2008 financial crisis

• 1. Introduction

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  The 2008 financial crisis struck the United States and quickly spread across the entire world, becoming one of the five worst financial crises in recorded history. On the morning of the 18th of September 2008, Treasury Secretary Henry Paulson and Federal Reserve Chair Ben Bernanke sat down with congressional leaders and delivered a warning so stark it bordered on apocalyptic. Bernanke told them that if Congress did not authorize a $700 billion fund to buy up toxic mortgages, there might not be an economy left by Monday. That single sentence captured what had been building for years inside the American housing market and financial system. How did the world arrive at that moment? What chain of decisions, deregulations, and miscalculations allowed a collapse in U.S. home prices to threaten the entire global financial order? And who paid the price when it all fell apart?

• 2. The Bubble and Its Roots

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  Between 1998 and 2006, the price of a typical American home rose by 124 percent. That figure alone does not capture the scale of the distortion. During the 1980s and 1990s, the national median home price had stayed between 2.9 and 3.1 times the median household income. By 2006, that ratio had climbed to 4.6. The Federal Reserve bears part of the explanation. From 2000 to 2003, the Fed cut the federal funds rate from 6.5 percent down to 1 percent, partly to cushion the dot-com collapse and the September 11 attacks. Cheap credit flooded into housing rather than business investment, and some economists at the time openly argued that the Fed needed to manufacture a housing bubble to replace the deflating Nasdaq bubble.

  Abroad, a separate current was flowing. After financial crises in Asia and Russia in the late 1990s, a vast pool of savings accumulated in emerging economies and oil-exporting nations. Federal Reserve Chair Ben Bernanke later described this as a "saving glut." Between 1996 and 2004, the U.S. current account deficit grew by $650 billion, from 1.5 to 5.8 percent of GDP, as the country borrowed enormous sums to finance consumption. Foreign capital rushed into American financial assets, pushing down interest rates further and feeding demand for anything that promised a higher return.

  Wall Street provided the answer. Investment banks developed mortgage-backed securities and collateralized debt obligations that bundled home loans into packages, received high ratings from credit agencies, and were sold to institutional investors worldwide. An NPR program that later won a Peabody Award described a pool of roughly $70 trillion in worldwide fixed-income investments searching for yields that U.S. Treasury bonds could no longer provide. That pool had roughly doubled between 2000 and 2007. Wall Street connected it to the American mortgage market, generating enormous fees at every link in the supply chain.

• 3. Lax Standards and Predatory Lending

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  In 1999, parts of the 1933 Banking Act, known as the Glass-Steagall Act, were repealed. The Gramm-Leach-Bliley Act that replaced it effectively removed the separation between commercial banks and investment banks, increasing speculative activity by institutions that also held ordinary deposits. Regulatory loosening did not stop there. In 2004, the federal government overrode state anti-predatory lending laws, allowing lenders in the private sector to pursue increasingly risky borrowers with minimal oversight.

  As the Federal Reserve kept rates low through the early 2000s, lenders increasingly targeted low-income borrowers, largely from racial minority communities, with high-risk loans. By 2006, one-third of all mortgages were either subprime or carried no documentation at all, and that category represented 17 percent of all home purchases that year. The riskiest loans of the entire cycle were originated between 2004 and 2007, the years of fiercest competition among securitizers trying to generate enough raw material to package and sell.

  The securitization process itself made predatory lending easier to sustain. Because mortgage originators could sell the loans onward almost immediately, passing the default risk to someone else, they had little financial incentive to screen borrowers carefully. Credit default swaps were sold as insurance against those bundled securities failing, but the true scope of the risk was never priced accurately. The Financial Crisis Inquiry Commission later concluded that the crisis resulted from "widespread failures in financial regulation," "dramatic failures of corporate governance," and a "systemic breakdown in accountability and ethics" at every level. Michael Burry, a fund manager, recognized the underlying fragility as early as May 2005 when he opened a $60 million credit default swap against subprime mortgage bonds, projecting the loans would sour within two years of their low teaser rates expiring.

• 4. The Unraveling

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  Housing prices peaked in 2006 and mortgage delinquencies began to rise. On the 2nd of April 2007, New Century Financial, a major subprime lender, filed for Chapter 11 bankruptcy protection. By July of that year, the Dow Jones Industrial Average closed above 14,000 for the first time, reaching 14,000.41, even as early tremors were spreading through structured credit markets.

  The warning signs accelerated in August 2007. BNP Paribas blocked withdrawals from three hedge funds holding $2.2 billion in assets, citing what it called "a complete evaporation of liquidity," making valuation of the funds impossible. That phrase described something alarming: banks had stopped doing business with each other. Central banks began injecting liquidity, but the underlying machinery of the mortgage market had already seized.

  By March 2008, Bear Stearns, the fifth-largest U.S. investment bank, faced collapse. It held $46 billion of mortgage assets that had not been written down and $10 trillion in total assets. The Fed arranged an emergency sale to JPMorgan Chase in what was called a fire sale. Bear Stearns stock had traded at $178 a share a year earlier; the buyout was first struck at $2 per share, later raised to $10. That transaction marked the Fed's first emergency meeting in 30 years. Officials believed the intervention would contain the crisis. It did not.

  Fannie Mae and Freddie Mac, the two government-sponsored entities that together owned or guaranteed half the entire U.S. housing market, were seized by the federal government on the 7th of September 2008, under authority granted by the Housing and Economic Recovery Act passed in July. A week later, on September 15, Lehman Brothers, the fourth-largest U.S. investment bank, filed for the largest bankruptcy in American history after the Federal Reserve declined to guarantee its loans. The Dow fell 504.48 points, or 4.42 percent, that same day. The next day, the Fed took over American International Group with $85 billion in debt and equity funding. AIG was the country's largest insurer.

• 5. The Worst Ten Days

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  the 17th of September 2008 produced a crisis within the crisis. Investors withdrew $144 billion from U.S. money market funds in a single day, compared with $7.1 billion the week before. Money market funds routinely invest in commercial paper that corporations use to fund daily operations and payrolls. When those funds froze, the short-term lending market locked up almost immediately. The Reserve Primary Fund "broke the buck," meaning its value fell below one dollar per share, after it was exposed to Lehman Brothers securities. The government stepped in with a temporary guarantee analogous to bank deposit insurance.

  On September 26, Washington Mutual collapsed after panicked depositors withdrew $16.7 billion in ten days. The FDIC seized it in the largest bank failure in U.S. history. Three days later, on September 29, the House of Representatives rejected the Emergency Economic Stabilization Act by a vote of 225 to 208, most Democrats in favor and most Republicans opposed. The Dow fell 777.68 points, or 6.98 percent, then the largest single-day point drop in its history. The S&P 500 fell 8.8 percent; the Nasdaq Composite fell 9.1 percent. Several global stock indices fell 10 percent.

  President George W. Bush addressed the country the following day, saying that Congress must act and that the economy depended on decisive government action. The Senate passed the bill on October 1, the House on October 3, and Bush signed it the same day, authorizing the $700 billion Troubled Asset Relief Program. From October 6 through October 10, the Dow fell in every single session, declining 18.2 percent for the week in its worst weekly performance ever on both a point and percentage basis. On October 11, the head of the International Monetary Fund warned that the world financial system was teetering on the "brink of systemic meltdown." In the United Kingdom, Alistair Darling, the Chancellor of the Exchequer, later said Britain came within hours of a breakdown of law and order on the day Royal Bank of Scotland was bailed out.

• 6. The Human Cost

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  Assessments of the damage in the United States suggest approximately 8.7 million jobs were lost. Unemployment climbed from 5 percent in 2007 to a high of 10 percent in October 2009. The average work week fell to 33 hours, the lowest level since the government began collecting that data in 1964. The percentage of Americans living in poverty rose from 12.5 percent in 2007 to 15.1 percent in 2010.

  Household wealth collapsed. From its peak of $61.4 trillion in the second quarter of 2007, total U.S. household wealth fell $11 trillion by the end of the first quarter of 2009, reaching $50.4 trillion. Some estimates suggest one in four households lost 75 percent or more of their net worth. A Federal Reserve survey of 4,000 households found that the total wealth of 63 percent of all Americans declined between 2007 and 2009, and 77 percent of the wealthiest families suffered a loss. By 2011, median household wealth in the United States had fallen 35 percent, from $106,591 to $68,839.

  The crisis did not distribute pain evenly. Half of the poorest families did not suffer wealth declines because they held no financial investments. A study commissioned by the ACLU and released in June 2015 found that white home-owning households recovered from the crisis faster than Black home-owning households, widening the racial wealth gap. The connection between who built the bubble and who bore the losses would become a defining political grievance for years after the recession officially ended.

• 7. Accountability and Reform

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  In the aftermath, 47 bankers served jail time globally as a result of the crisis. More than half were from Iceland, where the collapse of all three major banks relative to the size of the economy represented the largest economic failure any country had ever suffered. In April 2012, Iceland's former prime minister Geir Haarde became the only politician in the world convicted as a result of the crisis. In the United States, the sole banker to serve prison time was Kareem Serageldin of Credit Suisse, sentenced to 30 months and ordered to return $24.6 million in compensation for manipulating bond prices to conceal $1 billion in losses. No individuals in the United Kingdom were convicted.

  On the civil side, Goldman Sachs paid a $550 million penalty to the SEC and acknowledged that its marketing materials for collateralized debt obligations contained incomplete information. The Financial Crisis Inquiry Commission published its report in January 2011, and the Senate's Levin-Coburn Report followed in April 2011; both identified systemic failures in regulation, governance, and ethics.

  In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted, overhauling financial regulation with the stated goal of promoting the financial stability of the United States. It faced opposition from many Republicans and was subsequently weakened by the Economic Growth, Regulatory Relief, and Consumer Protection Act in 2018. Basel III capital and liquidity standards were adopted by countries worldwide. As late as August 2023, UBS agreed to pay $1.435 billion in civil penalties to the U.S. Department of Justice to settle claims related to the issuance and sale of residential mortgage-backed securities between 2006 and 2007, a reminder that the legal accounting for what happened took more than a decade to complete.