March 25, 2011- The 2012 presidential primary season is already upon us and the Grand Old Party is, not surprisingly, engaged in a grand old opportunity to rewrite history about the causes and consequences of the Great Recession. So it’s time, once again, to set the record straight.
The Great Recession was so great not just because of very sharp unemployment increases but also due to an unprecedented decline in wealth—as the Federal Reserve detailed in a report released this week. That wealth destruction is key to understanding the Great Recession since massive house price drops led to a foreclosure crisis that then fueled massive layoffs. Much of the unprecedented wealth destruction in 2007 and 2008 can be traced back to failed economic policies under President George W. Bush, when opportunities to put the economy and the labor market on the right track were ignored.
Incoming President Barack Obama’s hand was thus forced to first pass the American Recovery and Reinvestment Act of 2009 to save the economy from sliding deeper into an economic hole amid rising job losses, and to then tackle the problems that had been ailing the economy and American families—low incomes and rapidly rising prices for health care and energy—for the previous eight years.
Wealth destruction probably doesn’t adequately capture what happened in the early stages of the crisis. Wealth was vaporized at a breathtaking, eye-popping speed. American families lost a total of $19.4 trillion (in 2010 dollars) in household wealth from June 2007 to March 2009, when the stimulus started to take hold. First it was the housing market, and then it was the housing and the stock market together that tanked. American families lost $6.4 trillion in home value during this period.
Trillions of dollars are sometimes hard to grasp, so think of it this way: One complete house (at 2008 prices) was lost every 1.7 seconds during the Great Wealth Destruction. And this doesn’t even count what happened to American families’ rainy day funds and retirement savings.
The story of the Great Recession unfolded very quickly after that. The drop in home values meant that fewer people wanted to build and buy new homes, putting a lot of construction workers out of work. And the drop in home values put many borrowers underwater, meaning they owed more on their mortgage than their house was worth, precipitating a massive wave in foreclosures. This ultimately threatened to bring down the entire U.S. financial system but it also tightened credit such that businesses couldn’t expand, even if they wanted to. Jobs disappeared across all industries, not just in construction, leading to the highest unemployment rate in almost 30 years.
This crisis did not fall from the sky. We saw it coming. My colleague Scott Lilly and I pointed out in 2004 that the economic trends that ailed the economy and led to the sharp rise in household debt were unsustainable. American workers lived through the weakest labor market since the Great Depression after the previous recession ended in November 2001. Yet prices for key household items such as health care, energy, transportation, food, and housing rose, often at runaway speed. American families only managed to pay their bills by borrowing on their credit cards, for large consumer items and on their homes. The massive debt boom was a reflection of the economic squeeze American families were in during the 2000s.