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Andres
Andres Zuniga

ECON308-012

12/05/2022

Topic Write-Up #2: Topic #2

The Great Recession of 2007-2009 is historically known as the most impactful economic

event of the 21st century and while nothing yet has topped it, the world is currently facing a

recession that could get to that point if political matters are not resolved soon. This recession not

only affected the U.S. but the entire world at a massive scale due to many factors. While it

started as just a US housing market problem, it had a domino effect, resulting in many economies

of other countries to decline severely. While the main forecasters for the economies of the world

such as the IMF and World Bank made small changes to their growth forecasts during 2008 and

2009, it wasn’t enough for policymakers to predict for the crisis to end up as bad as it did (Verick

3-4). Even though this was true, all the warnings were present to act in preparation for a

recession: deficits in the U.S. and U.K., loose monetary policy by the Federal Reserve and poor

financial regulation.

In order to mention the impact this recession caused for the economies of other countries

across the world, there needs to be context to fully understand how it unfolded. The origin begins

with the U.S. housing market and how investment banks such as Lehman Brothers went bankrupt

due to relying on mortgage-backed securities for profit. Before the recession, subprime

mortgages offered much higher returns to investors and ridiculously low premiums which is why

they were so attractive in the first place. Due to lenders (e.g., investment banks, hedge funds,

commercial banks, etc.) being so generous with loans to people who couldn’t afford them

(asymmetric information), many people were defaulting on their loans, leading to high levels of
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unemployment, causing these mortgage-backed securities to completely lose value. While this is

true, the low interest rates prior to the recession caused the initial demand for these housing loans

from borrowers and loose monetary policy practiced by the Federal Reserve to regulate that

demand.

The steps on how this recession unfolded were as follows: households borrowed loans

from brokers/lending institutions, those lending institutions sold the mortgages to other financial

institutions, those same financial institutions created mortgage-backed securities (MBS) to

repackage the mortgages in order to sell them to investors (including foreign ones) and finally,

those same MBS purchased by the investors were “re-securitized” by collateralized debt

obligations to continue distributing risk and keep them off their balance sheet. This allowed these

mortgages that were only subject to domestic acquisition to be traded in open markets

internationally since they were over-the-counter transactions (Verick 19). This led to the rise in

bad loans in 2006 into 2007, which led to borrowers not being able to pay for their home loans

on time, otherwise known as home loan delinquency.

Because of this chain reaction, a liquidity crisis in the US followed, creating reductions in

domestic lending. The problem with this crisis is that industries such as trade that depend on

around 90 percent of financing with short-term trade credit couldn’t function properly due to the

tightness of lending caused by the liquidity crisis, leading to global trade declining 15 percent

between 2008 and 2009 (Naudé 7). The developing countries that were impacted drastically were

Armenia, Mexico, South Africa, Turkey, Ukraine as well as the Baltic countries like Estonia,

Lithuania, and Latvia that relied heavily on trade to function properly. Another form of income

from families in these developing countries that was affected greatly were remittances, which

account for $300 billion a year. In addition, 80 percent of remittances to developing countries
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come from high-income countries, leaving many families to struggle (Alexander 1). Not only

was the trade industry and remittances to foreigners affected, but since the liquidity crisis caused

people to sell the properties that they had purchased with these loans, it caused a selling domino

effect, ranging all the way from the selling of stocks to junk bonds in order to have the most cash

on hand possible. This led to a reduction in financial outflows to developing countries as they

heavily relied on inflows to facilitate and accelerate their economic growth and development

(Naudé 6). Meanwhile, economically rich countries such as China and India were able to

establish resiliency within their economy due to their domestic demand only falling 6.7 percent

in 2009 (Verick 5).

While the US was hit the hardest in terms of economic activity and stability, since many

of these developing countries relied so heavily on the U.S.’s economic state and financial aid, it

led to increased inequality within these countries and as a result, pushing between 130 and 155

million people into poverty in 2008 (Alexander 1). In 2009, the UN recorded that the global

recession put another 100 million people below the poverty line as well.

In conclusion, the Great Recession of 2007-2009 that started off as a domestic economic

downturn resulted in other less-developed economies to be affected by a domino effect caused by

the liquidity crisis after the U.S. housing market crashed. Only in these scenarios do we truly

realize how many countries rely so heavily on the U.S. for their economic growth and stability

and how bad they can get as a result from these types of economic events. Not only does the U.S.

provide financial outflows to so many developing countries but it also creates a level of

confidence for these countries to invest and profit from the U.S. as a result.

Works Cited
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Verick, Sher and Islam, Iyanatul, The Great Recession of 2008-2009: Causes, Consequences

and Policy Responses. IZA Discussion Paper No. 4934, Available at

SSRN: https://ssrn.com/abstract=1631069 or http://dx.doi.org/10.2139/ssrn.1631069

Naudé, W. (2009) The Financial Crisis of 2008 and the Developing Countries. Discussion Paper

2009/001. Helsinki: UNU-WIDER.

Alexander, D. (2010), The Impact of the Economic Crisis on the World’s Poorest Countries.

Global Policy, 1: 118-120. https://doi.org/10.1111/j.1758-5899.2009.00018.x