2008 financial crisis

Based on Wikipedia: 2008 financial crisis

On September 15, 2008, Lehman Brothers—the fourth-largest investment bank in the United States—filed for bankruptcy in what would become the largest corporate bankruptcy in American history. Within forty-eight hours, the Dow Jones Industrial Average dropped over four hundred points. The event marked the moment when a housing bubble burst, and with it, the illusion that the global financial system was stable.

The crisis that unfolded through 2007 and 2008 was not simply a Wall Street affair. It was the product of decades of policy decisions, financial engineering, and the erosion of safeguards meant to protect ordinary people from predatory lending. The ripples spread from American living rooms to international boardrooms, turning a regional mortgage crisis into the most devastating financial collapse since the Great Depression.

The Perfect Storm

The roots of the catastrophe stretch back to the 1990s, when Congress passed legislation intended to expand affordable housing through looser financing rules. In 1999, parts of the Glass-Steagall Act—the cornerstone of American banking regulation since 1933—were repealed. The law had once separated commercial banking from the riskier operations of investment banks and proprietary trading. Its repeal allowed institutions to merge low-risk operations with high-risk ones.

As the Federal Reserve lowered the federal funds rate from 2000 to 2003, something shifted in American financial culture. Banks began targeting low-income homebuyers—many belonging to racial minorities—with high-risk loans that they knew would strain borrowers near the breaking point. The regulators who might have reined in this behavior simply weren't watching.

The result was a housing bubble unlike anything America had seen in generations. U.S. home mortgage debt relative to GDP increased from an average of 46% during the 1990s to 73% by 2008. In dollar terms, the mortgages amounted to roughly $10.5 trillion—around $15 trillion in today's currency values.

Cash-out refinancings fueled consumer spending that could no longer be sustained when home prices inevitably declined. Families extracted equity from their houses like ATMs, spending on things they later couldn't afford. The consumption spree was breathtaking: U.S. consumption accounted for more than a third of the growth in global consumption between 2000 and 2007.

The First Cracks

The subprime mortgage crisis began in early 2007, but its warning signs appeared sooner. As interest rates rose from 2004 to 2006, the cost of mortgages climbed while demand for housing fell. By early 2007, as more American subprime mortgage holders began defaulting on their repayments, lenders went bankrupt.

In April 2007, New Century Financial—one of the largest subprime originators—filed for bankruptcy. The writing was on the wall.

By August 2007, the financial contagion spread to global credit markets. Central banks began injecting liquidity in a desperate attempt to calm markets. But the web of derivatives built on mortgage-backed securities was unwinding faster than anyone could track.

Many financial institutions owned investments whose value depended on home mortgages—mortgage-backed securities or credit derivatives meant to insure against failure. These instruments declined in value significantly, and no one knew exactly how much exposure each bank had. The lack of transparency would prove catastrophic.

2008: The Year Everything Collapsed

March 2008 brought the first major casualty. Bear Stearns—the fifth-largest U.S. investment bank—was sold to JPMorgan Chase in a fire sale backed by Federal Reserve financing. The deal was essentially a government bailout, signaling that the Fed believed the institution too important to fail.

The summer of 2008 grew increasingly desperate. By July, Fannie Mae and Freddie Mac—companies which together owned or guaranteed half of the U.S. housing market—verged on collapse. The federal government seized both institutions in September through the Housing and Economic Recovery Act of 2008.

Then came September 15.

Lehman Brothers filed for bankruptcy on what became the largest bankruptcy in U.S. history. The event triggered a stock market crash and bank runs in several countries. The following day, the Federal Reserve executed a bailout of American International Group—the country's largest insurer—worth tens of billions of dollars. On September 25, Washington Mutual became the largest bank failure in U.S. history.

The panic was immediate and global. By October 3, Congress passed the Emergency Economic Stabilization Act, authorizing the Treasury Department to purchase toxic assets and bank stocks through the $700 billion Troubled Asset Relief Program—TARP.

The Human Toll

Assessments of the crisis's impact vary, but the numbers are devastating. Some 8.7 million jobs were lost, causing unemployment to rise from 5% in 2007 to a high of 10% in October 2009. In the fourth quarter of 2008, the quarter-over-quarter decline in real GDP in the U.S. was 8.4%.

The percentage of citizens living in poverty rose from 12.5% in 2010 to 15.1%. The Dow Jones Industrial Average fell by 53% between October 2007 and March 2009. Some estimates suggest one in four households lost 75% or more of their net worth.

From its peak in the second quarter of 2007 at $61.4 trillion, household wealth in the United States fell $11 trillion to $50.4 trillion by the end of the first quarter of 2009. The unemployment rate peaked at 11.0% in October 2009—the highest rate since 1983 and roughly twice the pre-crisis rate. The average hours per work week declined to 33, the lowest level since the government began collecting the data in 1964.

A Global Aftershock

The crisis rapidly spread into a global economic shock. Several banks failed worldwide. Economies slowed as credit tightened and international trade declined. Housing markets suffered and unemployment soared, resulting in mass evictions and foreclosures.

Toxic securities were owned by corporate and institutional investors globally—not just American ones. Derivatives such as credit default swaps increased the linkage between large financial institutions, spreading contagion across oceans.

The de-leveraging of financial institutions—as assets were sold to pay back obligations that couldn't be refinanced in frozen credit markets—further accelerated the solvency crisis and caused a decrease in international trade. Reductions in growth rates of developing countries were due to falls in trade, commodity prices, investment, and remittances sent from migrant workers.

The crisis was also a contributor to the 2008-2011 Icelandic financial crisis, which involved the bank failure of all three major banks in Iceland—and relative to the size of its economy, was the largest economic collapse suffered by any country in history. It was followed by the euro area crisis, which began with the Greek government-debt crisis in late 2009.

The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic assets and from bad loans from January 2007 to September 2009.

Recovery

The Fed began a program of quantitative easing, buying treasury bonds and other assets such as mortgage-backed securities. The American Recovery and Reinvestment Act—signed in February 2009 by newly elected President Barack Obama—included measures intended to preserve existing jobs and create new ones.

These initiatives, coupled with actions taken in other countries, ended the worst of the Great Recession by mid-2009. But the recovery was uneven and incomplete.

In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, overhauling financial regulations. It was opposed by many Republicans and subsequently weakened by the Economic Growth, Regulatory Relief, and Consumer Protection Act in 2018. The Basel III capital and liquidity standards were adopted by countries around the world.

The crisis led to a loss of more than $2 trillion from the global economy—roughly equivalent to the GDP of France and Germany combined.

Aftermath

What happened in 2008 was not simply a financial event. It revealed how interconnected the world's economies had become—and how quickly a crisis in American mortgages could cascade into a global panic. The housing bubble that began with predatory lending practices targeting vulnerable communities ended up bringing down institutions worth hundreds of billions of dollars.

The lesson, perhaps, is that regulations exist for a reason: when they are weakened or removed, the consequences can echo across decades and across borders, touching everyone from homeowners to bank executives to the smallest economies on Earth.