May 29, 2014 by Lisa Brammer
There has been a lot written about the Great Recession. More than 8 million people lost their jobs and more than 4 million homes were lost to foreclosure. And even though it officially lasted from December 2007 to June 2009, the devastating effects are still felt today, especially since unemployment rates are still well above average levels.
When economists write about the Great Recession they often compare it to the Great Depression of the 1930’s and hypothesize about the causes of these major financial declines. In a new book, “House of Debt” by Atif Mian of Princeton University and Amir Sufi of the University Of Chicago Booth School Of Business, the authors argue that the data compiled during these events reveals that almost all severe economic downturns are preceded by a sharp rise in household debt.
In the years immediately before the recession, Americans doubled their household debt to $14 trillion. According to “House of Debt” a significant rise in debt, along with the gigantic drop in household spending that followed were key elements to both financial crashes.
Before the real estate bubble burst, there were noticeably more relaxed financing options. Sub-prime lending, zero-interest loans, zero-down payment, and low-interest ARMs all made home buying more affordable. As home prices sky-rocketed, homeowners— especially those with lower borrowing power—refinanced their homes and used the newly found equity to buy, Buy, BUY! The economy continued to grow, but people weren’t earning more money—they were borrowing more.
When the bubble burst, the house of cards came tumbling down. According to Sufi, the excessive household debt led to the foreclosures which caused people to spend less and save more. Less spending meant less demand for goods which was followed by the decline in production and huge job losses. Sufi says, “The only way to break that cycle is directly attacking debt.” Foreclosures may be on the decline, but according to Sufi, there is a new concern on the horizon—student debt.
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