Financial crisis of 2007–2008

Financial Crisis of 2007–2008

The financial crisis of 2007–2008, also known as the Global Financial Crisis (GFC), was a severe worldwide economic crisis considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s. It 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.

Background

The financial crisis was triggered by a complex interplay of valuation and liquidity problems in the United States banking system in 2007. The crisis was rooted in the collapse of the housing bubble, which peaked in 2006. The bursting of the housing bubble led to a high default rate on "subprime" and adjustable-rate mortgages (ARM), causing a decline in the value of mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which were key instruments in the financial markets.

Causes

Several factors contributed to the financial crisis:

Housing Bubble

The housing bubble was fueled by low interest rates and lax lending standards, which led to a rapid increase in housing prices. Many borrowers took on mortgages they could not afford, often with little or no documentation of income or assets.

Financial Innovation

Financial institutions created complex financial products such as MBS and CDOs, which were sold to investors worldwide. These products were poorly understood and often misrated by credit rating agencies.

Regulatory Failures

Regulatory agencies failed to adequately oversee financial institutions and enforce existing regulations. The Gramm-Leach-Bliley Act of 1999, which repealed parts of the Glass-Steagall Act, allowed commercial banks, investment banks, and insurance companies to consolidate, increasing systemic risk.

Global Imbalances

Large global imbalances, such as the U.S. current account deficit and the corresponding surpluses in countries like China, contributed to the crisis by creating a glut of savings that fueled the housing bubble.

Key Events

Collapse of Lehman Brothers

The bankruptcy of Lehman Brothers in September 2008 was a pivotal event in the crisis. It led to a severe loss of confidence in the financial system and a freeze in credit markets.

Government Interventions

Governments around the world took unprecedented steps to stabilize the financial system. In the United States, the Troubled Asset Relief Program (TARP) was established to purchase distressed assets from banks. Central banks, including the Federal Reserve, cut interest rates and provided liquidity to financial institutions.

Impact

The financial crisis had a profound impact on the global economy. It led to a severe recession, with millions of people losing their jobs and homes. The crisis also resulted in significant changes to financial regulation, including the Dodd-Frank Wall Street Reform and Consumer Protection Act in the United States.

Aftermath

In the years following the crisis, there was a significant focus on reforming the financial system to prevent a similar crisis in the future. This included increased capital requirements for banks, enhanced oversight of financial institutions, and efforts to improve transparency in financial markets.

See Also

• Subprime mortgage crisis
• Great Recession
• Too big to fail

References

• Reinhart, Carmen M., and Kenneth S. Rogoff. This Time is Different: Eight Centuries of Financial Folly. Princeton University Press, 2009.
• "The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States." January 2011.