Which of the following best relays the events of the 2007dash–2009 recession aft

Question

Which of the following best relays the events of the

2007dash–2009

recession after the bust in housing prices?

A.

Mortgage foreclosures, a credit contraction, a leftward shift in the demand for labor, and a strong drop in consumption

B.

Mortgage foreclosures, a credit expansion, a rightward shift in the demand for labor, and an increase in consumption

C.

Mortgage foreclosures, a credit contraction, a rightward shift in the demand for labor, and an increase in consumption

D.

Mortgage foreclosures, a credit expansion, a leftward shift in the demand for labor, and a strong drop in consumption

Explanation / Answer

Answer :

A. Mortgage foreclosures, a credit contraction, a leftward shift in the demand for labor, and a strong drop in consumption

Following the burst of the tech bubble and the recession of the early 2000s, the Federal Reserve kept short-term interest rates low for an extended period of time. This coincided with a global savings glut, as developing countries and commodity-producing nations accumulated large financial reserves. As these excess savings were invested, global interest rates declined to record low levels. Frustrated with low returns, investors began to assume more risk by seeking higher returns wherever they could be found. For several years, global financial markets entered a period which came to be called the "Great Moderation" due to the above-average returns and below-average volatility demonstrated by a wide variety of asset classes.

In the United States, the Great Moderation coincided with a housing boom, as prices soared (particularly on the coasts and in cities such as Phoenix and Las Vegas). Rising home prices led to rampant real estate speculation, and also fueled excessive consumer spending as people began to view their homes as a piggy bank that they could extract cash from to fuel discretionary purchases. As home prices soared and many homeowners stretched to make their mortgage payments, the possibility of a collapse grew. However, the true extent of the danger was hidden because so many mortgages had been securitized and turned into AAA-rated securities.

When the long-held belief that home prices do not decline turned out to be inaccurate, prices on mortgage-backed securities plunged, prompting large losses for banks and other financial institutions. These losses soon spread to other asset classes, fueling a crisis of confidence in the health of many of the world's largest banks. Events reached their climax with the bankruptcy of Lehman Brothers in September 2008, which resulted in a credit freeze that brought the global financial system to the brink of complete collapse.

Unprecedented central bank actions combined with fiscal stimulus (notably in the U.S. and China) helped ease some of the panic in the markets, but by late winter 2009, rumor had it that Citigroup Inc., Bank of America Corp., and other large banks would have to be nationalized if the global economy was to survive. Fortunately, the aggressive actions by governments around the world eventually helped avoid financial collapse, but the credit freeze forced the global economy into the worst recession since World War II.

So, we can see that mortgages foreclosed and this led to collapse of big financial institutions. This led to credit contraction to very low levels by the surviving institutions. Due to low credit availability, investment fell and in turn resulting in a leftward shift in the demand for labour. the chain leading to a drop in consumption. Thus a vicious cycle of recession was established in the economy.

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