What caused the Great Recession?

The Great Recession, which is considered the most significant downturn in the worldwide economy since the Great Depression of the 1930s, was caused by a combination of complex factors. The primary causes included:

1. The Housing Bubble and Burst: In the United States, there was a significant rise in housing prices that led to a housing bubble. This bubble was driven by low interest rates, easy credit conditions, and speculative investments in real estate. Eventually, the bubble burst when housing prices started to decline, leading to a high rate of mortgage delinquencies and foreclosures.

2. High-Risk Mortgage Loans and Securitization: Financial institutions issued high-risk loans, including subprime mortgages to borrowers with poor credit histories. Lenders then bundled these risky mortgages into financial products called mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), selling them to investors. When homeowners began defaulting on their mortgages, the value of these securities plummeted.

3. Financial Institutions' Leverage: Many financial institutions had high levels of debt compared to their equity, which is known as leverage. When the value of the mortgage-backed assets fell, these institutions didn't have enough capital to cover their losses, leading to a credit crisis.

4. Lack of Proper Regulation: Inadequate financial regulation and oversight failed to identify and mitigate the risky practices and excessive risk-taking by financial institutions and investors.

5. Global Financial System Integration: The increased interconnectedness of the global financial system meant that the problems in the US housing market had a ripple effect across the world, affecting financial markets and economies globally.

6. Credit Crunch: As banks incurred losses and the value of their assets fell, they became reluctant to lend money, resulting in a credit crunch. This made it difficult for businesses and consumers to get loans, which slowed down economic activity.

7. Reduction in Consumer Wealth and Spending: The decline in the housing market and the stock market reduced household wealth, which led to cuts in consumer spending. Since consumer spending is a significant component of economic activity, this further exacerbated the economic downturn.

These factors together created a vicious cycle, where the decline in one area, such as the housing market, affected financial institutions, which then affected consumer spending and business investment, leading to a broad and severe recession.