Global Financial Crisis (2008)

21st Century · 2000 – present

The Global Financial Crisis was a severe banking and credit crisis that began in the United States housing and mortgage markets and spread through the world's financial system in 2007 and 2008. Its sharpest moment came in September 2008, when the investment bank Lehman Brothers failed and credit markets across North America and Europe seized up. Governments and central banks responded with huge rescues of banks and large injections of money.

The crisis was followed by the deepest worldwide recession since the 1930s, often called the Great Recession, with falling output, rising unemployment and lost homes in many countries. It led to new banking rules, years of low interest rates, a sovereign debt crisis in the euro area, and lasting political arguments about banks, inequality and the role of the state. This entry covers the events that led up to the crisis and some stories commonly told about it.

Things happened, and the rest is history

The US housing boom and subprime lending
Event
What happened
From the late 1990s to about 2006, house prices in the United States rise steeply, helped by low interest rates and easy credit. Lenders make growing numbers of subprime mortgages to borrowers with weaker credit, often with low introductory rates. Many of these loans are packaged into mortgage-backed securities and sold to investors in the United States and abroad.
The rest is history
US house prices peaked around 2006 and then began to fall. As introductory rates ended and prices dropped, defaults on subprime loans rose sharply during 2007. Securities built on these loans lost value, and banks holding them reported large losses. The US Financial Crisis Inquiry Commission, in its 2011 report, concluded that the crisis was avoidable and blamed failures of regulation, risk management and lending standards.
Sources
1. PrimaryFinancial Crisis Inquiry Commission. The Financial Crisis Inquiry Report. Washington, DC: US Government Printing Office, 2011.
2. BookTooze, Adam. Crashed: How a Decade of Financial Crises Changed the World. New York: Viking, 2018.
Deregulation and the growth of shadow banking
Event
What happened
In 1999 the US Gramm-Leach-Bliley Act repeals parts of the Glass-Steagall separation of commercial and investment banking. In 2000 the Commodity Futures Modernization Act exempts most over-the-counter derivatives from regulation. Meanwhile, investment banks, money market funds and other institutions outside ordinary bank supervision grow to carry a very large share of lending, financed by short-term borrowing.
The rest is history
Historians and economists debate how much these laws caused the crisis, since much of the damage came from institutions Glass-Steagall had never covered. There is wide agreement that the system had become heavily leveraged and dependent on short-term funding, which made it fragile when confidence fell. The Financial Crisis Inquiry Commission pointed to the shadow banking system as central to how the panic spread in 2008.
Sources
1. PrimaryGramm-Leach-Bliley Act. United States public law 106-102, 1999.
2. BookGorton, Gary B. Slapped by the Invisible Hand: The Panic of 2007. Oxford: Oxford University Press, 2010.
Global imbalances and cheap credit
Event
What happened
In the early 2000s the United States runs large trade deficits, while China, oil exporters and some other countries build up large surpluses and reserves. Much of this money is invested in US government and agency bonds. The US Federal Reserve also cuts interest rates to 1 percent by 2003 after the dotcom bust and the 2001 recession, and keeps them low for some time.
The rest is history
Many economists argue that abundant foreign savings and low rates helped push down borrowing costs and encouraged risk-taking and the housing boom. Others stress domestic policy and regulatory failures instead, and the weight of each cause is still debated. Ben Bernanke, later Fed chairman, argued in 2005 that a global savings glut was lowering US long-term interest rates.
Sources
1. PrimaryBernanke, Ben S. "The Global Saving Glut and the U.S. Current Account Deficit." Remarks at the Sandridge Lecture, Virginia Association of Economists, 10 March 2005.
2. BookBernanke, Ben S. The Courage to Act: A Memoir of a Crisis and Its Aftermath. New York: W. W. Norton, 2015.
Early warnings: BNP Paribas and the run on Northern Rock
Event
What happened
On 9 August 2007 the French bank BNP Paribas freezes withdrawals from three investment funds exposed to US mortgages, because it cannot value their holdings. Interbank lending tightens and central banks inject cash. In September 2007 depositors queue outside branches of the British bank Northern Rock, which relies on short-term market funding, and the British government later takes it over in February 2008.
The rest is history
These events showed that the mortgage losses had frozen the funding markets that banks depended on. In March 2008 the US investment bank Bear Stearns collapsed and was sold to JPMorgan Chase with Federal Reserve support. Pressure then moved to larger institutions, leading to the events of September 2008.
Sources
1. BookTooze, Adam. Crashed: How a Decade of Financial Crises Changed the World. New York: Viking, 2018.
2. PrimaryFinancial Crisis Inquiry Commission. The Financial Crisis Inquiry Report. Washington, DC: US Government Printing Office, 2011.
Fannie Mae and Freddie Mac placed in conservatorship
Event
What happened
Fannie Mae and Freddie Mac, government-sponsored companies that guarantee or hold a large part of US home mortgages, suffer growing losses as house prices fall. On 7 September 2008 the US government places both into conservatorship under the Federal Housing Finance Agency. The Treasury commits to support them with capital.
The rest is history
The takeover was one of the largest rescues up to that point and was meant to keep mortgage credit flowing. It came only days before the Lehman failure and showed how far the crisis had reached into the core of US housing finance. Both firms remained under government control for many years after.
Sources
1. PrimaryFinancial Crisis Inquiry Commission. The Financial Crisis Inquiry Report. Washington, DC: US Government Printing Office, 2011.
2. BookPaulson, Henry M. On the Brink: Inside the Race to Stop the Collapse of the Global Financial System. New York: Business Plus, 2010.
The failure of Lehman Brothers
Event
What happened
On 15 September 2008 Lehman Brothers, the fourth largest US investment bank, files for bankruptcy after talks to sell it fail and the US government declines to rescue it. The same week Merrill Lynch is sold to Bank of America, and the Federal Reserve lends to the insurer AIG. A major money market fund, the Reserve Primary Fund, falls below par value on 16 September.
The rest is history
Funding markets froze, and credit to businesses dried up around the world. Governments responded in October 2008 with bank guarantees and recapitalizations, and the US Congress passed the Troubled Asset Relief Program. Lehman's failure is widely seen as the turning point that turned a US financial crisis into a global one, although historians still debate whether a different decision could have avoided the panic.
Sources
1. BookSorkin, Andrew Ross. Too Big to Fail. New York: Viking, 2009.
2. PrimaryValukas, Anton R. Report of Anton R. Valukas, Examiner, In re Lehman Brothers Holdings Inc. United States Bankruptcy Court, Southern District of New York, 2010.
The G20 response and the Great Recession
Event
What happened
In November 2008 leaders of the G20 group meet in Washington for the first time at leaders' level, and in April 2009 meet again in London. Governments launch fiscal stimulus packages, central banks cut interest rates close to zero, and the Federal Reserve begins quantitative easing. World output falls in 2009 for the first time in decades.
The rest is history
The coordinated action is generally credited with preventing a repeat of the 1930s collapse, though recovery was slow and uneven. The G20 replaced the G8 as the main forum for economic coordination. New rules followed, including the Dodd-Frank Act in the United States in 2010 and the Basel III bank capital standards agreed that year.
Sources
1. PrimaryG20. Declaration of the Summit on Financial Markets and the World Economy. Washington, DC, 15 November 2008.
2. BookBlinder, Alan S. After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead. New York: Penguin Press, 2013.
The euro-area sovereign debt crisis
Event
What happened
In late 2009 the new Greek government reveals that its budget deficit is far larger than previously reported. Borrowing costs for Greece rise, and in May 2010 the euro-area states and the IMF agree the first Greek rescue loan. Ireland, Portugal, Spain and Cyprus also come under pressure in the following years.
The rest is history
The crisis grew out of the 2008 downturn, bank rescues that burdened public finances, and weaknesses in the euro's design. In July 2012 the European Central Bank president Mario Draghi pledged to do 'whatever it takes' to preserve the euro, and markets calmed. Austerity programmes in debtor countries led to deep recessions and political upheaval.
Sources
1. BookTooze, Adam. Crashed: How a Decade of Financial Crises Changed the World. New York: Viking, 2018.
2. PrimaryDraghi, Mario. Speech at the Global Investment Conference, London, 26 July 2012. European Central Bank.
The crisis was caused by greedy poor borrowers
Popular belief
The legend
In this popular account, the crisis happens because irresponsible low-income homebuyers take on mortgages they cannot afford. Government housing policies, especially the Community Reinvestment Act and the push for affordable homes, are said to have forced banks to lend to them.
The rest is history
Subprime borrowers did default in large numbers, but research and official inquiries do not support the claim that the Community Reinvestment Act was the main cause. Much risky lending came from lenders not covered by that law, and many losses came from complex securities, high leverage and weak oversight on Wall Street. The Financial Crisis Inquiry Commission split on the exact causes, with its majority blaming widespread failures of regulation and risk management.
Sources
1. PrimaryFinancial Crisis Inquiry Commission. The Financial Crisis Inquiry Report. Washington, DC: US Government Printing Office, 2011.
2. BookLewis, Michael. The Big Short: Inside the Doomsday Machine. New York: W. W. Norton, 2010.
No one saw it coming
Popular belief
The legend
It is often said that the crisis struck out of nowhere and that no one in the economics profession or in finance saw it coming. In a well-known story, Queen Elizabeth II asks economists at the London School of Economics in November 2008 why no one noticed.
The rest is history
The Queen did ask the question during a visit to the LSE on 5 November 2008. A group of British economists later replied in a letter to her in July 2009 that the failure was one of collective imagination. Some people had warned of risks, including the economists Raghuram Rajan in 2005 and Nouriel Roubini, and a few investors bet against subprime mortgages. These warnings were a minority view, and most official forecasters did not expect a crisis on this scale.
Sources
1. PrimaryBesley, Tim, and Peter Hennessy. Letter to Her Majesty The Queen, 22 July 2009. British Academy.
2. ArticleRajan, Raghuram G. "Has Financial Development Made the World Riskier?" Proceedings of the Federal Reserve Bank of Kansas City Economic Symposium (2005): 313-369.
The bailouts were gifts and banks never paid them back
Popular belief
The legend
A common belief holds that the government handed trillions of dollars to banks as a gift, and that taxpayers never saw any of it again.
The rest is history
Most of the US rescue money was lent or invested rather than given. The Treasury's TARP bank programme was largely repaid with interest, and the Treasury reported that the overall bank investments made a profit. Other parts of the rescue, such as support for the car industry and AIG, were repaid in large part, though some programmes lost money. The wider costs to taxpayers and society, through lost output, unemployment and later budget deficits, were far larger than the direct cost of the bank rescues.
Sources
1. PrimaryUS Department of the Treasury. Troubled Asset Relief Program: Monthly Report to Congress and Program Updates, 2008-2014.
2. BookBlinder, Alan S. After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead. New York: Penguin Press, 2013.
Lehman was the only cause of the global crash
Popular belief
The legend
A simple version of the story says everything was fine until Lehman Brothers was allowed to fail on 15 September 2008, and that this single decision caused the world crash.
The rest is history
Lehman's collapse did mark the sharpest phase of panic, but trouble had been building for more than a year, with bank runs, falling house prices and big losses since 2007. Bear Stearns, Fannie Mae, Freddie Mac and Northern Rock had all been rescued earlier. Historians generally see the failure as the trigger of a panic in a system already weakened by high leverage and short-term funding. Whether a rescue would have been legal or possible is still argued, and Treasury officials said they lacked the authority to save the bank.
Sources
1. BookSorkin, Andrew Ross. Too Big to Fail. New York: Viking, 2009.
2. BookBernanke, Ben S. The Courage to Act: A Memoir of a Crisis and Its Aftermath. New York: W. W. Norton, 2015.

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Things happened, and the rest is history

The US housing boom and subprime lending

Deregulation and the growth of shadow banking

Global imbalances and cheap credit

Early warnings: BNP Paribas and the run on Northern Rock

Fannie Mae and Freddie Mac placed in conservatorship

The failure of Lehman Brothers

The G20 response and the Great Recession

The euro-area sovereign debt crisis

The crisis was caused by greedy poor borrowers

No one saw it coming

The bailouts were gifts and banks never paid them back

Lehman was the only cause of the global crash