Introduction

1. 2008/09 Financial Crisis Lending Landscape

Factors that Showed the Recession Was Coming

• The housing market bubble started in 2007, eventually leading to the global financial crisis. Lending institutions offered low-interest rates and encouraged many home buyers to take out mortgages they could not repay.
• The subprime loans packaged as mortgage-backed securities and originated with high loan-to-value (LTV) ratios posed the most significant risk factor. Moreover, issuing loans without proper documentation of income or assets increased the risk factors for massive defaulting.
• Deregulation of the Glass-Steagall Act by allowing large mergers and separating commercial and investment banking led to a nationwide expansion of corporations that swallowed smaller banks and brokerage firms, making people believe they were "too big to fail."
• As 2007 got underway, many subprime borrowers were stuck with mortgages they could not pay. Consequently, subprime lenders started filing for bankruptcy, one after another. From February through March 2007, over 25 subprime lenders went under. For example, New Century Financial filed for bankruptcy and laid off 54% of its staff.
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•  Risky financial behaviors at Wall Street securitized and bundled poor security loans and sold them to institutions that later repackaged and resold them as collateralized debt obligations (CDOs). Banks also insured subprime loans using credit default swaps (CDS), making it hard for investors to assess the actual risk.

Characteristics of the Lending Landscape

Increased Interest Rates

• The Federal Reserve kept interest rates low throughout the early 2000s and started hiking them in 2004 when the federal funds rate was 1.25%, and by 2006 it reached 5.25%.
• At the same time, home prices were peaking while the market was slowing down. Hence, when supply exceeded demand, home prices declined.
• The increasing interest rate and falling home prices wiped home values and made it difficult for subprime borrowers to repay their mortgages.

Loose Lending Standards

• Real estate was booming in the decade leading to the 2008/09 recession. To encourage more buyers, lenders approved as many loans as they could, including subprime mortgages.
• The new move opened a window for new home buyers who did not qualify for conventional mortgages. While the interest rates were lower during this period, they rose after the recession, leaving many subprime buyers unable to afford their homes.

Poor Loan Rating System

• A report by Senate later found that the actions of the nation's financial watchdogs, S&P, Moody’s Corp, and Fitch Ratings Inc., contributed to the financial crisis.
• The watchdogs rated many subprime loans AAA, which they later cut to junk status. During that period leading to the crisis, the agencies rated many securities AAA, even though they contained risky mortgages.

Most Impacted Industries by the Recession

• The most impacted industries by the recession include
• The building material, construction, and supplies sector.
• The manufacturing industry.
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• As shown in the image above, the construction and manufacturing sectors saw the biggest decline in employment from 2007 to 2011.
• The construction sector's employment shrunk by over -25%, while manufacturing shrunk by over -15%. Each sector lost about two million employees.

2. Current Lending Landscape (2021-2023)

Indicators Indicating a Recession Is Coming

• The U.S. recession probability index for January 024 is predicted at 57.13%. The probability had been climbing from 7.08% in June 2022.
•  Declining small business lending and softening loan demand indicate fewer consumers seek loans amid fears of an imminent recession. In 2022, demand for loans at small and large banks declined by 2% and 5% across mid-sized banks.
• Increasing interest rates have caused concerns about a recession. As a result, the Fed recently hiked the federal funds rate by 75 bps to curb inflation. The higher rates make borrowing expensive, and rising credit cards, mortgages, auto loans, etc., will reduce Americans' disposable income.
• The declining U.S. gross domestic product plunged by 1.4% in Q1 and 0.9% in Q2, making people worried that the economy is slowing down. While a slowing economy could be good for easing inflation as spending becomes curbed, continued slowing down can lead to a recession.
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•  Higher inflation remains the biggest threat to the U.S. economy. In 2022, the inflation rate was 7.48%, declining to 6.41% by January 2023. The higher inflation causes employees' pay to drop, and people of color bear the most pain since they struggle to afford necessities.

Characteristics of the Lending Landscape

Declining Demand for Loans

•  Higher interest rates and forecasts for slower economic growth have led to decreased demand for loans as consumers and commercial clients become worried about a potential recession.
• The recent increase in interest rates by the Federal Reserve to curb inflation resulted in a decrease in borrowing and spending. As a result, bankers and analysts expect loan demand to slow in the year ahead.

Negative Yield Curve

• The current Negative Yield Curve (a measure of investors' returns on bonds) does not point to a good direction for the U.S. economy.
• It has been flattening, and in early April 2022, it dropped to the negative territory, fluctuations that cast doubts on the economy's direction.

Rising Delinquency Rate for Mortgages

• The Mortgage Bankers Association noted that by the end of 2022, economic headwinds and inflationary pressures caused delinquency rates for residential property loans to rise.
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• Mortgage delinquency rates reached 3.96% in Q4, up 51 basis points from Q3. The weaker economy and ongoing inflationary pressures contribute to the rising delinquencies across all loan types.

Most Impacted Industries by the Current Lending Landscape

• According to Acorns, the real estate sector suffers a lot during recessions, with many activities, from construction to supplies coming to a standstill.
• The banking sector is also significantly affected by a recession. Demand for new loans slows, and consumers fear taking loans due to job insecurity during economic downturns.

Research Strategy

Key Takeaways

• To curb the impact of high oil prices, President Carter introduced car mileage standards, deregulated transportation (rail, airline, and trucking industries), and deregulated oil prices. He also established the U.S. Department of Energy to regulate energy prices and develop alternative fuels.
• President Carter also reduced government expenditures and increased taxes. He reduced fiscal spending by $13 billion, freeze federal hiring, established federal job ceilings that would eliminate 20,000 federal jobs, and proposed federal retirees' cost of living increases would be calculated annually rather than twice a year. He also introduced and increased taxes that included introducing an oil import fee and increasing payroll taxes.
• To resolve this inflation crisis, President Nixon introduced a 90-day price and wage freeze. Whereas these policies introduced by President Nixon had a short-term impact in resolving inflation and unemployment, the oil embargo of 1974 led to a resurgence of inflation and unemployment in the country.

Introduction

The brewing economic crisis 1960s to 1970s

• Since World War II, the US dollar was designated by the Bretton Woods system as the defacto world reserve currency. It generated excessive demand for the Dollar and led to its subsequent overvaluation, which resulted in the United States exports being expensive whereas imports were cheap. As such, the US manufacturing industry stagnated leading to growing unemployment. To resolve the crisis of high unemployment, President Nixon sought to devalue the US dollar by ending the gold standard in 1971, which would result in American exports being cheaper effectively stimulating manufacturing and employment.
• During this time of high unemployment, the nation was also experiencing high inflation as a result of the expansion of social programs without an increase in taxation. To resolve this crisis, President Nixon introduced a 90-day price and wage freeze. Whereas these policies introduced by President Nixon had a short-term impact in resolving inflation and unemployment, the oil embargo of 1974 led to a resurgence of inflation and unemployment in the country.

President Carter policies

• The president appointed Paul Volker as the Chairman of the Federal reserve. At the helm of the Federal Reserve, Volker tightened monetary policy by increasing interest rates, which targeted the suppression of inflation through depressing demand and economic growth. He also sought to curb consumer and business credit.
• To curb the impact of high oil prices, President Carter introduced car mileage standards, deregulated transportation (rail, airline, and trucking industries), and deregulated oil prices. He also established the U.S. Department of Energy to regulate energy prices and develop alternative fuels.
• President Carter also reduced government expenditures and increased taxes. He reduced fiscal spending by $13 billion, freeze federal hiring, established federal job ceilings that would eliminate 20,000 federal jobs, and proposed federal retirees' cost of living increases would be calculated annually rather than twice a year. He also introduced and increased taxes that included introducing an oil import fee and increasing payroll taxes.

Impact of President Carter's Policies

• The Federal Reserve Chairman had tightened monetary policy by increasing interest rates by 20%. It resulted in the inflation increased in the short term to a high of 14% in 1980 before subsiding to 3.5% by the end of the year.
• President Carter had began the deregulation of the transportation industry. Particulary, rail, airline, and trucking industries felt the impact of the deregulation impacts and eventually the spike of inflation. The curb consumer and business credit affected retail industry.

 

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Research Strategy