Global financial crisis

Global financial crisis
David Shankbone · CC BY-SA 3.0 · source
Name	Global financial crisis
Period	2007–2009 (most acute), extended effects through 2010s
Location	Worldwide; notable centers: New York City, London, Tokyo, Frankfurt am Main, Beijing
Causes	Housing bubble, securitization, leverage, shadow banking, liquidity shock
Outcome	Bank failures, sovereign interventions, regulatory reform, prolonged recession

Global financial crisis

The crisis was a severe international banking and credit shock that precipitated a major downturn across United States, United Kingdom, Eurozone, Japan, China and other jurisdictions. It erupted as losses on complex financial instruments tied to United States housing bubble mortgages revealed vulnerabilities in institutions such as Lehman Brothers, AIG, Bear Stearns and prompted coordinated actions by central banks including the Federal Reserve, European Central Bank, Bank of England and Bank of Japan. The episode reshaped relationships among firms like Goldman Sachs, JPMorgan Chase, Citigroup, Deutsche Bank, HSBC Holdings and sovereign actors such as United States Treasury and International Monetary Fund.

Background and Causes

Preceding the crisis, decades of financial innovation and policy shifts influenced risk-taking: deregulation trends tied to laws like the repeal of parts of Glass–Steagall Act and policy decisions associated with administrations including Bill Clinton and George W. Bush intersected with global capital flows involving China and petrodollar recycling by Saudi Arabia. The expansion of mortgage credit—subprime mortgages originated by firms such as Countrywide Financial and funded by securitization through vehicles like collateralized debt obligations—expanded exposure for banks including Morgan Stanley and Barclays. Rating agencies such as Moody's Investors Service, Standard & Poor's, and Fitch Ratings assigned high ratings to structured products that later defaulted. The growth of the shadow banking system—money market funds including Reserve Primary Fund, mortgage originators, and securitizers—created interconnected counterparty risks exemplified by crises at Northern Rock and run dynamics similar to historical episodes like the Panic of 1907. Key triggers included rising delinquency rates in California, Florida, and Nevada housing markets and shocks to liquidity in interbank markets represented by rates such as LIBOR.

Timeline of the Crisis

Early signs appeared in 2007 when New Century Financial, a large subprime lender, filed for bankruptcy and markets tightened after BNP Paribas froze funds. In March 2008, Bear Stearns was acquired by JPMorgan Chase with support from the Federal Reserve. On September 15, 2008, Lehman Brothers filed for bankruptcy, while two days earlier American International Group received an emergency rescue backed by the United States Treasury. Governments in United Kingdom nationalized Northern Rock and later intervened in Royal Bank of Scotland and Lloyds Banking Group. The European sovereign debt crisis followed as fiscal strains emerged in Greece, Ireland, Portugal, Spain and Italy with programs coordinated by European Commission and European Financial Stability Facility. Central bank liquidity programs such as the Term Auction Facility and quantitative easing by the Federal Reserve and Bank of England expanded in 2008–2009. By 2009, indicators such as S&P 500 and FTSE 100 had dropped sharply before stabilizing amid stimulus measures by leaders including Barack Obama and Gordon Brown.

Major Affected Economies and Markets

The United States housing, credit, and equity markets bore immediate losses, with major firms like Washington Mutual collapsing and being acquired by JPMorgan Chase. The United Kingdom banking sector faced nationalizations and capital injections for Royal Bank of Scotland and HBOS. Continental Europe saw sovereign contagion in Greece leading to bailouts involving European Central Bank, International Monetary Fund and European Stability Mechanism later. Iceland experienced systemic failure and capital controls after the collapse of banks such as Glitnir and Landsbanki. Emerging markets including Russia, Brazil, India and South Africa experienced capital outflows and currency pressures, while China deployed a large fiscal stimulus to sustain growth. Global equity exchanges—New York Stock Exchange, London Stock Exchange, Tokyo Stock Exchange—registered precipitous declines alongside stresses in credit default swap and repo market instruments.

Policy Responses and Interventions

Public authorities pursued emergency measures: the United States Treasury implemented the Troubled Asset Relief Program (TARP) and capital injections into firms such as Citigroup. Central banks coordinated liquidity provision via swap lines among Federal Reserve, European Central Bank, Bank of England and Swiss National Bank. Fiscal stimulus packages were enacted, including the American Recovery and Reinvestment Act of 2009 and measures by Chinese government and German government. Regulatory backstops included temporary guarantees for bank liabilities administered by entities like Federal Deposit Insurance Corporation and nationalization or partial nationalization in jurisdictions such as Belgium and Netherlands for financial groups like Fortis. International institutions like the International Monetary Fund expanded lending facilities to countries including Hungary, Ukraine, and Iceland.

Economic and Social Impacts

The crisis produced a deep global recession with sharp rises in unemployment across United States Department of Labor measures, high joblessness in Spain and Greece, and significant contractions in United Kingdom GDP. Housing markets in United States and Ireland collapsed, foreclosures surged, and household wealth declined impacting consumer demand and firms such as Ford Motor Company and General Motors. Political repercussions included electoral shifts and movements like Occupy Wall Street and debates involving figures such as Bernanke and Geithner. Sovereign credit downgrades affected countries like Greece and Portugal, compelling austerity measures in several capitals including Athens and Lisbon.

Regulatory Reforms and Legacy

Post-crisis reforms included passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act in the United States, establishment of the Financial Stability Board, and strengthened capital and liquidity standards via Basel III negotiated by the Basel Committee on Banking Supervision. Authorities created resolution regimes for systemically important institutions labeled by Financial Stability Oversight Council and designated systemically important financial institutions subject to stress tests by Federal Reserve. Reforms targeted shadow banking activities, derivatives clearing through Central Counterparty Clearing House initiatives, and consumer protections under the Consumer Financial Protection Bureau. The crisis reshaped fiscal policy debates in capitals such as Washington, D.C., Berlin and Tokyo and influenced monetary frameworks at institutions including the Bank for International Settlements.

Category:Financial crises