At one point in his administration, Bush might have pointed to the economic recovery that began in 2001 as a major success. But late in 2007, the economy entered a recession. And in 2008, the American banking system suddenly found itself on the brink of collapse, threatening to drag the national and world economies into a repeat of the Great Depression.
The roots of the crisis of 2008 lay in a combination of public and private policies that favored economic speculation, free-wheeling spending, and get-rich-quick schemes over more traditional avenues to economic growth and personal advancement. For years, the Federal Reserve Bank kept interest rates at unprecedented low levels, first to help the economy recover from the bursting of the technology bubble in 2000 and then to enable more Americans to borrow money to purchase homes. The result was a new bubble, as housing prices rose rapidly. Consumer indebtedness also rose dramatically as people who owned houses took out second mortgages, or simply spent to the limits on their credit cards. In mid-2008, when the median family income was around $50,000, the average American family owed an $84,000 home mortgage, $14,000 in auto and student loans, $8,500 to credit card companies, and $10,000 in home equity loans.
A stalled residential project in Merced, California, symbolizes the collapse of the housing bubble in 2008. Merced, like many communities in California, was the site of numerous housing developments planned to be built when prices were at their peak. When prices fell, developers declared bankruptcy. In 2008, the half-finished project sat vacant.
All this borrowing fueled increased spending. The yearly savings of the average family amounted to less than $400. An immense influx of cheap goods from China accelerated the loss of manufacturing jobs in the United States (which continued their decline despite the overall economic recovery) but also enabled Americans to keep buying, even though for most, household income stagnated during the Bush years. Indeed, China helped to finance the American spending spree by buying up hundreds of billions of dollars worth of federal bonds—in effect loaning money to the United States so that it could purchase Chinese-made goods. Banks and other lending institutions issued more and more “subprime” mortgages—risky loans to people who lacked the income to meet their monthly payments. The initially low interest rates on these loans were set to rise dramatically after a year or two. Banks assumed that home prices would keep rising, and if they had to foreclose, they could easily resell the property at a profit.
Figure 28.1 PORTRAIT OF A RECESSION
These graphs offer a vivid visual illustration of the steep decline in the American economy in 2008 and the first part of 2009.
Wall Street bankers developed complex new ways of repackaging and selling these mortgages to investors. Insurance companies, including the world’s largest, American International Group (AIG), insured these new financial products against future default. Credit rating agencies gave these securities their highest ratings, even though they were based on loans that clearly would never be repaid. Believing that the market must be left to regulate itself, the Federal Reserve Bank and other regulatory agencies did nothing to slow the speculative frenzy. Banks and investment firms reported billions of dollars in profits, and rewarded their executives with unheard-of bonuses.