You need to Understand why we had a recession.

Housing Market Collapse and Global Recession
By: Patrick DeCosta

The housing market collapse in late 2006 had worldwide economic consequences for almost all developed countries. After almost five years of unprecedented expansion of mortgage lending and free flowing credit the bubble finally burst and sent a tidal wave through the global financial system. More and more countries have become integrated and heavily dependent on the stability of one another. The housing market collapse in 2006 and subsequent economic recession in 2008 shows the impact that decisions made by U.S. bankers and policy makers echo throughout the world. Bankers and U.S. economic policy makers (Allan Greenspan and the Federal Reserve) caused the housing market collapse of 2006 because they did not understand the precarious predicament they had placed themselves in and over extended the credit market.
The financial market downfall originated when the Federal Reserve began implementing unusual regulatory interventions that distorted interest rates and the value of major assets such as homes. Beginning in 2001 the Federal Reserve began essentially expanding the U.S. money supply while decreasing the Federal Funds interest rate. They decreased the Federal Fund interest rate so much that it dipped below the rate of inflation. In doing so, a person could buy a house and that house would increase in value just based on the inflation rate alone. In 2003 the housing market was booming with low interest rate loans and increasing home values. The monetary policy of the Federal Reserve from 2001 to 2006 saturated the housing market and drastically inflated the value of the assets. The price of houses rose 6 percent from 2002 to 2006. The poor monetary policy of the Federal Reserve coupled with over reaching financial institutions would eventually lead to the massive global recession in 2008.
In 2003 to 2006 people were buying houses at an unprecedented rate and bankers were reluctant to pull back the reigns. The bankers showed little skepticism about the possibility of the huge boom in mortgages declining. The problem was that lenders, primarily the big banks, sold countless subprime mortgages to individuals with very poor credit. The banks believed this was ok because they found ways to package mortgages and sell them off in a way that the risk of the bad loans defaulting was minimized. Or so they thought. The new market for derivatives was unknown in the financial world and no one could know for certain if it could work. The idea could have worked if mortgage rates stayed the same but unfortunately most of the subprime mortgages that were issued were done so as adjustable rate mortgages (ARMs). This meant that the borrower and the banks depended on the interest rates staying low. In 2003 an ARM was much cheaper than a 30 year fixed rate mortgage and borrowers could not wait to take advantage of that situation.
On August 15 2008 shares of Country Wide Financial fell 13% after Merrill Lynch changed its buy rating on the stock. This triggered a panic because investors believed there may be funding difficulties. The Federal Reserve tried to stabilize the panic with a large injection of liquidity into the banks. By this time it was too late and there were massive sell offs in the worldwide markets which sent the U.S. financial markets tumbling out of control. The over extension of credit for the past several years had caught up to the big banks and now credit was frozen. The big banks and hedge fund investors were stuck with huge amounts of defaulted loans and bad assests. None of the big banks had the liquidity to support the massive debt they had incurred. Goldman Sachs, for example, was using $40 billion in equity to support $1.1 trillion of assets and Merrill Lynch had about $30 billion in equity to support its $1 trillion in assets. If the markets are rising it is ok to have balance sheet like that but if they start to fall or in this case drastically decline the bank is in serious trouble. Now interest rates were much high and all of those bad loans that were protected with the leverage of good loans were defaulting. This caused all of the derivatives sold to decrease in value which essentially shut down the banks and big investors. Many big investors had staked retirement accounts and 401k plans on the success of derivatives and those values dropped rapidly, businesses were forced to lay off employees because they could not get loans from banks and those people whose mortgage payments doubles or tripled overnight were foreclosed. The markets tumbled lower and lower as the dominos fell one after another. With a nationwide credit freeze employers could not expand or even finance their current payroll. Unemployment rose dramatically which led to even more loans being defaulted and the economy declining further. Essentially banks could not loan any money which hurt businesses and led to millions of people becoming unemployed. Even though neo-liberal policy dictates that we focus on supply side economics; when unemployment rises that high and demand drops heavily we can see that the effects are catastrophic.
Looking back we can see how the Federal Reserve’s monetary policy led to easy credit for borrowers. That easy credit and huge wave of new borrowers was too good for bankers to resist. The bankers capitalized on the perfect storm and drove the U.S. economy to record levels with little consideration for the consequences of their actions. It is safe to say that neither the economic policy makers at the Federal Reserve nor the leaders of the leading financial institutions knew what they were getting into. The banks saw the opportunity to make massive amounts of money at the expense of the middle class and they threw caution to the wind.