Financial crisis of 2008
Overview
The Financial Crisis of 2008 was a severe worldwide economic crisis that occurred in the late 2000s. It is considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s. The crisis began in 2007 with a crisis in the subprime mortgage market in the United States and developed into a full-blown international banking crisis with the collapse of the investment bank Lehman Brothers on September 15, 2008. Excessive risk-taking by banks such as Lehman Brothers helped to magnify the financial impact globally. Massive bailouts of financial institutions and other palliative monetary and fiscal policies were employed to prevent a collapse of the global financial system. Despite these efforts, the crisis was followed by a global economic downturn, the Great Recession.
Causes
The financial crisis was the result of a combination of complex factors, including the proliferation of financial products like mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), the housing bubble, and the failure of financial institutions to adequately manage risk.
Housing Bubble
The housing bubble in the United States was a major precursor to the financial crisis. From the late 1990s to 2006, housing prices rose rapidly, driven by low interest rates, relaxed lending standards, and speculative investment. The Federal Reserve's monetary policy, which kept interest rates low, encouraged borrowing and contributed to the housing boom.
Subprime Mortgage Crisis
The subprime mortgage crisis was a key trigger of the financial crisis. Subprime mortgages were loans made to borrowers with poor credit histories, and they carried higher interest rates to compensate for the increased risk. Financial institutions bundled these mortgages into MBS and sold them to investors, spreading the risk throughout the financial system. When housing prices began to fall in 2006, many subprime borrowers defaulted on their loans, leading to significant losses for financial institutions holding MBS.
Financial Innovation and Risk Management
Financial innovation, particularly the development of complex financial products such as CDOs, played a significant role in the crisis. These products were designed to spread risk, but they also obscured it, making it difficult for investors and regulators to assess the true level of risk in the financial system. Many financial institutions failed to adequately manage the risks associated with these products, leading to significant losses when the housing market collapsed.
Impact
The financial crisis had a profound impact on the global economy, leading to a severe recession and significant job losses. The crisis also had a lasting impact on the financial sector, leading to increased regulation and oversight.
Global Recession
The financial crisis led to a global recession, with many countries experiencing significant declines in economic output. The International Monetary Fund (IMF) estimated that global GDP fell by 0.1% in 2009, the first decline since World War II. The recession led to significant job losses, with the International Labour Organization estimating that global unemployment increased by more than 30 million people between 2007 and 2009.
Banking Sector
The financial crisis led to significant losses for many financial institutions, with several major banks requiring government bailouts to avoid collapse. The crisis also led to increased regulation of the financial sector, with the Dodd-Frank Wall Street Reform and Consumer Protection Act in the United States and the Basel III international regulatory framework being introduced to increase oversight and reduce risk.
Sovereign Debt Crisis
The financial crisis also contributed to a sovereign debt crisis in several European countries, including Greece, Ireland, and Portugal. These countries faced significant fiscal challenges as a result of the crisis, leading to the need for international financial assistance and austerity measures.
Responses
Governments and central banks around the world took unprecedented steps to address the financial crisis and stabilize the global economy.
Monetary Policy
Central banks, including the Federal Reserve, the European Central Bank, and the Bank of England, implemented a range of monetary policy measures to support the financial system. These measures included cutting interest rates to historic lows, providing emergency liquidity to financial institutions, and implementing quantitative easing programs to support economic growth.
Fiscal Policy
Governments around the world implemented fiscal stimulus measures to support economic growth and mitigate the impact of the recession. In the United States, the American Recovery and Reinvestment Act of 2009 provided $787 billion in tax cuts and spending increases to support the economy. Similar measures were implemented in other countries, including the United Kingdom, Germany, and China.
Financial Sector Reforms
In response to the financial crisis, governments implemented a range of financial sector reforms to increase oversight and reduce risk. In the United States, the Dodd-Frank Act introduced a range of measures to increase transparency and accountability in the financial sector, including the creation of the Consumer Financial Protection Bureau. Internationally, the Basel III framework introduced new capital and liquidity requirements for banks to reduce risk and increase stability.
Long-term Effects
The financial crisis of 2008 had lasting effects on the global economy and financial system.
Economic Inequality
The financial crisis contributed to increased economic inequality in many countries, as the recession disproportionately affected lower-income individuals and families. In the United States, for example, the Gini coefficient, a measure of income inequality, increased significantly in the years following the crisis.
Changes in Banking Practices
The financial crisis led to significant changes in banking practices, with many banks adopting more conservative lending practices and increasing their focus on risk management. The crisis also led to increased consolidation in the banking sector, with several major banks merging or being acquired to increase stability.
Regulatory Changes
The financial crisis led to significant changes in financial regulation, with increased oversight and stricter requirements for financial institutions. These changes have had a lasting impact on the financial sector, with many banks and other financial institutions adopting more conservative practices and increasing their focus on risk management.