What Happened: Financial Factors in the Great Recession

Abstract

At the onset of the recent global financial crisis, the workhorse macroeconomic models assumed frictionless financial markets. These frameworks were thus not able to anticipate the crisis, nor to analyze how the disruption of credit markets changed what initially appeared like a mild downturn into the Great Recession. Since that time, an explosion of both theoretical and empirical research has investigated how the financial crisis emerged and how it was transmitted to the real sector. The goal of this paper is to describe what we have learned from this new research and how it can be used to understand what happened during the Great Recession. In the process, we also present some new empirical work. We argue that a complete description of the Great Recession must take account of the financial distress facing both households and banks and, as the crisis unfolded, nonfinancial firms as well. Exploiting both panel data and time series methods, we analyze the contribution of the house price decline, versus the banking distress indicator, to the overall decline in employment during the Great Recession. We confirm a common finding in the literature that the household balance sheet channel is important for regional variation in employment. However, we also find that the disruption in banking was central to the overall employment contraction.

Innovative Empirical Model for Predicting National Banks’ Financial Failure with Artificial Intelligence Subset Data Analysis in the United States

“…In September 2008, Lehman Brothers became exposed to excess mortgage-related risks. As a result, the Federal Reserve was unable to act as a "lender of last resort," forcing Lehman Brothers to default because it could not offer sufficient collateral (Gertler & Gilchrist, 2018).…”

Essays on Financial Technology and SME Finance: A Tale of Two Effects of the Global Financial Crisis: Financing SMEs and Innovative Financing

“…This does suggest that more innovative younger firms are more willing to bear the external finance premium. This holds even during the crisis, when the external finance premium is elevated (Mark Gertler & Gilchrist, 2018). No corresponding relationships are found for older firms.…”

“…More recently, financial economists have shown that the loss in housing wealth (Mian and Sufi, 2010), a decrease in consumer credit (Mian, Rao, & Sufi, 2013), highly-levered households (Mian & Sufi, 2018) and panics from the collapse of Lehman Brother (Mian & Sufi 2015) led to a consumption-driven recession, reducing global demand. Some economists hold both these factors responsible (Gertler & Gilchrist, 2018).…”

“…Mian and Sufi (2015) in effect state that while the collapse of Lehman Brothers exacerbated economic weakness, it should not be seen as a primary cause of the demand-shock. More recently, Gertler & Gilchrist (2018) find that financial distress in balance sheets of both households and banks were responsible for the fall in corporate investment. Clearly, there is yet substantial debate as to the role of demand-and supply-side factors, leaving the acadesmic field open for evidence that can disentangle the two and strengthen the literature.…”

“…Brunnermeier, 2009), as well as the general credit shock (see e.g. Gorton, 2010) to firms during the crisis, elevated the external finance premium -termed by Bernanke & Gertler (1989) to mean the additional cost of external funding over internal funding -during the financial crisis (Mark Gertler & Gilchrist, 2018).…”