Financial crisis of 2007–2008

Financial crisis of 2007–2008
David Shankbone · CC BY-SA 3.0 · source
Name	Financial crisis of 2007–2008
Caption	Collapse of Lehman Brothers headquarters in 2008
Date	2007–2008
Location	United States; global
Causes	Subprime mortgage lending, securitization, leveraged financial institution balance sheets
Result	Global recession, regulatory reforms

Financial crisis of 2007–2008 The financial crisis of 2007–2008 was a global systemic shock centered in the United States housing and credit markets that precipitated a severe worldwide downturn, the Great Recession, and major restructuring of financial regulation. It began with rising defaults in subprime mortgage portfolios and malfunctioning markets for mortgage-backed securities and collateralized debt obligations, and culminated in the failure of major institutions such as Lehman Brothers and interventions by the Federal Reserve, United States Treasury, and foreign central banks.

Background and causes

A confluence of factors preceded the crisis, including expanded mortgage origination by firms such as Countrywide Financial and New Century Financial, aggressive risk-taking at investment banks like Lehman Brothers and Bear Stearns, and extensive securitization practices at Goldman Sachs and Morgan Stanley. Growth in subprime mortgage issuance in the mid-2000s involved originators, Fannie Mae, Freddie Mac, and private-label issuers, while ratings by Moody's Investors Service, Standard & Poor's, and Fitch Ratings often assigned high grades to complex instruments such as collateralized debt obligations created by firms including Citigroup and Bank of America. The rise of the shadow banking system—money market funds managed by BlackRock, Vanguard, and asset managers—interacted with wholesale funding markets like the repo market used by hedge funds, AIG Financial Products, and structured investment vehicles sponsored by UBS and Deutsche Bank. Innovations such as adjustable-rate mortgages, interest-only loans, and payoff-dependent underwriting combined with leverage strategies pursued by Bear Stearns hedge funds and proprietary desks at Merrill Lynch to amplify exposures as housing prices in California, Florida, and Arizona reversed.

Timeline of events

Early signs appeared in 2006–2007 as delinquencies rose among borrowers served by Countrywide Financial and Washington Mutual, prompting losses at conduits and collateral pools held by Bear Stearns hedge funds and precipitating the March 2008 rescue of a Bear Stearns affiliate by JPMorgan Chase with assistance from the Federal Reserve Bank of New York. In July 2007, the collapse of two credit default swap markets and runs on structured investment vehicles affected BNP Paribas and HSBC, while the Northern Rock run in the United Kingdom signaled contagion. The bankruptcy of Lehman Brothers in September 2008 followed AIG's near-failure and a bailout by the United States Treasury using the Troubled Asset Relief Program enacted under Secretary Henry Paulson. Global stock indices, including the Dow Jones Industrial Average and FTSE 100, plunged, money markets seized, and central banks coordinated interventions through swaps among the Federal Reserve, European Central Bank, Bank of England, and Bank of Japan.

Key institutions and instruments

Central actors included investment banks (Goldman Sachs, Morgan Stanley, Lehman Brothers, Bear Stearns), money center banks (Citigroup, Bank of America, Wells Fargo), government-sponsored enterprises (Fannie Mae, Freddie Mac), insurers (AIG), and rating agencies (Moody's Investors Service, Standard & Poor's, Fitch Ratings). Important instruments were mortgage-backed securitys, collateralized debt obligations, credit default swaps provided by entities such as AIG Financial Products and traded by Barclays and Deutsche Bank, repurchase agreements used in funding by Lehman Brothers and Goldman Sachs, and asset-backed commercial paper programs linked to Citigroup and Merrill Lynch. Market plumbing failures occurred in the repo market, commercial paper markets, and interbank lending platforms involving European Central Bank counterparties.

Government and central bank responses

Authorities implemented emergency measures: the Federal Reserve deployed discount window lending, term auction facility, and quantitative easing programs, while the United States Treasury executed capital injections and the Troubled Asset Relief Program under Secretary Henry Paulson and implemented guarantees for money market funds through the Federal Deposit Insurance Corporation. In Europe, the Bank of England provided liquidity to Northern Rock and coordinated with the European Central Bank to supply dollar swaps, while governments in United Kingdom, Germany, and France enacted bank recapitalizations and guarantees for interbank funding involving institutions like Royal Bank of Scotland and Deutsche Bank. Courts and regulators, including the Securities and Exchange Commission and Office of the Comptroller of the Currency, adjusted rules on capital, disclosure, and emergency powers.

Economic and social impacts

The shock triggered the Great Recession, with output contractions across United States, Eurozone, and United Kingdom, sharp unemployment rises affecting workers represented by United Auto Workers and sectors in Michigan and Ohio, and housing market collapses in California and Arizona. Wealth losses affected pension funds and household balance sheets exposed via 401(k) plans administered by Fidelity Investments and Vanguard, while foreclosures surged among borrowers serviced by Wells Fargo and Countrywide Financial. Social impacts included increased poverty rates tracked by agencies such as the U.S. Census Bureau and political consequences reflected in elections involving figures like Barack Obama and legislative debates in the United States Congress.

Legal, regulatory, and policy reforms

Reforms followed investigations by bodies such as the Financial Crisis Inquiry Commission and legislative actions culminating in the Dodd–Frank Wall Street Reform and Consumer Protection Act, which created the Consumer Financial Protection Bureau and the Financial Stability Oversight Council. Regulatory agencies including the Federal Reserve, Securities and Exchange Commission, and Office of the Comptroller of the Currency implemented enhanced capital and liquidity rules influenced by Basel Committee on Banking Supervision standards and international coordination through the Financial Stability Board. Legal actions targeted firms like Bank of America and Goldman Sachs over disclosure and sales practices, while settlements involved Moody's Investors Service and Standard & Poor's regarding ratings procedures.

Global transmission and international effects

Contagion spread through cross-border exposures involving European Central Bank counterparties, large banks such as UBS, Banco Santander, and HSBC, and sovereign balance sheets in Iceland and Ireland, leading to banking crises and rescues such as the Irish bank guarantee and interventions by the International Monetary Fund in countries like Greece and Iceland. Global trade contraction affected export-oriented economies including China and Germany, prompting coordinated stimulus responses by entities like the G20 and central bank policy actions by the Bank of Japan and People's Bank of China. The crisis reshaped international regulatory cooperation through the Financial Stability Board and influenced debates at International Monetary Fund meetings and G20 summits.

Category:2008 financial crisis