Global Financial Crisis of 2007–2008

Global Financial Crisis of 2007–2008
Name	Global Financial Crisis of 2007–2008
Caption	Banking turmoil in 2008
Date	2007–2008
Location	United States, United Kingdom, European Union, Iceland, Ireland, Spain
Causes	Subprime mortgage collapse; securitization; leverage; regulatory failures
Outcome	Bank failures; policy reforms; recession

Global Financial Crisis of 2007–2008 The crisis began with a collapse in United States subprime mortgage markets and propagated through global financial markets to trigger a severe downturn, affecting United Kingdom, European Union, Japan, China, Russia, Canada, Australia, Brazil, Mexico, South Africa and other jurisdictions. Major institutions including Lehman Brothers, Bear Stearns, AIG (American International Group), Citigroup, Royal Bank of Scotland, Merrill Lynch, Goldman Sachs, Morgan Stanley, and HSBC were central to contagion, while policymakers at Federal Reserve System, European Central Bank, Bank of England, International Monetary Fund, United States Department of the Treasury, and central banks in Sweden, Norway, Switzerland, Denmark, Icelandic Financial Supervisory Authority coordinated responses. The episode prompted reforms such as Dodd–Frank Wall Street Reform and Consumer Protection Act, Basel III, and changes at Financial Stability Board and Bank for International Settlements.

Background and Causes

The crisis had roots in policies and practices across United States housing finance, shadow banking, and international capital flows, involving actors such as Fannie Mae, Freddie Mac, Countrywide Financial, Washington Mutual, Capital One Financial Corporation, IndyMac Bank, New Century Financial Corporation, and Lehman Brothers. Financial innovation by Goldman Sachs, JP Morgan Chase, Merrill Lynch, Bear Stearns, and Deutsche Bank produced structured products including collateralized debt obligations and mortgage-backed securitys that relied on ratings from Moody's Investors Service, Standard & Poor's, and Fitch Ratings. Regulatory gaps at agencies like Securities and Exchange Commission, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation, UK Financial Services Authority, and the fragmented frameworks of European Central Bank and national supervisors allowed leverage and maturity transformation in entities such as Lehman Brothers and AIG (American International Group). Global imbalances between surplus countries like China, Germany, Japan, Singapore, Taiwan and deficit countries like United States, United Kingdom, Spain fueled demand for high-yielding instruments, while monetary policy decisions by Alan Greenspan at the Federal Reserve System and later by Ben Bernanke influenced credit conditions. Housing bubbles in regions including Florida, California, Arizona, Nevada, Ireland, Spain, United Kingdom, and Iceland were exacerbated by subprime originators, adjustable-rate mortgages, and securitization chains involving Wall Street investment banks.

Timeline and Key Events

Early signs appeared with the 2007 collapse of liquidity in credit default swap markets and the 2007 rescue of Bear Stearns by JP Morgan Chase arranged with support from the Federal Reserve System. In 2008, critical episodes included the nationalization of Northern Rock in the United Kingdom, the seizure of Fannie Mae and Freddie Mac by the United States Department of the Treasury, the bankruptcy of Lehman Brothers, the sale of Merrill Lynch to Bank of America, the AIG (American International Group) bailout, and the emergency measures for Royal Bank of Scotland and Lloyds Banking Group. Sovereign stress surfaced with interventions in Iceland and Ireland and contagion to Portugal, Greece, Spain, and Italy. International coordination involved meetings of Group of Seven finance ministers, Group of Twenty finance ministers and central bank governors, and emergency sessions at International Monetary Fund headquarters, while markets reacted with declines in the Dow Jones Industrial Average, NASDAQ Composite, FTSE 100, DAX (index), Nikkei 225, and volatility spikes in the VIX. Legal and political events included testimony before committees such as the United States Congress Joint Economic Committee and inquiries by the Financial Crisis Inquiry Commission.

Financial Instruments and Mechanisms

Key instruments included mortgage-backed securitys, collateralized debt obligations, credit default swaps, asset-backed commercial paper, repurchase agreements used in shadow banking, and structured investment vehicles created by Lehman Brothers, Citigroup, Royal Bank of Scotland, Barclays, and UBS (Union Bank of Switzerland). Counterparty risk and opacity of exposures in trades cleared through entities like The Clearing House and bilateral contracts with dealers such as Goldman Sachs and Morgan Stanley amplified systemic risk. Rating methodologies at Moody's Investors Service, Standard & Poor's, and Fitch Ratings mispriced tranches, while valuation practices tied to mark-to-market accounting rules under bodies like Financial Accounting Standards Board affected balance sheets of AIG (American International Group) and others. Leverage strategies employed by hedge funds, prime brokers at Credit Suisse, and securitization participants used repo financing from institutions including Bear Stearns and Lehman Brothers.

Government and Central Bank Responses

Policymakers enacted extraordinary measures: the Federal Reserve System provided lender-of-last-resort facilities, the United States Department of the Treasury implemented the Troubled Asset Relief Program, the Bank of England used liquidity injections and special schemes for Northern Rock and other banks, while the European Central Bank extended long-term refinancing operations to euro-area banks. Coordinated interventions by International Monetary Fund, European Commission, European Stability Mechanism, Bank for International Settlements, and national treasuries supported systemic institutions and sovereigns. Fiscal responses included stimulus packages advocated by leaders such as George W. Bush, Barack Obama, Gordon Brown, Angela Merkel, Nicolas Sarkozy, and Junichiro Koizumi-era policymakers, while central bankers like Ben Bernanke, Mervyn King, Jean-Claude Trichet, Mario Draghi, Haruhiko Kuroda, and Stanley Fischer adjusted policy rates and unconventional policies.

Economic and Social Impact

The downturn produced a global recession that reduced output, employment, and trade across United States, European Union, Japan, China, India, Brazil, Mexico, South Korea, Australia, Canada, and Russia. Unemployment spikes affected regions such as Detroit, Glasgow, Athens, Madrid, and Dublin, while household wealth losses hit homeowners in Florida, California, Ireland, and Spain. Sovereign debt tensions led to austerity debates in parliaments including Hellenic Parliament and policy shifts in cabinets led by George Papandreou, Jose Luis Rodriguez Zapatero, Gordon Brown, David Cameron, Angela Merkel, and Nicolas Sarkozy. Financial exclusion and foreclosures burdened families and communities, prompting nongovernmental responses from entities like Red Cross, Oxfam International, and World Bank programs supporting vulnerable populations.

Legal, Regulatory, and Political Aftermath

Regulatory reforms included passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act in the United States, revisions to Basel Committee on Banking Supervision standards culminating in Basel III, enhanced oversight through Financial Stability Board, and restructuring of supervisory roles in United Kingdom with successors to the Financial Services Authority. Litigation ensued involving Bank of America, Goldman Sachs, Citigroup, Wells Fargo, Deutsche Bank, UBS (Union Bank of Switzerland), and mortgage servicers, while inquiries by Financial Crisis Inquiry Commission and parliamentary committees in United Kingdom and Ireland produced reports influencing reforms. Political consequences included electoral effects for parties such as the Labour Party, Conservative Party, Democratic Party, and Republican Party, shifts toward regulatory frameworks in the European Union, and long-term debates about financial globalization led by scholars at Harvard University, London School of Economics, University of Chicago, Princeton University, Yale University, and policy institutes such as Brookings Institution, American Enterprise Institute, Peterson Institute for International Economics, and International Monetary Fund.

Category:Financial crises