Reasons for the Great Recession and the Gov. Response

With the recent collapse of the economy beginning in 2008, fingers began pointing towards possible causes of the greatest recession in American history since the 1930s. While many placed the blame on the Bush administration and their actions, an equal amount placed the blame on the Obama administration and their response to the failing economy. Though we can look to the government for providing the main idea that led to the crisis, we can’t completely find a single administration to blame. The main causes behind this economic breakdown were to be found in the decisions that were being made behind the scenes in the mortgage market. Due to the presence of both adverse selection and moral hazard, poor decisions were being made by buyers and lenders, which would lead to the subprime mortgage crisis. This crisis eventually spread wide enough to affect the economy as a whole, creating what we now know as “The Great Recession.” In response to this crisis, the government used multiple regulatory and monetary tools in an attempt to save the financial industry and reboot the economy. These tools consisted of the Troubled Asset Relief Program (TARP), the introduction of the Volcker rule, the usage of stress tests, as well as other policies that were meant to counteract the failing economy. As a result of these policies and tools, even though they can be criticized and have been for some time, the government was able to prevent a total collapse of the economy.

Before diving into the main causes of the economic downfall there are a couple important terms that need to be defined. Both adverse selection and moral hazard played a vital role in the financial crisis and were major contributing factors to the poor financial decisions that were being made over the course of 2007 and 2008. Adverse selection is defined as “the problem created by asymmetric information before a transaction occurs”. To understand this one would have to understand the meaning of asymmetric information....