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Vol. 8, No. 7 • september 2013
confluence of factors producedthe December 2007–June 2009Great Recession—bad bank loans, improper credit ratings,lax regulatory policies and misguidedgovernment incentives that encouragedreckless borrowing and lending.The worst downturn in the UnitedStates since the 1930s was distinctive.Easy credit standards and abundantfinancing fueled a boom-period expan-sion that was followed by an epic bust with enormous negative economicspillover.Despite extensive reviews of thecauses and consequences of the mostrecent financial crisis, there are few esti-mates of 
what it cost 
—the value of whatsociety gave up. Such a figure would helpdetermine the relative expense of policy proposals designed to avoid future crises. Any estimate of the toll exacted is boundto be incomplete—for example, theremay be future expenses not yet recog-nized—so it’s useful to calculate a rangeof likely costs.
What Society Gave Up
One way to measure the cost of lostoutput is in terms of how much worseoff society is relative to a baseline trendthat might have existed absent the crisis.Such an exercise is crucial to grasping
Assessing the Costs andConsequences of the 2007–09Financial Crisis and Its Aftermath
by David Luttrell, Tyler Atkinson and Harvey Rosenblum 
There are few estimates of what society gave up dueto the crisis: Our conservative estimateis $50,000 to $120,000 for every U.S.household.
the magnitude of what occurred and theeffects of the still-emerging recovery.Output per person as of mid-2013 stood12 percent below the average of U.S.economic recoveries over the past half-century, corroborating a large body of literature suggesting that recoveries fromfinancial crises are slower than reboundsfrom typical recessions (
Chart 1
).Our bottom-line estimate of the costof the crisis, assuming output
 returns to its precrisis trend path, is anoutput loss of $6 trillion to $14 trillion.This amounts to $50,000 to $120,000 forevery U.S. household, or the equivalent of 40 to 90 percent of one year’s economicoutput. This seemingly wide range of estimates is due in part to the uncertainty of how long it might take to return to theprecrisis growth trend. However, outputmay never return to trend—the path of future output may be
lowerthan before. If that’s the case, the crisiscost will exceed the $14 trillion high-endestimate of output loss.The crisis consumed an enormoussum of financial and housing wealth. U.S.household net worth plunged $16 trillion,or 24 percent, from third quarter 2007 tofirst quarter 2009. In addition, it wiped outa huge amount of “human capital,” bothcurrent wage income and discountedfuture wage income; that is, a
Economic Letter
Economic Letter • Federal Reserve Bank of Dallas • September 2013
Economic Letter
the total cost of the crisis easily exceedsthe value of the nation’s output for anentire year.
Explaining the Output Loss
The $6 trillion to $14 trillion baseestimate of lost output following thecrisis depends on assumptions aboutthe economy’s trend rate of growth and whether an oil-price shock in 2008 mighthave caused a mild recession anyway.
 This estimate of the aggregate cost of the crisis covers 2008 to 2023, when out-put is assumed to fully return to trend.Ultimately, there is no way to know for sure what path output would havefollowed or even if the financial crisiscaused the output drop. The standardassumption is that trend growth wouldhave continued at a pace similar to thatin the preceding period. From 1984 to2007—a period often referred to as theGreat Moderation due to its relativeeconomic and price stability—the aver-age annual growth rate of gross domes-tic product (GDP) per capita was 2.1percent.Conceivably, historically high crudeoil prices were partly responsible forthe contraction that followed, and trendgrowth overstates what output wouldhave been. The cause of the oil shock,however, may be inseparable from theroots of the financial crisis. A global-imbalances narrative posits that an influx of overseas demand for U.S. financialassets fueled an unsustainable creationof structured credit products (financialinstruments such as mortgage-backedsecurities) that pushed real (inflationadjusted) interest rates lower. This con-nection between financial flows and various hard-asset commodity prices—including the crude oil price spike—sowed seeds of instability in 2007–08.The estimated gap between what GDP would have been absent the financial cri-sis and realized GDP is shown in Chart 2.The graphic also captures the possibility that an oil-shock recession would haveoccurred regardless of the crisis.The forecast (represented by the redline in Chart 2) provides a reasonablemiddle ground between the extremely unlikely, immediate return to trend andthe uncertain, perpetual output lossimplied by a continued modest paceof economic growth (represented by the blue line in Chart 2). In addition toimpacting the amount of U.S. goods andservices produced, the 2007–09 busttriggered (or is at least associated with)a worldwide downturn. A similar output-loss exercise for world GDP excluding theU.S. results in an estimated $8.1 trillionloss just through year-end 2012.
Trauma and Reduced Capacity
 While the recession was an economicphenomenon, its impact went beyond asizable drop in output or consumption.The adverse psychological consequencesexpectation of potential earning power.If the effects of the crisis are permanent,the path of consumption observed since2007 suggests that the cost of the crisismay be more than double the $6 trillionto $14 trillion estimate.
The results of boththe output-loss and path-of-consumptionapproaches are presented in Table 1A.
 Some of the harder-to-quantify impactsof the crisis, shown in Table 1B, are theconsequence of extended unemployment,reduced opportunity and increased gov-ernment presence in the economy.Even taking into account the likely overlap of estimates in Table 1A and 1B,
rund in p Caia ouu Wak han in pviu Cyc
ra GDp  caiaindx, 100 = cyc ak
9095100105110115120222120191817161514131211109876543210–1–2–3 Quarters after peakAverage of prior cycles2007:Q1–2013:Q2Still 12% belowaverage recovery
Note: th hadd aa indica h ang f aj cin inc 1960, xcuding h h 1980 cin.soUrCes: buau f ecnic Anayi; Cnu buau; auh’ cacuain.
Diffn Aach  mauing h Cii’ C
A. Looking at Lost Output and Forgone Consumption
According topath of outputAccording to pathof consumption
Cin 2012 da$6 iin$14 iin $15 iin$30 iinpcnf 2007 uu4090%100190%
B. Other Harder-to-Quantify Outcomes
National traumaand lost opportunityExtraordinarygovernment support
Cin 2012 daU$14 iin $12 iin$13 iinpcnf 2007 uuU90%8085%
Economic Letter
Economic Letter • Federal Reserve Bank of Dallas • September 2013
Economic Letter
are enormous, even if they are not easily quantifiable.Nonfarm payrolls fell by more than8.7 million, or 6.3 percent, and thenumber of unemployed climbed to 14.7million over the course of the recession,peaking at 10 percent of the nation’s laborforce in October 2009. Further, many  workers faced extended bouts of unem-ployment or left the labor force alto-gether. The ranks of the underemployed(those who want a job but can only findpart-time work) and frustrated job seek-ers (those who become discouraged andgive up looking for work) rose to 12 mil-lion, a 94 percent increase. In July 2013,four years after the recession is deemedto have ended, labor underutilizationremains intractably high: 11.5 millionpeople are unemployed and an addi-tional 10.6 million are underemployed orfrustrated.Branches of economics that survey broader measures of life satisfactionapart from income have confirmed theintuition of the nonpecuniary costs of unemployment—for example, the psy-chological effects of stress and feelings of diminished self-worth.
In addition, high-er unemployment has spillover effects onthe rest of society: decreased job security for the employed as well as higher taxesto fund the transfer payments to the job-less and the underemployed. While thepsychological toll of a weakened econo-my may be small for employed workersrelative to the unemployed, the aggregatesocietal consequences can be significant.
  Although subjective well-being canbe hard to quantify, one study estimateda cost of as much as $14 trillion from lossof security in the workforce due to risingunemployment.
This figure representsthe lost income of the unemployed, the value of the loss of subjective well-beingamong the unemployed and the nega-tive spillover effects on the employed,including the adverse effects of highunemployment on future income and jobprospects. A job is a path to dignity and a senseof accomplishment that is paramountto personal progress. Optimism regard-ing perceived opportunities—the notionthat the future will be better than thepresent—is a crucial source of motiva-tion for job seekers and job keepers. Thecrisis deflated this sense of security andoptimism for many—reflected in a down- ward revision to households’ permanentincome, some of the decline in the laborforce participation rate and a slower paceof household formation observed from2007 through 2011. Individuals changethese behaviors when they reassess theirmedium- and long-term prospects anddo not like what they see. A stark legacy of the recession andthe lackluster labor market is reducedopportunity and deterioration capturedin subjective measures of well-being.Since the recession’s onset in December2007, more citizens believed their income would be lower in the future than thoughtit would be higher. This is the first time in
recession since the 1960s that incomeexpectations turned negative.
Unintended Consequences
The crisis resulted in a significant lossof trust in government institutions andthe U.S. capitalist economic system. Inthe Fraser Institute’s Index of EconomicFreedom global ranking, the U.S. fell fromsecond in 2000 to 18th in 2012. The assess-ment by the economics and public policy think tank is based on 42 variables thatinvolve aspects of government size, prop-erty rights, money soundness, interna-tional trade freedom and regulation.
Thelower ranking reflected perceptions of less-secure property rights, bigger government,increased regulation of businesses andfavoritism accorded to special interests. A crisis of confidence portends aloss of public trust. Saving the systemfrom complete collapse—especially withextraordinary government assistance,including bailouts to a handful of giantfinancial institutions—reinforced a per-ception that public support exists primar-ily for large, interconnected, complex financial entities. Deemed “too big tofail,” these financial intermediaries lackeddiscipline and accountability leading upto the crisis and proved largely immuneto the downside of their excessive risk tak-ing. This special treatment violated a basictenet of American capitalism: All peopleand institutions have the freedom to suc-ceed and also to fail based on the meritsof their actions. In a way, the 2008–09bailouts exacted an unfair and nontrans-parent tax upon the American people.
  Although unprecedented fiscal andmonetary action in the throes of panicduring 2008–09 may have prevented afull-blown depression, such interventiondid not come without significant costs.Society must deal with the consequencesof a swollen federal debt, an expandedFederal Reserve balance sheet andincreased regulations and governmentintervention for years to come. Directgovernment support for the U.S. finan-cial sector totaled approximately $12.6trillion, or more than 80 percent of 2007GDP—a sum over and above what wasprovided via precrisis Federal DepositInsurance Corp. deposit insurance lim-its and the Federal Reserve’s traditional
ouu l I lag evn wih oiiic Fca
ra GDp, iin f 2009 da
14,00015,00016,00017,00018,00019,00020,00021,00022,00023,00024,000’23’22’21’20’19’18’17’16’15’14’13’12’11’10’09’08’07’06 Output lossfrom oil shock:$2.1 trillionOutput lossfrom financial crisis:$11.7 trillionTrend (constant GDP per capita growth)Oil-shock-induced recessionActualBlue Chip consensus forecastsForecast return to trend
soUrCes: buau f ecnic Anayi; Cnu buau; bu Chi ecnic Indica; auh’ cacuain.

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