Causes and Effects of the Recession

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“As long as greed is stronger than compassion, there will always be suffering.” – Rusty Eric

The year is 2003. The bursting of the dot-com bubble and a post-911 mindset remain detrimental to the global economy. In a desperate attempt to increase market activity, The Federal Reserve lowers interest rates to 1% – and the first domino falls.

The liquidity of interest rates creates an enormous spike in the economy. Banks are able to borrow massive amounts of money through a system called leverage, enabling them to turn incredible profits. Leverage is the economic term for the borrowing of capital in order to increase the potential profit of an investment. Say, for example, there is a metaphorical cupcake business which makes a $1.00 profit per cupcake. Using leverage, the business would borrow money from a bank, make 1 million cupcakes, and yield a 1 million dollar profit.

Now, imagine that, instead of cupcakes, the business borrowing money for collateralized debt obligations. CDOs are stockpiles of mortgage loans which are commonly purchased by banks as a source of constant income. This, of course, is a fantastic business model for many reasons: the forever increasing value of homes, perpetual influx of capital, etc. However, for investment bankers on Wall Street, it wasn’t enough.

The introduction of subprime lending marks the definitive turning point in the economic prosperity of large banks. Now, several years after the introduction of the 1% interest rate, banks begin their vicious attempts to make even more money. No longer is a person obligated to provide proof of their financial stability in order to obtain a mortgage loan. This creates a tremendous increase in the housing market by allowing the irresponsible to buy houses which they sonorously cannot afford.



Unsurprisingly, CDOs begin to fill up with foreclosures due to the inability of occupants to pay their mortgages. Initially, banks do not think it is a problem because they figure they can just sell the houses. However, the government then rose the interest rates to counter the rise in inflation, causing house values to decrease tremendously. Responsible home-buyers then begin to realize that they owe more on their house than it is worth, leading to even more foreclosures. These events cause a substantial diminishment in the value of CDOs, causing many banks to go bankrupt – and the last domino drops.

Without massive banks, the United States experiences a credit freeze;  no person nor bank is able to borrow money. This situation nearly pushes the United States into a depression. However, the government implements an emergency $700 billion bailout, saving the economy. After reforming financial laws, the United States is able to begin the slow and strenuous rehabilitation process.



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About the author

Joseph Smith is 17 years old, a resident of Westborough, Massachusetts, and a member of the class of 2017 at St. Mark’s School. He plans on getting undergraduate degrees in economics and computer science. He is involved in several leadership positions at St. Mark’s, including sustainability prefect and captain of the varsity golf team. He enjoys traveling, computer programming, graphic design, golf and squash. Joseph is also a passionate humanitarian; last summer he spent 3 weeks volunteering as a counsellor at Brantwood sleep-away Camp for the underprivileged and has spent hours upon hours volunteering at the Boys and Girls Club of Marlborough, during his sophomore and junior years. Joseph is a STEM Research Fellow at St. Mark's working on a data manipulation, allocation, compression and analytics algorithm.

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