economic growth in
the short term, loomed like dark clouds on the horizon, threatening inflation and currency devaluations. Low
interest rates encouraged immediate business activity, but, like budget deficits, they could ultimately feed
inflation. International trade, which suffered as countries hunkered down and adopted “me-first” policies, held
below precrisis levels. In the U.S., foreclosure rates were high and rising. Nearly one house in four was worth
less than what the occupants owed on the mortgage, and similar problems in commercial real estate were
mounting.
Despite this, harbingers of prosperity were not hard to find. Stock markets turned robustly upward, with the
DJIA making up half of its losses by year-end 2009. Although unemployment in the U.S. reached a peak of
10.2%, its highest level since 1983, it declined to 10%, and the 2.2% annual growth rate that the economy
registered in the third quarter suggested future job growth. Economists even took heart from the plight of
Dubai World, a government-owned developer in Dubai, U.A.E., that could not pay back $3.5 billion in loans
by a December 14 deadline. Just in the nick of time, fellow emirate Abu Dhabi bailed out Dubai with $10
billion. Not only was that enough to get Dubai World well beyond its immediate default date, but it also
proved that not every financial cough would mean pneumonia for the global economy.