The Great Depression and the 2008 financial crisis resulted from the housing bubble. These events affected the US business cycle. Before the Great Depression, the commercial banks offered low interest as part of the new monetary policy. Also, the less qualified borrowers had access to credit opportunities. As a result, there was an increase in the construction of new homes. The housing price rose, leading to an inevitable burst. As the Great Depression approached, most banks failed due to improper mortgage lending options. Americans foresaw a decline in house prices. The outcome was a housing bubble burst and Great Depression, which shrank the US economy, caused a decline in demand for producer and consumer goods and worsened international trade.
The 2006 housing bubble burst and the Great Depression resulted in the US economic activity contraction. They affected the real sector, including the Gross Domestic Product (GDP), residential investment, consumer durables, nondurable consumption, and producer durables. After the recession, there was a sharp decline in residential investment due to increased concerns about the future housing pricing ( Gertler & Gilchrist, 2018 ). Two factors led to this outcome: the disruption of credit markets, which enhanced the borrowing options for construction companies, and challenges in the asset-based commercial paper market, leading to increased pressure on the mortgage credit cost. The US economic activity shrank due to a decline in demand for consumer durable goods when the recession started, mainly due to a drop in automobile demand ( Gertler & Gilchrist, 2018 ). The reduction in household values and deficits in bank balance sheets created this problem. When homeowners realized that they could not make significant returns from their investments, they avoided buying cars since they considered them depreciating assets that would put them in further debt.
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Figure 1: The image provides insight into GDP, residential investment, consumer and producer durables, and nondurable consumption. The shaded region is a time frame between the peak and trough of the Great Depression, while the vertical lines represent Lehman Brothers bankruptcy. Retrieved from https://www.aeaweb.org/articles?id=10.1257/jep.32.3.3
Furthermore, the recession harmed the supply and demand for consumer and producer durable goods. By 2009, the consumer durables had dropped by 15% and producer durables by 35% ( Gertler & Gilchrist, 2018 ). The charts below present real personal expenditures for durable goods and the US trade balance. During the Great Depression and the decline in house prices and home construction items, the Americans panicked and avoided buying appliances, automobiles, and furniture (Sumner & Erdmann, 2020). Although the nonfinancial firms were not affected by the fall in home prices like homeowners and commercial banks, the equity values dropped significantly, affecting the balance sheets. As a result, access to credit facilities became challenging. Lehman Brothers, the largest investment bank at the time, was highly exposed to mortgage-related risk. Besides, unemployment rates increased after mid-2007 (Sumner & Erdmann, 2020). Thus, there was reduced money circulation causing panic and a significant drop in demand for producer and consumer goods.
Figure 2: The above image represents the trend in demand for consumer durable goods during and after the Great Depression. Retrieved from https://www.brookings.edu/blog/ben-bernanke/2018/09/21/the-housing-bubble-the-credit-crunch-and-the-great-recession-reply-to-paul-krugman/
Moreover, the house bubble burst and Great Depression adversely affected US imports and exports. During this period, the aggregate demand for American goods was modest. Besides, international trade is credit-sensitive since importers and exporters depend on the financial system, and most goods are durable (Hasbini, 2017). In late 2008 and early 2009, there was a significant disruption in the credit supply. Exporters and importers raised the prices of their goods. As a result, the demand for American goods reduced, shrinking the economic activity and global trade.
Overall, the 2006 housing bubble burst and Great Depression hurt the American economy. Despite cash availability to less qualified borrowers, the housing prices fell since most Americans invested in homebuilding. This trend caused a decline in demand for producer and consumer goods. Commercial banks created a financial deficit since they could regain the money that the borrowers owed them. As a result, the US entered into a financial crisis that included rising unemployment rates and industries' collapse.
References
Gertler, M., & Gilchrist, S. (2018). What happened: Financial factors in the great recession? Journal of Economic Perspectives , 32 (3), 3-30. https://doi.org/10.1257/jep.32.3.3
Hasbini, M. A. (2017). The Great Recession of 2007 and the housing market crash: Why did so many builders fail? Graduate Theses and Dissertations . http://scholarcommons.usf.edu/etd/7031
Sumner, S., & Erdmann, K. (2020). Housing policy, monetary policy, and the Great Recession. Mercatus Research Series . http://dx.doi.org/10.2139/ssrn.3667309
