2008-2009 Global Financial Crisis
The Great Recession, often called the 2008–2009 Financial Crisis, was a significant global economic downturn
What is the 2008-2009 Global Financial Crisis?
The 2008–2009 Global Financial Crisis profoundly affected the world economy and marked one of the most significant financial downturns since the Great Depression.
It brought about a collapse in economic activities, leading to financial institution failures, massive layoffs, and a steep decline in various sectors. Housing prices fell, stock markets tanked, and companies experienced a significant drop in demand.
The worldwide recession was brought on by the crisis, which started in the United States but swiftly extended to other nations. Due to excessive lending, subprime mortgages, and a lack of adequate regulation, the American housing bubble falls were at the center of the crisis.
Numerous borrowers defaulted when the housing market tanked, causing enormous losses for banking institutions that owned mortgage-backed securities.
The Bankruptcy of Lehman Brothers worsened the crisis in September 2008. This event eroded faith in the financial system, resulting in frozen credit markets and broken relationships between financial institutions.
The objectives during the crisis were to stop more bank collapses, regain consumer trust, and promote economic expansion.
Rising unemployment rates accompanied rising debt levels and restricted credit access for individuals and enterprises. The weaknesses in the system of financial regulation prompted the financial crisis and increased the need for more regulation and reform.
Governments and international organizations responded by implementing changes in the regulatory landscape to enhance the financial system's resilience and prevent future crises of this magnitude.
The Global Financial Crisis's repercussions persisted for years after the world economy recovered. The crisis had a long-lasting effect on the financial sector, changing the regulatory environment and how institutions operate risk and lending practices.
The Global Financial Crisis of 2008–2009 modified the global economic landscape. It revealed the interconnections and weaknesses of the financial system. Debates and policy choices to lessen the danger of future financial crises continue to be informed by its teachings.
Key Takeaways
- The Great Recession, often called the 2008–2009 Financial Crisis, was a significant global economic downturn.
- Lehman Brothers' bankruptcy in September 2008 exacerbated the crisis by causing a loss of trust and freezing the credit markets.
- Governments and central banks conducted massive bailouts and stimulus programs, and Global economic production decreased due to the crisis, leading to widespread job losses.
- The financial crisis exposed flaws in regulatory systems, leading to subsequent changes in risk management and financial regulation practices.
- After the financial crisis, the American Recovery and Reinvestment Act was introduced in 2009, aiming to boost the US economy.
Causes of 2008-2009 Global Financial Crisis
The economic crisis was caused by the housing market's collapse, driven by low interest rates, poor regulation, cheap lending, and hazardous subprime mortgages. An aggressive Fed and stricter banking rules are two effects of the Great Recession.
There are several causes of the Great Recession. They are,
1. Immoderate investments and deregulation
Before the Great Recession, there were two decades (from the middle of the 1980s until 2007) of successful economic growth, low inflation, and just two minor recessions, often referred to as The Great Moderation.
The term alludes to the current conviction that the classic boom-and-bust business cycle has been defeated in favor of moderate but steady economic development.
However, unrestrained optimism, particularly among investors who enjoy taking risks, resulted in excessive expenditure. Everyone, even bankers and homeowners, thought the economy would continue to expand.
Note
Taking dangerous actions like leveraged methods, aggressive investing, and excessive debt-taking appeared safe before the Great Recession.
2. The Glass-Steagall Act Amendments
The repeal of certain provisions of the Glass-Steagall Act allowed for national corporate expansion and the creation of "too big to fail" institutions, which exacerbated the impact of the financial crisis.
3. The housing market's lax lending criteria
The residential housing industry experienced a boom in real estate values before 2007, driven by increased investment and home purchases.
Subprime mortgages contributed to the housing crisis by increasing demand and costs. Their adjustable rates made it hard for borrowers to keep up, leading to a downturn in the market.
This led to borrowers with precarious financial situations struggling to make payments as interest rates soared.
Note
Many homebuyers took out loans without understanding the risks associated with the haste to profit from a booming market and low interest rates.
4. Faulty Watchdogs
Credit rating agencies were responsible for rating Mortgage-Backed Securities (MBS) and Collateralized Debt Obligations (CDOs).
The "Big Three" credit rating companies are Moody's, S&P, and Fitch Group. Even though they included a sizable proportion of subprime mortgages, these agencies awarded numerous securities the AAA ratings typically reserved for the safest assets.
Note
Financial instruments such as CDOs, CDSs, and MBS caused the housing sector to collapse with a domino-like effect, significantly worsening the financial crisis.
Remember that credit-rating organizations are supposed to remain unbiased. Likewise, there was an inherent conflict of interest, given that the banks issuing the securities were paying the rating agencies to assess them.
5. The issue with subprime lending
Interest rates started to climb in 2004 due to an overheated economy and concerns about inflation after being low during the early 2000s.
In the middle of 2004, the Federal funds rate was 1.25%. In the middle of 2006, 5.25% was the interest rate. The timing for the increase in rates was unfortunate.
Midway through 2006, the market had slowed, and property values had reached their high. Home prices skyrocketed when supply began to outstrip demand.
Note
It took a lot of work for buyers to pay for their houses due to the combination of high interest rates and declining property values.
6. Dangerous Wall Street practices
Lenders discovered a way to profit from the real estate market by packaging subprime mortgage loans and reselling them through securitization. This involved combining subprime loans into securities and selling them as MBS to global investors.
Investment banks began offering collateralized debt obligations (CDOs) instead of mortgage-backed securities, bundled into segments or tranches with different risk profiles.
Note
Wall Street mathematical models supported this hypothesis, but many tranches had subpar mortgages, reducing overall portfolio returns.
Investment banks and institutional investors borrowed large sums at favorable short-term rates to purchase CDOs, and credit default swaps (CDS) were employed to guarantee against CDO defaults.
This further complicated the situation, as banks and hedge funds began purchasing and selling swaps on CDOs without evaluating the risks.
7. The Stock Exchange Crash of 2008
The CDO fiasco led to a full-fledged financial crisis by the spring of 2008, with complexities arising from the packaging and repackaging of hazardous securities, making it challenging to identify their location on balance sheets.
Consequently, banks started charging exorbitant interest rates to lend to other banks and organizations, reflecting the uncertainty and heightened risk in the financial markets.
Note
Lehman Brothers, an investment bank, suffered greatly. CDS was expected to cover $400 billion of the company's $600 billion debt. Unfortunately, the loan was essentially worthless at that point.
Lehman filed for bankruptcy on September 15, and due to the scared banks' full cessation of lending, the global financial system ran out of money. The stock market had a strong reaction. The Dow Jones Industrial Index plunged 3,600 points between September 19 and October 10, 2008.
The Housing Market Bubble
The housing market bubble that emerged in 2007 was the cornerstone of the global financial catastrophe. Banks and lending organizations pushed many homeowners to take out loans they couldn't afford by offering cheap mortgage interest rates.
A housing bubble happens with a temporary housing shortage and high demand, causing inflated prices. Numerous variables, such as increased economic prosperity, low interest rates, a broader selection of mortgage products, and simple credit access, contribute to these bubbles.
Note
A housing bubble can burst when housing demand decreases due to economic downturns or increasing interest rates.
Mortgage-backed securities (MBS) were new financial products packaged from mortgages and sold as securities with little risk burden since they were backed by credit default swaps (CDS). Lenders could transfer the mortgages and all the risk easily.
Unfortunately, due to shoddy underwriting practices resulting from outdated rules that were not strictly followed, it became challenging to determine the true worth of these mortgage-backed securities.
This lack of transparency contributed to the overall uncertainty in the financial markets and added to the severity of the crisis.
The Bubble Bursts
Banks started making rash loans to people and families that lacked the resources to repay the loans they had been given. Then, it was inevitable that these high-risk (subprime) loans would be packaged and transferred through the chain.
Lending institutions started having financial issues as subprime mortgage packages increased to an unmanageable level, and many defaulted. This escalation of subprime mortgage defaults significantly contributed to the global financial crisis from 2008 to 2009.
The subprime mortgage market played an important function in 2008-2009. Currently, it still impacts the economy. There is an increase in subprime borrowers experiencing challenges in repaying their loans, leading to possible negative impacts.
Before the financial crisis, banks and lending institutions provided investors with mortgage-backed securities, essentially subprime loans integrated.
However, when the housing market collapsed and subprime borrowers defaulted, the value of these mortgage-backed securities plummeted, resulting in significant losses for the financial institutions and investors that held them.
The financial crisis was exacerbated by a lack of market confidence and liquidity due to the interconnectedness among financial institutions.
As institutions faced losses and uncertainty, they became hesitant to lend to one another, leading to a freeze in the credit markets and a breakdown in the normal functioning of the financial system.
The Aftermath Of The Global Financial Crisis Of 2008-2009
The aftermath of the 2008-2009 Global Financial Crisis was considered by significant economic and social consequences reverberating worldwide.
1. Impact on financial institutions
Financial institutions require capital reserves to withstand future economic crises. They became more cautious about lending to riskier borrowers and demanded more collateral.
Note
Large banks like Lehman Brothers, American International Banks, and Bear Stearns were impacted by this crisis.
Those banks faced a Loss of assets in the financial crisis, leading to a loss of trillions of dollars on assets like mortgage investments, securities, and other financial products.
2. Foreclosures in the housing market
The crisis impacted the real estate markets differently - California suffered, but Texas recovered quickly. The crisis complexly impacted housing, causing property prices to drop and foreclosures to increase.
Foreclosure of homes has led to increased available homes in the market. This leads to decreased home prices. To attract buyers, sellers wish to sell homes at lower prices.
3. Global Unemployment and Trade Slowdown
The crisis had lasting effects on global unemployment and trade. Some countries have high unemployment, and trade recovery still needs to be completed. The economy is recovering, but slowly.
Note
The crisis has disproportionately affected unemployment and trade worldwide, with some countries being hit more severely.
Comparatively, China quickly recovered, but the United States was hit hard. Global unemployment and trade were affected. Several factors are leading to rising unemployment and declining trade.
4. Government Efforts and Reconstruction Efforts
Following the financial crisis, the government provided funding for unstable institutions and the government implemented fiscal stimulus and quantitative relaxation measures.
Note
Tighter capital requirements and increased market surveillance have been introduced. The government's recovery efforts are wide-ranging. Slowing economic growth and high unemployment hampered the upturn. The government's reconstruction efforts have been uneven.
5. Austerity measures and economic effects
Austerity measures are those policies governments take to regulate the public mainly to reduce budget deficits that have caused negative effects like job losses, reduced social benefits, and harm to public welfare.
There can be a decrease in economic growth, an increase in poverty, and an increase in inequality due to new policies implemented by the government.
Reducing government spending on social safety net programs, which can leave people without access to essential services, disproportionately affects people experiencing poverty and the vulnerable.
2008-2009 Global Financial Crisis FAQs
Banks and lending institutions provided to people with bad credit after the US subprime mortgage market collapsed. Financial institutions suffered significant financial losses when borrowers fell behind on mortgage payments due to mortgage-backed securities.
According to many projections, the crisis began in 2007 and continued through 2009. A severe economic collapse and financial turmoil characterized the time.
The crisis had widespread impacts on the global economy. The aftermath resulted in a significant recession, elevated rates of unemployment, and a decline in economic growth across several nations.
Financial institutions faced significant losses; some even went bankrupt, and governments had to intervene with bailouts and stimulus measures. The crisis also exposed weaknesses in the financial system and led to regulatory reforms.
The crisis began in the housing market, and it had a catastrophic impact on the housing industry. Home prices declined significantly, increasing the need to be completed and decreasing housing construction and sales.
Many homeowners found themselves underwater, owing more on their mortgages than their homes were worth.
The major consequences of the crisis were far-reaching. They included the collapse or near-collapse of major financial institutions, loss of employment opportunities, a global recession, government debt increases, and a decline in consumer and investor confidence.
It also prompted regulatory reforms to address the weaknesses and prevent future crises.
In response to the crisis, various regulatory reforms were enacted. The United States implemented the Consumer Protection Act and Dodd-Frank Wall Street Reform Act to enhance or make better supervision of the financial sector and safeguard the interests of consumers.
Internationally, efforts were made to improve banks' capital requirements and risk management practices.
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