- Jul 15, 2008
The Fed’s actions signaled that policymakers, including Congress and Bush Administration were working hard to stem the financial crisis. It was too late for the rattled economy. With the entire financial system hemorrhaging losses, and with every corner of the credit markets in disarray, loans to consumers, businesses, and even state and local governments became scarcer and more costly. Banks aggressively ratcheted up their lending standards; borrowers who normally were considered good credits and could readily get a loan, now could not. Not only was a subprime loan out of the question, but even prime borrowers were struggling to get credit.
Without credit, home sales buckled, and subprime borrowers who had hoped to refinance before their mortgage payments exploded higher could not do so. Foreclosure seemed the only option. Inventories of unsold homes surged and house prices collapsed.
Commercial property markets froze as tighter bank underwriting and problems in the commercial mortgage securities market undermined deals. Just a year earlier, transaction volumes and real estate prices had been at record highs. Now property deals could not be consummated, weighing on commercial real estate prices and impairing developers’ ability to finance new projects.
Even small and midsize companies in far-flung businesses completely unrelated to housing or mortgage finance found themselves in tough negotiations, with lenders demanding more stringent and costly terms. Financing investment and hiring was suddenly more difficult.
Previously stalwart stock investors, who had held on admirably through the turmoil in the credit markets, finally capitulated. They began to discount a recession. Financial shares of commercial and investment banks, mortgage insurers, and financial guarantors were crushed. The financial system’s problems were daunting when the economy was still growing; with the economy in recession, they were overwhelming. The massive losses investors and insurers had already recognized on their mortgage holdings now seemed inadequate.
Credit is the mother’s milk of a well-functioning economy, and with credit no longer flowing freely, the economy stalled. The nation’s GDP barely grew at the end of 2007, and unemployment began to rise. A weakening job market mixed with the financial turmoil was too much for households to bear; consumer confidence plunged to lows last seen in the early 1980s when both unemployment and inflation were well into the double-digits. Vehicle sales plunged, and scared consumers reined in their buying. All this made businesses even more nervous, prompting less hiring and more unemployment. The selfreinforcing negative cycle that characterizes recession was now in full swing. The presidential candidates who just a few months earlier were distinguishing themselves by their positions on the Iraq war began debating the merits of fiscal stimulus and a housing bailout.