Technically speaking, the financial crisis of 2008, the biggest economic meltdown in the U.S. since the Great Depression, lasted a little more than 18 months, and ended long ago. From December 2007 to June 2009, the GDP contracted sharply, and then the economy began growing again.
At ground level for many, though, the world has never been quite the same.
“One in five employees lost their jobs at the beginning of the Great Recession. Many of those people never recovered; they never got real work again,” says Wharton management professor Peter Cappelli, director of the school’s Center for Human Resources. “The spike in disability claims was in part caused by the difficulty laid-off people had in securing any jobs. A generation of young people entering the job market had their careers disrupted by it. The fact that this age group continues to delay buying houses, having children, and other markers of stable, adult life is largely attributed to this.” (Cappelli recently spoke about the impact of the recession on the job market on the Knowledge at Wharton radio show on SiriusXM. Listen to the podcast at the top of this page.)
“It was a very traumatic event. Vast numbers of lives were changed forever undoubtedly when you look at the economy as a whole,” says Wharton management professor Matthew Bidwell.
The Great Recession accelerated a number of trends and arrested the development of others. “The fact that so many people took temporary jobs, often as contractors, was pushed along by the downturn, in part because employers were so unsure about the future but also because workers had no choice but to take them,” says Cappelli. “Good employee-management practices took a big step back during this period because employees were willing to put up with anything as long as they had a job.”
What we could have taken away from the financial crisis was the resolve to take steps so that it should never happen again, Cappelli says. “But it’s easier to ignore that, so we are.”
The Cost of Cheap Money
This is not to say that the greater meaning of the financial crisis is a settled matter. The Federal Reserve Board’s decision to drop interest rates to effectively zero in November of 2008 stands as an important moment in financial and political history, says Peter Conti-Brown, Wharton professor of legal studies and business ethics.
“[We] hadn’t seen interest rates so low for so long,” he says. “But there is also a growing, bipartisan chorus of Fed critics who see the Fed’s monetary decisions as too timid rather than too bold. It may well be that historians regard the Fed’s ambivalence about inflation in 2007 and 2008 as exacerbating the traumas of the crisis. We’ve seen this pattern before. Most scholars blame the Fed for the worst of the Great Depression, but that consensus didn’t arise for decades after the event. It is still early, even 10 years out, for us to understand exactly the consequences of the Fed’s actions, for good or for ill.”
“One in five employees lost their jobs at the beginning of the Great Recession. Many of those people never recovered; they never got real work again.”–Peter Cappelli
For the average person, there’s a strong argument that the Fed prevented even greater pain. Unemployment reached 10%, but not the 25% of the Great Depression. “And borrowers were highly advantaged in this context during the relevant period,” says Conti-Brown. “Those whose investment strategies included broad exposure to stocks and bonds also did very well. Only those whose investment strategy had them owning to maturity fixed-income assets suffered. That’s a relatively small crowd compared to the much broader benefits.”
At the same time, though, the failure to be more aggressive — to drop interest rates sooner, to consider pushing inflation higher — may have caused real harm to those millions of people displaced by the crisis, Conti-Brown says. “It’s not clear that the 10% unemployment was at all inevitable. That’s the rub.”
Retiring in Debt
Those workers who kept their jobs or found new ones following the crisis are now facing the prospect of needing to delay retirement while having a much smaller nest egg to rely on. Many economists foresee global capital markets paying much lower expected returns on investments in the future compared to the past, and that will influence work, retirement, saving and the investment behavior of older Americans, according to a working paper from Wharton’s Pension Research Council. “In a low expected return regime, workers build up less wealth in their tax-qualified 401(k) accounts compared to the past. Moreover, men and women optimally claim Social Security benefits later and work more when expected real returns are low,” write Vanya Horneff, Raimond Maurer and Wharton professor of business economics and public policy Olivia S. Mitchell in “How Will Persistent Low Expected Returns Shape Household Behavior?”
In their paper, the authors construct a life-cycle model that includes, among other variables, stock market and labor market uncertainty, U.S. tax rules and minimum distribution requirements for 401(k) plans, and real-world Social Security benefit formulas. Next, they simulate anticipated changes in behavior given lower real expected returns and compare outcomes with the baseline results.
What they find is that persistently low returns shape behavior across a heterogeneous population. “For instance,” they write, “both men and women claim Social Security benefits about a year later and work longer, and the response is strongest for the college-educated. Additionally, better-educated persons are more sensitive than others to real returns and so they reduce their saving more in their tax-qualified retirement accounts.”
“It is still early, even 10 years out, for us to understand exactly the consequences of the Fed’s actions, for good or for ill.”–Peter Conti-Brown
At the same time, Americans today are more likely to enter retirement in debt than ever before, and higher debt levels make older households quite sensitive to rising interest rates. Retirees may need to devote a growing fraction of their incomes to servicing the rising debt, writes Mitchell in a separate study.
U.S. consumer credit and mortgage borrowing expanded rapidly prior to the 2008 financial crisis, allowing relatively unsophisticated consumers to decide how much they could afford to borrow, explain Mitchell and co-authors Annamaria Lusardi and Noemi Oggero in “The Changing Face of Debt and Financial Fragility at Older Ages,” published in the American Economic Association’s AEA Papers and Proceedings.
“One of the most important decisions people make during retirement is how to decumulate wealth, yet our results imply that aging Americans will also need to manage and pay off heavy debt burdens in retirement,” they note. “This is made more difficult by the fact that older persons frequently move a portion or all of their wealth to fixed-income assets. In addition, if future equity returns are lower than in the past (as many predict), it will be increasingly critical for older people to manage assets and liabilities wisely, and to pay off some of this higher-interest debt. These challenges are exacerbated by older persons’ unwillingness to sell their homes, move to smaller homes, or engage in reverse mortgages.”
From Buying to Renting
But will future generations have homes and the equity socked away in them to draw upon in retirement? The financial crisis of a decade ago resulted in tightened credit standards relative to historic norms, which has made it harder to get a mortgage, says Susan Wachter, Wharton professor of real estate and co-director of the Penn Institute for Urban Research at the University of Pennsylvania.
“If you look at home-ownership rates, they have dramatically decreased,” says Wachter. “For millennials, ages 25 to 35, they have really declined, shown by the increase in rentership, but also the historically high percentage of people who are still living at home, and this is despite the improving job market. The job market has improved, but housing prices continue to increase faster than wages. So it’s difficult to get a loan for a millennial — not just for minorities, but across the board.”
“We don’t properly know why wages and job conditions stayed low, and until we do, we don’t know when this will change.”–Iwan Barankay
Tight lending standards include higher down payments, higher credit-score requirements, and a debt-to-income ratio that is lower. “As we become a majority-minority nation, this tightening, if it becomes the new norm, together with the rising housing prices relative to wages, is likely to have the effect of pushing the nation into significantly lower aggregate home ownership rates,” Wachter says. After the crisis, minority groups were hit harder by tightening lending standards, she adds, “because minorities disproportionately have lower wealth and lower credit scores.”
Will it be possible for the U.S. to remain the nation of homeowners it has been for decades? Homeownership in the country grew from 44% in 1940 to 62% in 1960, rose to 69% by 2004, and by 2015 fell back to 63.4%. But if certain key drivers materialize, homeownership could plunge, according to findings by Wachter, Laurie S. Goodman and Arthur Acolin in “A Renter or Homeowner Nation?” published in the U.S. Department of Housing and Urban Development’s Cityscape.
“Our base case average scenario forecasts a decrease in homeownership to 57.9% by 2050, but alternate simulations show that it is possible for the homeownership rate to decline from current levels of around 64% to around 50% by 2050, 20 percentage points less than at its peak in 2004,” they write.
The current and post-WW II normal of two out of three households owning may hold, but only if credit conditions improve; if, as we move toward being a majority-minority nation, minorities’ economic endowments move toward replicating those of majority households; and if recent rent growth relative to income stabilizes, the researchers say.
Of course, tighter credit requirements necessitate applicants with less debt and better-paying jobs. And yet, real median household income in the U.S. hasn’t budged in two decades, according to the Federal Reserve Bank of St. Louis. Many looking to buy a house are less prepared to do so than their parents were at their age. And many millennials today are experiencing a “double-whammy” of increasing student debt and lower median wage growth.
“It is very alarming that after such a long expansion, with the labor market finally back to normal, we still have historically low interest rates and a swelling budget deficit.”–Matthew Bidwell
Low Wages and Disrupted Careers
Why did wages, benefits and job conditions not improve with the falling unemployment rate? Economists and HR experts don’t have a commonly agreed upon explanation, says Iwan Barankay, Wharton professor of management.
“A fundamental principle that commonly governs our understanding of recoveries and steers monetary policy is the Phillips Curve, which says that there is an inverse relationship between changes in inflation and changes in unemployment,” he says. “However, since the end of the recession, as unemployment dropped all the way down to the lowest level since the 1970s, wages in the U.S. barely rose in real terms. That is also true, on average, in Europe and Japan.”
One possible explanation is the diminished power of unions, Barankay says, noting that some studies point out that France saw higher wage increases, but lower growth, than Germany for that reason. “But I think this does not explain the persistently low wage-growth since unions were also weak after the previous recession — the dot-com bubble — after which wages rose again,” he adds. “I think we need to look deeper into what a recession does to the internal organization of firms and their decision processes.” He suggests that the shedding of managers along with workers in 2008-2009 — a key difference compared to previous recessions, when fewer upper-tier jobs were lost — may have concentrated decision-making power inside firms.
“But again, we don’t properly know why wages and job conditions stayed low, and until we do, we don’t know when this will change,” Barankay notes. “Indeed, it is possible that the next recession will arrive before wages start to pick up again, and we might never find out.”
It is hard to know what will keep the labor market healthy, Bidwell says. “It is very alarming that after such a long expansion, with the labor market finally back to normal, we still have historically low interest rates and a swelling budget deficit. That makes it very hard to know what we can do when the next downturn comes.”
He also stressed the need to differentiate cyclical factors from longer running trends: While the Great Recession undoubtedly hit labor markets very hard, many of the reasons workers are suffering stem from other issues, including a long-running decline in worker protections, technological change eroding middle-skill jobs and competition from China. “These are serious challenges, but it is very hard to see much of a response to them in the current political climate,” Bidwell adds.
“There may be a pressing need for more government regulation, but even more pervasive is a much more corrosive sense that the system is broken.”–Matthew Bidwell
As for what can or should be done to help those whose careers were disrupted by the Great Recession, Cappelli asks: done by whom? “In the past, nothing has been done by employer or by policy. In terms of policy, something to help graduates drowning in student loan debt would be good, as their inability to get jobs that paid enough was certainly, and continues to be, hurt. For employers, recognizing that people who entered the labor market in that period aren’t going to have CVs that are as good-looking would be smart.”
Bidwell thinks we are hard-pressed to tell a Great-Recession-changed-everything story. “It was particularly long-lasting, and there was this devastating collapse in the labor market,” he says. “But I think we’ve seen a recovery and at this point most of the indicators pretty much resemble what they were before. But the real question is, how long will that last?”
What the Great Recession did leave was a residue that Bidwell characterizes as an increased appreciation for the vulnerability of the economy.
“If you look at the Depression there really was this kind of delegitimization of free-market capitalism, so you saw in the U.S. and around the globe the growth of regulation because there was a sense that free markets on their own didn’t deliver stable growth. The Depression also followed 60 or 70 years of crisis and volatile markets. I think this last crisis delivered a great deal of cynicism about big business on behalf of the public, and probably nervousness about the stability of capital markets. Now we are sitting around asking when the next major landmine under the markets is going to blow up.
“There may be a pressing need for more government regulation,” he says, “but even more pervasive is a much more corrosive sense that the system is broken, without any constructive suggestions about what to do about it.”