Thebankruptcy of Lehman Brothers (headquarters pictured), the fourth-largest U.S. investment bank (behindGoldman Sachs,Morgan Stanley, andMerrill Lynch), on September 15, 2008, is often considered the climax of the 2008 financial crisis.TheTED spread, an indicator of perceivedcredit risk in the financial system, increased significantly during the crisis. It spiked sharply in August 2007, remained volatile for a year, and spiked even higher in September 2008 to reach a record 4.65% on October 10, 2008.
Assessments of the crisis's impact in the U.S. vary, but suggest that some 8.7 million jobs were lost, causing unemployment to rise from 5% in 2007 to a high of 10% in October 2009. The percentage of citizens living in poverty rose from 12.5% in 2007 to 15.1% in 2010. TheDow Jones Industrial Average fell by 53% between October 2007 and March 2009, and some estimates suggest that one in four households lost 75% or more of theirnet worth. In 2010, theDodd–Frank Wall Street Reform and Consumer Protection Act was passed, overhauling financial regulations.[6] It was opposed by manyRepublicans, and it was weakened by theEconomic Growth, Regulatory Relief, and Consumer Protection Act in 2018. TheBasel III capital and liquidity standards were also adopted by countries around the world.[7][8]
World map showingreal GDP growth rates for 2009 (countries in brown were in recession)Share in GDP of U.S. financial sector since 1860[9]
The crisis exacerbated theGreat Recession, aglobal recession that began in mid-2007.[10][11][12][13][14] It was also followed by theeuro area crisis, which began with the start of theGreek government-debt crisis in late 2009, and the2008–2011 Icelandic financial crisis, which involved thebank failure of all three of the major banks inIceland and, relative to the size of its economy, was the largest economic collapse suffered by any country in history.[15] It was among the five worst financial crises the world had experienced and led to a loss of more than $2 trillion from the global economy.[16][17] U.S. home mortgage debt relative toGDP increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 (~$15 trillion in 2024) trillion.[18] The increase incash out refinancings, as home values rose, fueled an increase in consumption that could no longer be sustained when home prices declined.[19][20][21] Many financial institutions owned investments whose value was based on home mortgages such asmortgage-backed securities, orcredit derivatives used to insure them against failure, which declined in value significantly.[22][23][24] TheInternational Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion ontoxic assets and from bad loans from January 2007 to September 2009.[25]
Lack of investor confidence in banksolvency and declines in credit availability led to plummeting stock andcommodity prices in late 2008 and early 2009.[26] The crisis rapidly spread into a global economic shock, resulting in severalbank failures.[27] Economies worldwide slowed during this period since credit tightened and international trade declined.[28] Housing markets suffered and unemployment soared, resulting inevictions andforeclosures. Several businesses failed.[29][30] From its peak in the second quarter of 2007 at $61.4 trillion, household wealth in the United States fell $11 trillion, to $50.4 trillion by the end of the first quarter of 2009, resulting in a decline in consumption, then a decline in business investment.[31][32] In the fourth quarter of 2008, the quarter-over-quarter decline in real GDP in the U.S. was 8.4%.[33] The U.S. unemployment rate peaked at 11.0% in October 2009, the highest rate since 1983 and roughly twice the pre-crisis rate. The average hours per work week declined to 33, the lowest level since the government began collecting the data in 1964.[34][35]
The economic crisis started in the U.S. but spread to the rest of the world.[29] U.S. consumption accounted for more than a third of the growth in global consumption between 2000 and 2007 and the rest of the world depended on the U.S. consumer as a source of demand.[36][37] Toxic securities were owned by corporate and institutional investors globally. Derivatives such ascredit default swaps also increased the linkage between large financial institutions. Thede-leveraging of financial institutions, as assets were sold to pay back obligations that could not be refinanced in frozen credit markets, further accelerated the solvency crisis and caused a decrease in international trade. Reductions in the growth rates ofdeveloping countries were due to falls in trade, commodity prices, investment andremittances sent from migrant workers (example: Armenia[38]). States with fragile political systems feared that investors from Western states would withdraw their money because of the crisis.[39]
As part ofnational fiscal policy response to the Great Recession, governments and central banks, including theFederal Reserve, theEuropean Central Bank and theBank of England, provided then-unprecedented trillions of dollars inbailouts andstimulus, including expansivefiscal policy andmonetary policy to offset the decline in consumption and lending capacity, avoid a further collapse, encourage lending, restore faith in the integralcommercial paper markets, avoid the risk of adeflationary spiral, and provide banks with enough funds to allow customers to make withdrawals.[40] In effect, the central banks went from being the "lender of last resort" to the "lender of only resort" for a significant portion of the economy. In some cases the Fed was considered the "buyer of last resort".[41][42][43][44][45] During the fourth quarter of 2008, these central banks purchased US$2.5 trillion (~$3.57 trillion in 2024) of government debt and troubled private assets from banks. This was the largest liquidity injection into the credit market, and the largest monetary policy action in world history. Following a model initiated by the2008 United Kingdom bank rescue package,[46][47] the governments of European nations and the United States guaranteed the debt issued by their banks and raised the capital of their national banking systems, ultimately purchasing $1.5 trillion newly issuedpreferred stock in major banks.[32] TheFederal Reserve created then-significant amounts of new currency as a method to combat theliquidity trap.[48]
Bailouts came in the form of trillions of dollars of loans, asset purchases, guarantees, and direct spending.[49] Significant controversy accompanied the bailouts, such as in the case of theAIG bonus payments controversy, leading to the development of a variety of "decision making frameworks", to help balance competing policy interests during times of financial crisis.[50]Alistair Darling, the U.K.'sChancellor of the Exchequer at the time of the crisis, stated in 2018 that Britain came within hours of "a breakdown of law and order" the day thatRoyal Bank of Scotland was bailed-out.[51] Instead of financing more domestic loans, some banks instead spent some of the stimulus money in more profitable areas such as investing in emerging markets and foreign currencies.[52]
In July 2010, theDodd–Frank Wall Street Reform and Consumer Protection Act was enacted in the United States to "promote the financial stability of the United States".[53] TheBasel III capital and liquidity standards were adopted worldwide.[54] Since the 2008 financial crisis, consumer regulators in America have more closely supervised sellers of credit cards and home mortgages in order to deter anticompetitive practices that led to the crisis.[55]
In total, 47 bankers served jail time as a result of the crisis, over half of whom were fromIceland, where the crisis was the most severe and led to the collapse of all three major Icelandic banks.[56] In April 2012,Geir Haarde of Iceland became the only politician to be convicted as a result of the crisis.[57][58] Only one banker in the United States served jail time as a result of the crisis,Kareem Serageldin, a banker atCredit Suisse who was sentenced to 30 months in jail and returned $24.6 million in compensation for manipulating bond prices to hide $1 billion of losses.[59][56] No individuals in the United Kingdom were convicted as a result of the crisis.[60][61] InSEC v. Goldman Sachs,Goldman Sachs paid a $550 million civil penalty and acknowledged that its marketing materials for CDO contained incomplete information, settlingsecurities fraud charges after allegedly anticipating the financial crisis and selling toxic investments to its clients.[62][63][64]
With fewer resources to risk increative destruction, the number of patent applications was flat, compared to exponential increases in patent application in prior years.[65]
Share of income going to the top 1% of earners, one measure of economic inequality in the US from 1913 to 2008.
Typical American families did not fare well, nor did the "wealthy-but-not-wealthiest" families just beneath the pyramid's top.[66][67][68] However, half of the poorest families in the United States did not have wealth declines at all during the crisis because they generally did not own financial investments whose value could fluctuate. The Federal Reserve surveyed 4,000 households from 2007 to 2009, and found that the total wealth of 63% of all Americans declined in that period and 77% of the richest families had a decrease in total wealth, while only 50% of those on the bottom of the pyramid suffered a decrease.[69][70][71]
The following is a timeline of the major events of the financial crisis, including government responses, and the subsequent economic recovery.[72][73][74][75]
Cost of housing by State from the year 2000 to 2022
May 19, 2005: Fund managerMichael Burry closed acredit default swap against subprime mortgage bonds withDeutsche Bank valued at $60 million – the first such CDS. He projected they would become volatile within two years of the low "teaser rate" of the mortgages expiring.[76][77]
2006: After years of above-average price increases, housing prices peaked andmortgage loan delinquency rose—the first sign of the bursting of theUnited States housing bubble.[78][79] Due to increasingly lax underwriting standards, one-third of all mortgages in 2006 were subprime or no-documentation loans,[80] which comprised 17% of home purchases that year.[81]
May 2006:JPMorgan warned clients of a housing downturn, especially in sub-prime housing.[82]
August 2006: Theyield curve inverted, signaling a recession was likely within a year or two.[83]
November 2006:UBS warned of "an impending crisis in the U.S. housing market".[82]
February 27, 2007: Stock prices in China and the U.S. fell by the most since 2003 as reports of a decline in home prices anddurable goods orders stoked growth fears, withAlan Greenspan predicting a recession.[84] Due to increased delinquency rates insubprime lending,Freddie Mac said that it would stop investing in certain subprime loans.[85]
July 30, 2007:IKB Deutsche Industriebank, the first banking casualty of the crisis, announces its bailout by German public financial institutionKfW.[92]
August 9, 2007:BNP Paribas blocked withdrawals from three of itshedge funds with a total of $2.2 billion inassets under management, due to "a complete evaporation of liquidity", making valuation of the funds impossible – a clear sign that banks were refusing to do business with each other.[89][93][94]
August 16, 2007: The DJIA closes at 12,945.78 after falling on 12 out of the previous 20 trading days following its peak. It had fallen 1,164.63 or 8.3%.[91]
December 19, 2007: theStandard and Poor's rating agency downgrades the ratings of many monoline insurers which pay out bonds that fail.[citation needed]
December 31, 2007: Despite volatility through the last part of the year, markets close above where they started the year, with the DJIA closing at 13,264.82, up 6.4% for the year.[106]
January 18, 2008: Stock markets fell to a yearly low as the credit rating ofAmbac, abond insurance company, was downgraded. Meanwhile, an increase in the amount of withdrawals caused Scottish Equitable to implement delays of up to 12 months on people wishing to withdraw money.[108]
January 22, 2008: The US Federal Reserve cut interest rates by 0.75% to stimulate the economy, the largest drop in 25 years and the first emergency cut since 2001.[109]
January 2008: U.S. stocks had the worst January since 2000 over concerns about the exposure of companies that issuebond insurance.[110]
March 17, 2008:Bear Stearns, with $46 billion ofmortgage assets that had not been written down and $10 trillion in total assets, faced bankruptcy; instead, in its first emergency meeting in 30 years, the Federal Reserve agreed to guarantee its bad loans to facilitate its acquisition byJPMorgan Chase for $2/share. A week earlier, the stock was trading at $60/share and a year earlier it traded for $178/share. The buyout price was increased to $10/share the following week.[114][115][116]
March 18, 2008: In a contentious meeting, the Federal Reserve cut thefederal funds rate by 75 basis points, its 6th cut in 6 months.[117] It also allowedFannie Mae &Freddie Mac to buy $200 billion in subprime mortgages from banks. Officials thought this would contain the possible crisis. TheU.S. dollar weakened and commodity prices soared.[data missing][118][119][120]
Late June 2008: Despite the U.S. stock market falling to 20% below its highs, commodity-related stocks soared as oil traded above $140/barrel for the first time and steel prices rose above $1,000 per ton. Worries aboutinflation combined with strong demand from China encouraged people to invest incommodities during the2000s commodities boom.[121][122]
July 11, 2008:IndyMac failed. Oil prices peaked at $147.50[123][109]
September 15, 2008: After the Federal Reserve declined to guarantee its loans as it did for Bear Stearns, thebankruptcy of Lehman Brothers led to a 504.48-point (4.42%) drop in the DJIA, its worst decline in seven years. To avoid bankruptcy,Merrill Lynch was acquired byBank of America for $50 billion in a transaction facilitated by the government.[126] Lehman had been in talks to be sold to either Bank of America orBarclays but neither bank wanted to acquire the entire company.[127]
September 17, 2008: Investors withdrew $144 billion from U.S.money market funds, the equivalent of abank run onmoney market funds, which frequently invest incommercial paper issued by corporations to fund their operations and payrolls, causing the short-term lending market to freeze. The withdrawal compared to $7.1 billion in withdrawals the week prior. This interrupted the ability of corporations to rollover theirshort-term debt. The U.S. government extended insurance for money market accounts analogous to bankdeposit insurance via a temporary guarantee[129] and with Federal Reserve programs to purchase commercial paper.
September 20, 2008: Paulson requested the U.S. Congress authorize a $700 billion fund to acquire toxic mortgages, telling Congress "If it doesn't pass, then heaven help us all".[131]
September 29, 2008: By a vote of 225–208, with most Democrats in support and Republicans against, the House of Representatives rejected theEmergency Economic Stabilization Act of 2008, which included the $700 billionTroubled Asset Relief Program. In response, the DJIA dropped 777.68 points, or 6.98%, then the largest point drop in history. The S&P 500 Index fell 8.8% and the Nasdaq Composite fell 9.1%.[139] Several stock market indices worldwide fell 10%. Gold prices soared to $900/ounce. The Federal Reserve doubled its credit swaps with foreign central banks as they all needed to provide liquidity.Wachovia reached a deal to sell itself to Citigroup; however, the deal would have made shares worthless and required government funding.[140]
September 30, 2008: PresidentGeorge W. Bush addressed the country, saying "Congress must act. ... Our economy is depending on decisive action from the government. The sooner we address the problem, the sooner we can get back on the path of growth and job creation". The DJIA rebounded 4.7%.[141]
October 3, 2008: The House of Representatives passed theEmergency Economic Stabilization Act of 2008 and the $700 billion Troubled Asset Relief Program.[144] Bush signed the legislation that same day.[145] Wachovia reached a deal to be acquired byWells Fargo in a deal that did not require government funding.[146]
October 6–10, 2008: From October 6–10, 2008, the Dow Jones Industrial Average (DJIA) closed lower in all five sessions. Volume levels were record-breaking. The DJIA fell 1,874.19 points, or 18.2%, in its worst weekly decline ever on both a points and percentage basis. The S&P 500 fell more than 20%.[147]
October 7, 2008: In the U.S., per the Emergency Economic Stabilization Act of 2008, theFederal Deposit Insurance Corporation increased deposit insurance coverage to $250,000 per depositor.[148]
During the 2008 global financial crisis, theBSE SENSEX experienced a sharp decline. It dropped from over 21,000 points in January 2008 to below 8,000 points in October 2008.[149]
October 8, 2008: TheIndonesian stock market halted trading after a 10% drop in one day.[150] Global central banks held emergency meetings and coordinated interest rate cuts before the US stock markets opened.[151]
October 11, 2008: The head of theInternational Monetary Fund (IMF) warned that the world financial system was teetering on the "brink of systemic meltdown".[152]
October 14, 2008: Having been suspended for three successive trading days (October 9, 10 and 13), the Icelandic stock market reopened on October 14, with the main index, theOMX Iceland 15, closing at 678.4, which was about 77% lower than the 3,004.6 at the close on October 8, after the value of the three big banks, which had formed 73.2% of the value of the OMX Iceland 15, had been set to zero, leading to the2008–2011 Icelandic financial crisis.[153] TheFederal Deposit Insurance Corporation created theTemporary Liquidity Guarantee Program to guarantee the senior debt of all FDIC-insured institutions through June 30, 2009.[154]
October 24, 2008: Many of the world's stock exchanges experienced the worst declines in their history, with drops of around 10% in most indices.[156] In the U.S., the DJIA fell 3.6%, although not as much as other markets.[157] TheUnited States dollar, theJapanese yen and theSwiss franc soared against other major currencies, particularly theBritish pound andCanadian dollar, as world investors sought safe havens. Acurrency crisis developed, with investors transferring vast capital resources into stronger currencies, leading many governments of emerging economies to seek aid from theInternational Monetary Fund.[158][159] Later that day, the deputy governor of theBank of England,Charlie Bean, suggested that "This is a once in a lifetime crisis, and possibly the largest financial crisis of its kind in human history".[160] In a transaction pushed by regulators,PNC Financial Services agreed to acquireNational City Corp.[161]
Restaurant inBristol, United Kingdom, advertising cheap "Credit Crunch Lunch"
November 6, 2008: The IMF predicted a worldwide recession of −0.3% for 2009. On the same day, theBank of England and theEuropean Central Bank, respectively, reduced their interest rates from 4.5% to 3%, and from 3.75% to 3.25%.[162]
November 20, 2008: Iceland obtained an emergency loan from theInternational Monetary Fund after the failure of banks in Iceland resulted in a devaluation of theIcelandic króna and threatened the government with bankruptcy.[164]
There is a really good reason for tighter credit. Tens of millions of homeowners who had substantial equity in their homes two years ago have little or nothing today. Businesses are facing the worst downturn since theGreat Depression. This matters for credit decisions. A homeowner with equity in her home is very unlikely to default on a car loan or credit card debt. They will draw on this equity rather than lose their car and/or have a default placed on their credit record. On the other hand, a homeowner who has no equity is a serious default risk. In the case of businesses, their creditworthiness depends on their future profits. Profit prospects look much worse in November 2008 than they did in November 2007 ... While many banks are obviously at the brink, consumers and businesses would be facing a much harder time getting credit right now even if the financial system were rock solid. The problem with the economy is the loss of close to $6 trillion in housing wealth and an even larger amount of stock wealth.[166]
December 1, 2008: The NBER announced the US was in a recession and had been since December 2007. The Dow tumbled 679.95 points or 7.8% on the news.[167][91]
January 6, 2009: Citi claimed that Singapore would experience "the most severe recession in [its] history" in 2009. In the end, the economy grew in 2009 by 0.1% and in 2010 by 14.5%.[170][171][172]
February 20, 2009: The DJIA closed at a six-year low, amidst worries that the largest banks in the United States would have to benationalized.[178]
February 27, 2009: TheDJIA closed at its lowest value since 1997 as the U.S. government increased its stake inCitigroup to 36%, raising further fears of nationalization and a report showed that GDP shrank at the sharpest pace in 26 years.[179]
March 3, 2009: President Obama stated that "Buying stocks is a potentially good deal if you've got a long-term perspective on it".[182]
March 6, 2009: The Dow Jones hit its lowest level of 6,469.95, a drop of 54% from its peak of 14,164 on October 9, 2007, over a span of 17 months, before beginning to recover.[183]
March 10, 2009: Shares ofCitigroup rose 38% after the CEO said that the company was profitable in the first two months of the year and expressed optimism about its capital position going forward. Major stock market indices rose 5–7%, marking the bottom of the stock market decline.[184]
March 12, 2009: Stock market indices in the U.S. rose another 4% afterBank of America said it was profitable in January and February and would likely not need more government funding.Bernie Madoff was convicted.[185]
First quarter of 2009: For the first quarter of 2009, the annualized rate of decline in GDP was 14.4% in Germany, 15.2% in Japan, 7.4% in the UK, 18% in Latvia,[186] 9.8% in the Euro area and 21.5% for Mexico.[29]
April 10, 2009:Time magazine declared "More Quickly Than It Began, The Banking Crisis Is Over".[187]
April 29, 2009: The Federal Reserve projected GDP growth of 2.5–3% in 2010; an unemployment plateau in 2009 and 2010 around 10% with moderation in 2011; and inflation rates around 1–2%.[188]
May 1, 2009: People protested economic conditions globally during the2009 May Day protests.
... the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainableeconomic growth in a context of price stability.[190]
September 12, 2010: European regulators introducedBasel III regulations for banks, which increased capital ratios, limits on leverage, narrowed the definition of capital to exclude subordinated debt, limited counter-party risk, and added liquidity requirements.[203][204] Critics argued that Basel III didn't address the problem of faulty risk-weightings. Major banks suffered losses from AAA-rated created byfinancial engineering (which creates apparently risk-free assets out of high risk collateral) that required less capital according to Basel II. Lending to AA-rated sovereigns has a risk-weight of zero, thus increasing lending to governments and leading to the next crisis.[205]Johan Norberg argued that regulations (Basel III among others) have indeed led to excessive lending to risky governments (seeEuro area crisis) and theEuropean Central Bank pursues even more lending as the solution.[206]
November 3, 2010: To improve economic growth, the Federal Reserve announced another round ofquantitative easing, dubbed QE2, which included the purchase of $600 billion in long-termTreasuries over the following eight months.[207]
March 2011: Two years after thenadir of the crisis, many stock market indices were 75% above their lows set in March 2009. Nevertheless, the lack of fundamental changes in banking and financial markets worried many market participants, including theInternational Monetary Fund.[208]
2011: Median household wealth fell 35% in the U.S., from $106,591 to $68,839 between 2005 and 2011.[209]
August 2012: In the United States, many homeowners still faced foreclosure and could not refinance or modify their mortgages. Foreclosure rates remained high.[211]
September 13, 2012: To improve lower interest rates, support mortgage markets, and make financial conditions more accommodative, the Federal Reserve announced another round ofquantitative easing, dubbed QE3, which included the purchase of $40 billion in long-termTreasuries each month.[212]
2014: A report showed that the distribution of household incomes in the United States became more unequal during the post-2008economic recovery, a first for the United States but in line with the trend over the last ten economic recoveries since 1949.[213][214]Income inequality in the United States grew from 2005 to 2012 in more than 2 out of 3 metropolitan areas.[215]
June 2015: A study commissioned by theACLU found that white home-owning households recovered from the financial crisis faster than black home-owning households, widening theracial wealth gap in the U.S.[216]
2017: Per theInternational Monetary Fund, from 2007 to 2017, "advanced" economies accounted for only 26.5% of globalGDP (PPP) growth while emerging and developing economies accounted for 73.5% of global GDP (PPP) growth.[217]
August 2023:UBS reaches an agreement with theUnited States Department of Justice to pay a combined $1.435 billion in civil penalties to settle a legacy matter from 2006–2007 related to the issuance, underwriting and sale of residential mortgage-backed securities.[218]
In the table, the names of emerging and developing economies are shown in boldface type, while the names of developed economies are in Roman (regular) type.
The top twenty growing economies (by increase in GDP (PPP) from 2007 to 2017)
Economy
Incremental GDP (billions in USD)
(01)China
14,147
(02)India
5,348
(03)United States
4,913
(—)European Union
4,457
(04)Indonesia
1,632
(05)Turkey
1,024
(06)Japan
1,003
(07)Germany
984
(08)Russia
934
(09)Brazil
919
(10)South Korea
744
(11)Mexico
733
(12)Saudi Arabia
700
(13)United Kingdom
671
(14)France
566
(15)Nigeria
523
(16)Egypt
505
(17)Canada
482
(18)Iran
462
(19)Thailand
447
(20)Philippines
440
The twenty largest economies contributing to global GDP (PPP) growth (2007–2017)[219]
The expansion of central bank lending in response to the crisis was not confined to theFederal Reserve's provision of aid to individual financial institutions. The Federal Reserve has also conducted several innovative lending programs to improve liquidity and strengthen different financial institutions and markets, such asFreddie Mac andFannie Mae. In this case, the major problem in the market is the lack of free cash reserves and flows to secure the loans. The Federal Reserve took many steps to deal with financial market liquidity worries. One of these steps was a credit line for major traders, who act as the Fed's partners in open market activities.[220] Also, loan programs were set up to make the money market mutual funds and commercial paper market more flexible. Also, theTerm Asset-Backed Securities Loan Facility (TALF) was put in place thanks to a joint effort with the US Department of the Treasury. This plan made it easier for consumers and businesses to get credit by giving Americans who owned high-quality asset-backed securities more credit.
Before the crisis, the Federal Reserve's stocks of Treasury securities were sold to pay for the increase in credit. This method was meant to keep banks from trying to give out their extra savings, which could cause the federal funds rate to drop below where it was supposed to be.[221] However, in October 2008, the Federal Reserve was granted the power to provide banks with interest payments on their surplus reserves. This created a motivation for banks to retain their reserves instead of disbursing them, thus reducing the need for the Federal Reserve to hedge its increased lending by decreases in alternative assets.[222]
Money market funds also went through runs when people lost faith in the market. To keep it from getting worse, the Fed said it would give money to mutual fund companies. Also, theDepartment of Treasury said that it would briefly cover the assets of the fund. Both of these things helped get the fund market back to normal, which helped the commercial paper market, which most businesses use to run. TheFDIC also did several things, such as raising the insurance cap from $100,000 to $250,000, to boost customer trust.
Headquarters of the United States Federal Reserve System
They engaged inquantitative easing, which added more than $4 trillion to the financial system and got banks to start lending again, both to each other and to people. Many homeowners who were trying to keep their homes from going into default got housing credits. A package of policies was passed that let borrowers refinance their loans even though the value of their homes was less than what they still owed on theirmortgages.[223]
While the causes of the bubble and subsequent crash are disputed, the precipitating factor for the Financial Crisis of 2007–2008 was the bursting of theUnited States housing bubble and the subsequentsubprime mortgage crisis, which occurred due to a high default rate and resulting foreclosures ofmortgage loans, particularlyadjustable-rate mortgages. Some or all of the following factors contributed to the crisis:[224][78][79]
"a combination of excessive borrowing, risky investments, and lack of transparency" by financial institutions and by households that put the financial system on a collision course with crisis.
ill preparation and inconsistent action by government and key policy makers lacking a full understanding of the financial system they oversaw that "added to the uncertainty and panic".
a "systemic breakdown in accountability and ethics" at all levels.
"collapsing mortgage-lending standards and the mortgage securitization pipeline".
The high delinquency and default rates by homeowners, particularly those with subprime credit, led to a rapid devaluation of mortgage-backed securities including bundled loan portfolios, derivatives and credit default swaps. As the value of these assets plummeted, buyers for these securities evaporated and banks who were heavily invested in these assets began to experience a liquidity crisis.
Securitization, a process in which many mortgages were bundled together and formed into new financial instruments calledmortgage-backed securities, allowed for shifting of risk and lax underwriting standards. These bundles could be sold as (ostensibly) low-risk securities partly because they were often backed bycredit default swap insurance.[231] Because mortgage lenders could pass these mortgages (and the associated risks) on in this way, they could and did adopt loose underwriting criteria.
Lax regulation allowedpredatory lending in the private sector,[232][233] especially after the federal government overrode anti-predatory state laws in 2004.[234]
TheCommunity Reinvestment Act (CRA),[235] a 1977 U.S. federal law designed to help low- and moderate-income Americans get mortgage loans required banks to grant mortgages to higher risk families.[236][237][238][239] Granted, in 2009, Federal Reserve economists found that "only a small portion of subprime mortgage originations [related] to the CRA", and that "CRA-related loans appear[ed] to perform comparably to other types of subprime loans". These findings "run counter to the contention that the CRA contributed in any substantive way to the [mortgage crisis]."[240]
Reckless lending by lenders such as Bank of America'sCountrywide Financial unit was increasingly incentivized and even mandated by government regulation.[241][242][243] This may have causedFannie Mae andFreddie Mac to lose market share and to respond by lowering their own standards.[244]
Mortgage guarantees by Fannie Mae and Freddie Mac, quasi-government agencies, which purchased many subprime loan securitizations.[245] The implicit guarantee by the U.S. federal government created amoral hazard and contributed to a glut of risky lending.
Government policies that encouraged home ownership, providing easier access to loans for subprime borrowers; overvaluation of bundled subprime mortgages based on the theory that housing prices would continue to escalate; questionable trading practices on behalf of both buyers and sellers; compensation structures by banks and mortgage originators that prioritize short-term deal flow over long-term value creation; and a lack of adequate capital holdings from banks and insurance companies to back the financial commitments they were making.[246][247]
The 1999Gramm-Leach-Bliley Act, which partially repealed theGlass-Steagall Act, effectively removed the separation betweeninvestment banks and depository banks in the United States and increased speculation on the part of depository banks.[248]
Fair value accounting was issued as U.S. accounting standardSFAS 157 in 2006 by the privately runFinancial Accounting Standards Board (FASB)—to which the SEC had delegated the task of establishing financial reporting standards.[253] This required that tradable assets such asmortgage securities be valued according to their current market value rather than their historic cost or some future expected value. When the market for such securities became volatile and collapsed, the resulting loss of value had a major financial effect upon the institutions holding them even if they had no immediate plans to sell them.[254]
Easy availability of credit in the US, fueled by large inflows of foreign funds after the1998 Russian financial crisis and1997 Asian financial crisis of the 1997–1998 period, led to a housing construction boom and facilitated debt-financed consumer spending. As banks began to give out more loans to potential home owners, housing prices began to rise. Lax lending standards and rising real estate prices also contributed to the real estate bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.[255][224][256]
As part of the housing and credit booms, the number ofmortgage-backed securities (MBS) andcollateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Suchfinancial innovation enabled institutions and investors to invest in the U.S. housing market. As housing prices declined, these investors reported significant losses.[257]
Falling prices also resulted in homes worth less than the mortgage loans, providing borrowers with a financial incentive to enter foreclosure. Foreclosure levels were elevated until early 2014.[258] drained significant wealth from consumers, losing up to $4.2trillion[259] Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses were estimated in the trillions of U.S. dollars globally.[257]
Financialization – the increased use of leverage in the financial system.
Financial institutions such as investment banks and hedge funds, as well as certain, differently regulated banks, assumed significant debt burdens while providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or losses.[260] These losses affected the ability of financial institutions to lend, slowing economic activity.
Some critics contend that government mandates forced banks to extend loans to borrowers previously considered uncreditworthy, leading to increasingly lax underwriting standards and high mortgage approval rates.[261][241][262][242] These, in turn, led to an increase in the number of homebuyers, which drove up housing prices. This appreciation in value led many homeowners to borrow against the equity in their homes as an apparent windfall, leading to over-leveraging.
US subprime lending expanded dramatically 2004–2006
The relaxing of credit lending standards by investment banks and commercial banks allowed for a significant increase insubprime lending. Subprime had not become less risky; Wall Street just accepted this higher risk.[263]
Due to competition between mortgage lenders for revenue and market share, and when the supply of creditworthy borrowers was limited, mortgage lenders relaxed underwriting standards and originated riskier mortgages to less creditworthy borrowers. In the view of some analysts, the relatively conservativegovernment-sponsored enterprises (GSEs) policed mortgage originators and maintained relatively high underwriting standards prior to 2003. However, as market power shifted from securitizers to originators, and as intense competition from private securitizers undermined GSE power, mortgage standards declined and risky loans proliferated. The riskiest loans were originated in 2004–2007, the years of the most intense competition between securitizers and the lowest market share for the GSEs. The GSEs eventually relaxed their standards to try to catch up with the private banks.[264][265]
A contrarian view is thatFannie Mae andFreddie Mac led the way to relaxed underwriting standards, starting in 1995, by advocating the use of easy-to-qualify automated underwriting and appraisal systems, by designing no-down-payment products issued by lenders, by the promotion of thousands of small mortgage brokers, and by their close relationship to subprime loan aggregators such asCountrywide.[266][267]
Depending on how "subprime" mortgages are defined, they remained below 10% of all mortgage originations until 2004, when they rose to nearly 20% and remained there through the 2005–2006 peak of theUnited States housing bubble.[268]
The majority report of theFinancial Crisis Inquiry Commission, written by the six Democratic appointees, the minority report, written by three of the four Republican appointees, studies byFederal Reserve economists, and the work of several independent scholars generally contend that governmentaffordable housing policy was not the primary cause of the financial crisis. Although they concede that governmental policies had some role in causing the crisis, they contend that GSE loans performed better than loans securitized by private investment banks, and performed better than some loans originated by institutions that held loans in their own portfolios.
In his dissent to the majority report of the Financial Crisis Inquiry Commission, conservativeAmerican Enterprise InstitutefellowPeter J. Wallison[269] stated his belief that the roots of the financial crisis can be traced directly and primarily to affordable housing policies initiated by theUnited States Department of Housing and Urban Development (HUD) in the 1990s and to massive risky loan purchases by government-sponsored entities Fannie Mae and Freddie Mac. Based upon information in the SEC's December 2011 securities fraud case against six former executives of Fannie and Freddie, Peter Wallison and Edward Pinto estimated that, in 2008, Fannie and Freddie held 13 million substandard loans totaling over $2 trillion.[270]
In the early and mid-2000s, theBush administration called numerous times for investigations into the safety and soundness of the GSEs and their swelling portfolio of subprime mortgages. On September 10, 2003, theUnited States House Committee on Financial Services held a hearing, at the urging of the administration, to assess safety and soundness issues and to review a recent report by theOffice of Federal Housing Enterprise Oversight (OFHEO) that had uncovered accounting discrepancies within the two entities.[271][272] The hearings never resulted in new legislation or formal investigation of Fannie Mae and Freddie Mac, as many of the committee members refused to accept the report and instead rebuked OFHEO for their attempt at regulation.[273] Some, such as Wallison, believe this was an early warning to the systemic risk that the growing market in subprime mortgages posed to the U.S. financial system that went unheeded.[274]
A 2000United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 showed that $467 billion of mortgage lending was made byCommunity Reinvestment Act (CRA)-covered lenders into low and mid-level income (LMI) borrowers and neighborhoods, representing 10% of all U.S. mortgage lending during the period. The majority of these were prime loans. Sub-prime loans made by CRA-covered institutions constituted a 3% market share of LMI loans in 1998,[275] but in the run-up to the crisis, fully 25% of all subprime lending occurred at CRA-covered institutions and another 25% of subprime loans had some connection with CRA.[276] However, most sub-prime loans were not made to the LMI borrowers targeted by the CRA,[277][278] especially in the years 2005–2006 leading up to the crisis,[279][278][280] nor did it find any evidence that lending under the CRA rules increased delinquency rates or that the CRA indirectly influenced independent mortgage lenders to ramp up sub-prime lending.[281][verification needed]
To other analysts the delay between CRA rule changes in 1995 and the explosion of subprime lending is not surprising, and does not exonerate the CRA. They contend that there were two, connected causes to the crisis: the relaxation of underwriting standards in 1995 and the ultra-low interest rates initiated by the Federal Reserve after the terrorist attack on September 11, 2001. Both causes had to be in place before the crisis could take place.[282] Critics also point out that publicly announced CRA loan commitments were massive, totaling $4.5 trillion in the years between 1994 and 2007.[283] They also argue that the Federal Reserve's classification of CRA loans as "prime" is based on the faulty and self-serving assumption that high-interest-rate loans (3 percentage points over average) equal "subprime" loans.[284]
Others have pointed out that there were not enough of these loans made to cause a crisis of this magnitude. In an article inPortfolio magazine,Michael Lewis spoke with one trader who noted that "There weren't enough Americans with [bad] credit taking out [bad loans] to satisfy investors' appetite for the end product." Essentially, investment banks and hedge funds used financial innovation to enable large wagers to be made, far beyond the actual value of the underlying mortgage loans, usingderivatives called credit default swaps, collateralized debt obligations andsynthetic CDOs.
By March 2011, the FDIC had paid out $9 billion (c. $12.3 billion in 2024[285]) to cover losses on bad loans at 165 failed financial institutions.[286][287] The Congressional Budget Office estimated, in June 2011, that the bailout to Fannie Mae and Freddie Mac exceeds $300 billion (c. $411 billion in 2024[285]) (calculated by adding the fair value deficits of the entities to the direct bailout funds at the time).[288]
EconomistPaul Krugman argued in January 2010 that the simultaneous growth of the residential and commercial real estate pricing bubbles and the global nature of the crisis undermines the case made by those who argue that Fannie Mae, Freddie Mac, CRA, or predatory lending were primary causes of the crisis. In other words, bubbles in both markets developed even though only the residential market was affected by these potential causes.[289]
Countering Krugman, Wallison wrote: "It is not true that every bubble—even a large bubble—has the potential to cause a financial crisis when it deflates." Wallison notes that other developed countries had "large bubbles during the 1997–2007 period" but "the losses associated with mortgage delinquencies and defaults when these bubbles deflated were far lower than the losses suffered in the United States when the 1997–2007 [bubble] deflated." According to Wallison, the reason the U.S.residential housing bubble (as opposed to other types of bubbles) led to financial crisis was that it was supported by a huge number of substandard loans—generally with low or no downpayments.[290]
Krugman's contention (that the growth of a commercial real estate bubble indicates that U.S. housing policy was not the cause of the crisis) is challenged by additional analysis. After researching the default of commercial loans during the financial crisis, Xudong An and Anthony B. Sanders reported (in December 2010): "We find limited evidence that substantial deterioration inCMBS [commercial mortgage-backed securities] loan underwriting occurred prior to the crisis."[291] Other analysts support the contention that the crisis in commercial real estate and related lending took placeafter the crisis in residential real estate. Business journalist Kimberly Amadeo reported: "The first signs of decline in residential real estate occurred in 2006. Three years later, commercial real estate started feeling the effects."[verification needed][292] Denice A. Gierach, a real estate attorney and CPA, wrote:
... most of the commercial real estate loans were good loans destroyed by a really bad economy. In other words, the borrowers did not cause the loans to go bad-it was the economy.[293]
A graph showing the median and average sales prices of new homes sold in the United States between 1963 and 2016 (not adjusted for inflation)[78]
Between 1998 and 2006, the price of the typical American house increased by 124%.[294] During the 1980s and 1990s, the national median home price ranged from 2.9 to 3.1 times median household income. By contrast, this ratio increased to 4.0 in 2004, and 4.6 in 2006.[295] Thishousing bubble resulted in many homeowners refinancing their homes at lower interest rates, or financing consumer spending by taking outsecond mortgages secured by the price appreciation.
In aPeabody Award-winning program,NPR correspondents argued that a "Giant Pool of Money" (represented by $70 trillion in worldwide fixed income investments) sought higher yields than those offered by U.S. Treasury bonds early in the decade. This pool of money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income generating investments had not grown as fast. Investment banks on Wall Street answered this demand with products such as themortgage-backed security and thecollateralized debt obligation that were assigned saferatings by thecredit rating agencies.[296]
In effect, Wall Street connected this pool of money to the mortgage market in the US, with enormous fees accruing to those throughout the mortgagesupply chain, from the mortgage broker selling the loans to small banks that funded the brokers and the large investment banks behind them. By approximately 2003, the supply of mortgages originated at traditional lending standards had been exhausted, and continued strong demand began to drive down lending standards.[296]
The collateralized debt obligation in particular enabled financial institutions to obtain investor funds to finance subprime and other lending, extending or increasing the housing bubble and generating large fees. This essentially places cash payments from multiple mortgages or other debt obligations into a single pool from which specific securities draw in a specific sequence of priority. Those securities first in line received investment-grade ratings from rating agencies. Securities with lower priority had lower credit ratings but theoretically a higher rate of return on the amount invested.[297]
By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak.[298][299] As prices declined, borrowers withadjustable-rate mortgages could not refinance to avoid the higher payments associated with rising interest rates and began to default. During 2007, lenders began foreclosure proceedings on nearly 1.3 million properties, a 79% increase over 2006.[300] This increased to 2.3 million in 2008, an 81% increase vs. 2007.[301] By August 2008, approximately 9% of all U.S. mortgages outstanding were either delinquent or in foreclosure.[302] By September 2009, this had risen to 14.4%.[303][304]
After the bubble burst, Australian economistJohn Quiggin wrote: "And, unlike the Great Depression, this crisis was entirely the product of financial markets. There was nothing like the postwar turmoil of the 1920s, the struggles over gold convertibility and reparations, or theSmoot-Hawley tariff, all of which have shared the blame for the Great Depression." Instead, Quiggin lays the blame for the 2008 near-meltdown on financial markets, on political decisions to lightly regulate them, and on rating agencies which had self-interested incentives to give good ratings.[305]
Lower interest rates encouraged borrowing. From 2000 to 2003, theFederal Reserve lowered thefederal funds rate target from 6.5% to 1.0%.[306][307] This was done to soften the effects of the collapse of thedot-com bubble and theSeptember 11 attacks, as well as to combat a perceived risk ofdeflation.[308] As early as 2002, it was apparent that credit was fueling housing instead of business investment as some economists went so far as to advocate that the Fed "needs to create a housing bubble to replace the Nasdaq bubble".[309] Moreover, empirical studies using data from advanced countries show that excessive credit growth contributed greatly to the severity of the crisis.[310]
US current account deficit
Additional downward pressure on interest rates was created by rising U.S.current account deficit, which peaked along with the housing bubble in 2006. Federal Reserve chairmanBen Bernanke explained how trade deficits required the U.S. to borrow money from abroad, in the process bidding up bond prices and lowering interest rates.[311]
Bernanke explained that between 1996 and 2004, the U.S. current account deficit increased by $650 billion, from 1.5% to 5.8% of GDP. Financing these deficits required the country to borrow large sums from abroad, much of it from countries running trade surpluses. These were mainly the emerging economies in Asia and oil-exporting nations. Thebalance of paymentsidentity requires that a country (such as the US) running acurrent account deficit also have acapital account (investment) surplus of the same amount. Hence large and growing amounts of foreign funds (capital) flowed into the U.S. to finance its imports.
All of this created demand for various types of financial assets, raising the prices of those assets while lowering interest rates. Foreign investors had these funds to lend either because they had very high personal savings rates (as high as 40% in China) or because of high oil prices.Ben Bernanke referred to this as a "saving glut".[312]
A flood of funds (capital orliquidity) reached the U.S. financial markets. Foreign governments supplied funds by purchasingTreasury bonds and thus avoided much of the direct effect of the crisis. U.S. households, used funds borrowed from foreigners to finance consumption or to bid up the prices of housing and financial assets. Financial institutions invested foreign funds inmortgage-backed securities.[citation needed]
The Fed then raised the Fed funds rate significantly between July 2004 and July 2006.[313] This contributed to an increase in one-year and five-yearadjustable-rate mortgage (ARM) rates, making ARM interest rate resets more expensive for homeowners.[314] This may have also contributed to the deflating of the housing bubble, as asset prices generally move inversely to interest rates, and it became riskier to speculate in housing.[315][316] U.S. housing and financial assets dramatically declined in value after the housing bubble burst.[317][32]
Subprime lending standards declined in the U.S.: in early 2000, a subprime borrower had a FICO score of 660 or less. By 2005, many lenders dropped the required FICO score to 620, making it much easier to qualify for prime loans and making subprime lending a riskier business. Proof of income and assets were de-emphasized. Loans at first required full documentation, then low documentation, then no documentation. One subprime mortgage product that gained wide acceptance was the no income, no job, no asset verification required (NINJA) mortgage. Informally, these loans were aptly referred to as "liar loans" because they encouraged borrowers to be less than honest in the loan application process.[318] Testimony given to theFinancial Crisis Inquiry Commission bywhistleblowerRichard M. Bowen III, on events during his tenure as the Business Chief Underwriter for Correspondent Lending in the Consumer Lending Group forCitigroup, where he was responsible for over 220 professional underwriters, suggests that by 2006 and 2007, the collapse ofmortgage underwriting standards was endemic. His testimony stated that by 2006, 60% of mortgages purchased byCitigroup from some 1,600 mortgage companies were "defective" (were not underwritten to policy, or did not contain all policy-required documents)—this, despite the fact that each of these 1,600 originators was contractually responsible (certified via representations and warrantees) that its mortgage originations metCitigroup standards. Moreover, during 2007, "defective mortgages (from mortgage originators contractually bound to perform underwriting toCiti's standards) increased ... to over 80% of production".[319]
In separate testimony to theFinancial Crisis Inquiry Commission, officers of Clayton Holdings, the largest residential loan due diligence and securitization surveillance company in the United States and Europe, testified that Clayton's review of over 900,000 mortgages issued from January 2006 to June 2007 revealed that scarcely 54% of the loans met their originators' underwriting standards. The analysis (conducted on behalf of 23 investment and commercial banks, including 7 "too big to fail" banks) additionally showed that 28% of the sampled loans did not meet the minimal standards of any issuer. Clayton's analysis further showed that 39% of these loans (i.e. those not meetingany issuer's minimal underwriting standards) were subsequently securitized and sold to investors.[320][321]
Predatory lending refers to the practice of unscrupulous lenders, enticing borrowers to enter into "unsafe" or "unsound" secured loans for inappropriate purposes.[322][323][324]
In June 2008,Countrywide Financial was sued by thenCalifornia Attorney GeneralJerry Brown for "unfair business practices" and "false advertising", alleging that Countrywide used "deceptive tactics to push homeowners into complicated, risky, and expensive loans so that the company could sell as many loans as possible to third-party investors".[325] In May 2009, Bank of America modified 64,000 Countrywide loans as a result.[326] When housing prices decreased, homeowners in ARMs then had little incentive to pay their monthly payments, since their home equity had disappeared. This caused Countrywide's financial condition to deteriorate, ultimately resulting in a decision by theOffice of Thrift Supervision to seize the lender. One Countrywide employee—who would later plead guilty to two counts ofwire fraud and spent 18 months in prison—stated that, "If you had a pulse, we gave you a loan."[327]
Former employees fromAmeriquest, which was United States' leading wholesale lender, described a system in which they were pushed to falsify mortgage documents and then sell the mortgages to Wall Street banks eager to make fast profits. There is growing evidence that suchmortgage frauds may be a cause of the crisis.[328]
According to Barry Eichengreen, the roots of the financial crisis lay in the deregulation of financial markets.[329] A 2012 OECD study[330] suggest that bank regulation based on the Basel accords encourage unconventional business practices and contributed to or even reinforced the financial crisis. In other cases, laws were changed or enforcement weakened in parts of the financial system. Key examples include:
In November 1999, U.S. President Bill Clinton signed into law theGramm–Leach–Bliley Act, which repealed provisions of the Glass-Steagall Act that prohibited abank holding company from owning other financial companies. The repeal effectively removed the separation that previously existed between Wall Street investment banks and depository banks, providing a government stamp of approval for a universal risk-taking banking model. Investment banks such as Lehman became competitors with commercial banks.[334] Some analysts say that this repeal directly contributed to the severity of the crisis, while others downplay its impact since the institutions that were greatly affected did not fall under the jurisdiction of the act itself.[335][336]
In 2004, theU.S. Securities and Exchange Commission relaxed thenet capital rule, which enabled investment banks to substantially increase the level of debt they were taking on, fueling the growth in mortgage-backed securities supporting subprime mortgages. The SEC conceded that self-regulation of investment banks contributed to the crisis.[337][338]
Financial institutions in theshadow banking system are not subject to the same regulation as depository banks, allowing them to assume additional debt obligations relative to their financial cushion or capital base.[339] This was the case despite theLong-Term Capital Management debacle in 1998, in which a highly leveraged shadow institution failed with systemic implications and was bailed out.
Regulators and accounting standard-setters allowed depository banks such asCitigroup to move significant amounts of assets and liabilities off-balance sheet into complex legal entities calledstructured investment vehicles, masking the weakness of the capital base of the firm or degree ofleverage or risk taken.Bloomberg News estimated that the top four U.S. banks will have to return between $500 billion and $1 trillion to their balance sheets during 2009.[340] This increased uncertainty during the crisis regarding the financial position of the major banks.[341] Off-balance sheet entities were also used in theEnron scandal, which brought downEnron in 2001.[342]
As early as 1997, Federal Reserve chairmanAlan Greenspan fought to keep the derivatives market unregulated.[343] With the advice of theWorking Group on Financial Markets,[344] the U.S. Congress and President Bill Clinton allowed the self-regulation of theover-the-counter derivatives market when they enacted theCommodity Futures Modernization Act of 2000. Written by Congress with lobbying from the financial industry, it banned the further regulation of the derivatives market. Derivatives such ascredit default swaps (CDS) can be used to hedge or speculate against particular credit risks without necessarily owning the underlying debt instruments. The volume of CDS outstanding increased 100-fold from 1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to $47 trillion. Total over-the-counter (OTC) derivativenotional value rose to $683 trillion by June 2008.[345]Warren Buffett famously referred to derivatives as "financial weapons of mass destruction" in early 2003.[346][347]
A 2011 paper suggested that Canada's avoidance of a banking crisis in 2008 (as well as in prior eras) could be attributed to Canada possessing a single, powerful, overarching regulator, while the United States had a weak, crisis prone and fragmented banking system with multiple competing regulatory bodies.[348]
Leverage ratios of investment banks increased significantly between 2003 and 2007Household debt relative to disposable income and GDP
Prior to the crisis, financial institutions became highly leveraged, increasing their appetite for risky investments and reducing their resilience in case of losses. Much of this leverage was achieved using complex financial instruments such as off-balance sheet securitization and derivatives, which made it difficult for creditors and regulators to monitor and try to reduce financial institution risk levels.[349][verification needed]
U.S. households and financial institutions became increasingly indebted oroverleveraged during the years preceding the crisis.[350] This increased their vulnerability to the collapse of the housing bubble and worsened the ensuing economic downturn.[351] Key statistics include:
Free cash used by consumers from home equity extraction doubled from $627 billion in 2001 to $1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion over the period, contributing to economic growth worldwide.[19][20][21] U.S. home mortgage debt relative to GDP increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion (c. $15 trillion in 2024[285]).[18]
U.S. household debt as a percentage of annualdisposable personal income was 127% at the end of 2007, versus 77% in 1990.[350] In 1981, U.S. private debt was 123% of GDP; by the third quarter of 2008, it was 290%.[352]
From 2004 to 2007, the top five U.S.investment banks each significantly increased their financial leverage, which increased their vulnerability to a financial shock. Changes in capital requirements, intended to keep U.S. banks competitive with their European counterparts, allowed lowerrisk weightings for AAA-rated securities. The shift from first-losstranches to AAA-rated tranches was seen by regulators as a risk reduction that compensated the higher leverage.[353] These five institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of U.S. nominal GDP for 2007.Lehman Brotherswent bankrupt and was liquidated,Bear Stearns andMerrill Lynch were sold at fire-sale prices, andGoldman Sachs andMorgan Stanley became commercial banks, subjecting themselves to more stringent regulation. With the exception of Lehman, these companies required or received government support.[354]
Fannie Mae and Freddie Mac, two U.S.government-sponsored enterprises, owned or guaranteed nearly $5 trillion (c. $7.13 trillion in 2024[285]) trillion in mortgage obligations at the time they were placed intoconservatorship by the U.S. government in September 2008.[355][356]
These seven entities were highly leveraged and had $9 trillion in debt or guarantee obligations; yet they were not subject to the same regulation as depository banks.[339][357]
Behavior that may be optimal for an individual, such as saving more during adverse economic conditions, can be detrimental if too many individuals pursue the same behavior, as ultimately one person's consumption is another person's income. Too many consumers attempting to save or pay down debt simultaneously is called theparadox of thrift and can cause or deepen a recession. EconomistHyman Minsky also described a "paradox of deleveraging" as financial institutions that have too much leverage (debt relative to equity) cannot all de-leverage simultaneously without significant declines in the value of their assets.[351]
Once this massive credit crunch hit, it didn't take long before we were in a recession. The recession, in turn, deepened the credit crunch as demand and employment fell, and credit losses of financial institutions surged. Indeed, we have been in the grips of precisely this adverse feedback loop for more than a year. A process of balance sheet deleveraging has spread to nearly every corner of the economy. Consumers are pulling back on purchases, especially on durable goods, to build their savings. Businesses are cancelling planned investments and laying off workers to preserve cash. And financial institutions are shrinking assets to bolster capital and improve their chances of weathering the current storm. Once again, Minsky understood this dynamic. He spoke of the paradox of deleveraging, in which precautions that may be smart for individuals and firms—and indeed essential to return the economy to a normal state—nevertheless magnify the distress of the economy as a whole.[351]
The termfinancial innovation refers to the ongoing development of financial products designed to achieve particular client objectives, such as offsetting a particular risk exposure (such as the default of a borrower) or to assist with obtaining financing. Examples pertinent to this crisis included: theadjustable-rate mortgage; the bundling of subprime mortgages intomortgage-backed securities (MBS) orcollateralized debt obligations (CDO) for sale to investors, a type ofsecuritization; and a form of credit insurance called credit default swaps (CDS). The usage of these products expanded dramatically in the years leading up to the crisis. These products vary in complexity and the ease with which they can be valued on the books of financial institutions.[citation needed]
CDO issuance grew from an estimated $20 billion in Q1 2004 to its peak of over $180 billion by Q1 2007, then declined back under $20 billion by Q1 2008. Further, the credit quality of CDO's declined from 2000 to 2007, as the level of subprime and other non-prime mortgage debt increased from 5% to 36% of CDO assets. As described in the section on subprime lending, the CDS and portfolio of CDS calledsynthetic CDO enabled a theoretically infinite amount to be wagered on the finite value of housing loans outstanding, provided that buyers and sellers of the derivatives could be found. For example, buying a CDS to insure a CDO ended up giving the seller the same risk as if they owned the CDO, when those CDO's became worthless.[358]
Diagram of CMLTI 2006 – NC2
This boom in innovative financial products went hand in hand with more complexity. It multiplied the number of actors connected to a single mortgage (including mortgage brokers, specialized originators, the securitizers and their due diligence firms, managing agents and trading desks, and finally investors, insurances and providers of repo funding). With increasing distance from the underlying asset these actors relied more and more on indirect information (including FICO scores on creditworthiness, appraisals and due diligence checks by third party organizations, and most importantly the computer models of rating agencies and risk management desks). Instead of spreading risk this provided the ground for fraudulent acts, misjudgments and finally market collapse.[359] Economists have studied the crisis as an instance ofcascades in financial networks, where institutions' instability destabilized other institutions and led to knock-on effects.[360][361]
Martin Wolf, chief economics commentator at theFinancial Times, wrote in June 2009 that certain financial innovations enabled firms to circumvent regulations, such as off-balance sheet financing that affects the leverage or capital cushion reported by major banks, stating: "an enormous part of what banks did in the early part of this decade—the off-balance-sheet vehicles, the derivatives and the 'shadow banking system' itself—was to find a way round regulation."[362]
Mortgage risks were underestimated by almost all institutions in the chain from originator to investor by underweighting the possibility of falling housing prices based on historical trends of the past 50 years. Limitations of default and prepayment models, the heart of pricing models, led to overvaluation of mortgage and asset-backed products and their derivatives by originators, securitizers, broker-dealers, rating-agencies, insurance underwriters and the vast majority of investors (with the exception of certain hedge funds).[363][364] While financial derivatives and structured products helped partition and shift risk between financial participants, it was the underestimation of falling housing prices and the resultant losses that led to aggregate risk.[364]
For a variety of reasons, market participants did not accurately measure the risk inherent with financial innovation such as MBS and CDOs or understand its effect on the overall stability of the financial system.[251] The pricing model for CDOs clearly did not reflect the level of risk they introduced into the system. Banks estimated that $450 billion of CDO were sold between "late 2005 to the middle of 2007"; among the $102 billion of those that had been liquidated, JPMorgan estimated that the average recovery rate for "high quality" CDOs was approximately 32 cents on the dollar, while the recovery rate formezzanine capital CDO was approximately five cents for every dollar.
AIG insured obligations of various financial institutions through the usage ofcredit default swaps. The basic CDS transaction involved AIG receiving a premium in exchange for a promise to pay money to party A in the event party B defaulted. However, AIG did not have the financial strength to support its many CDS commitments as the crisis progressed and was taken over by the government in September 2008. U.S. taxpayers provided over $180 billion in government loans and investments in AIG during 2008 and early 2009, through which the money flowed to various counterparties to CDS transactions, including many large global financial institutions.[365][unreliable source?][366]
The Commission concludesAIG failed and was rescued by the government primarily because its enormous sales of credit default swaps were made without putting up the initial collateral, setting aside capital reserves, or hedging its exposure—a profound failure in corporate governance, particularly its risk management practices. AIG's failure was possible because of the sweeping deregulation of over-the-counter (OTC) derivatives, including credit default swaps, which effectively eliminated federal and state regulation of these products, including capital and margin requirements that would have lessened the likelihood of AIG's failure.[367][368][369]
The limitations of a widely used financial model also were not properly understood.[370][371] This formula assumed that the price of CDS was correlated with and could predict the correct price of mortgage-backed securities. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies.[371] According to oneWired article:
Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users ofLi's formula hadn't expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril ... Li'sGaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees.[371]
As financial assets became more complex and harder to value, investors were reassured by the fact that the internationalbond rating agencies and bank regulators accepted as valid some complex mathematical models that showed the risks were much smaller than they actually were.[372]George Soros commented that "The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility."[373]
Aconflict of interest betweeninvestment management professional andinstitutional investors, combined with a global glut in investment capital, led to bad investments by asset managers in over-priced credit assets. Professional investment managers generally are compensated based on the volume of clientassets under management. There is, therefore, an incentive for asset managers to expand their assets under management in order to maximize their compensation. As the glut in global investment capital caused the yields on credit assets to decline, asset managers were faced with the choice of either investing in assets where returns did not reflect true credit risk or returning funds to clients. Many asset managers continued to invest client funds in over-priced (under-yielding) investments, to the detriment of their clients, so they could maintain their assets under management. They supported this choice with a "plausible deniability" of the risks associated with subprime-based credit assets because the loss experience with early "vintages" of subprime loans was so low.[374]
Despite the dominance of the above formula, there are documented attempts of the financial industry, occurring before the crisis, to address the formula limitations, specifically the lack of dependence dynamics and the poor representation of extreme events.[375] The volumeCredit Correlation: Life After Copulas, published in 2007 byWorld Scientific, summarizes a 2006 conference held by Merrill Lynch in London where several practitioners attempted to propose models rectifying some of the copula limitations. See also the article by Donnelly and Embrechts[376] and the book by Brigo, Pallavicini and Torresetti, that reports relevant warnings and research on CDOs appeared in 2006.[377]
Securitization markets were impaired during the crisis
There is strong evidence that the riskiest, worst performing mortgages were funded through the "shadow banking system" and that competition from theshadow banking system may have pressured more traditional institutions to lower their underwriting standards and originate riskier loans.
In a June 2008 speech, President and CEO of theFederal Reserve Bank of New YorkTimothy Geithner—who in 2009 becameUnited States Secretary of the Treasury—placed significant blame for the freezing of credit markets on arun on the entities in the "parallel" banking system, also called theshadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls. Further, these entities were vulnerable because ofasset–liability mismatch, meaning that they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would force them to engage in rapid deleveraging, selling their long-term assets at depressed prices. He described the significance of these entities:
In early 2007, asset-backed commercial paper conduits, in structured investment vehicles, in auction-rate preferred securities, tender option bonds and variable rate demand notes, had a combined asset size of roughly $2.2 trillion. Assets financed overnight in tri-party repo grew to $2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the five largest investment banks totaled $4 trillion. In comparison, the total assets of the top five bank holding companies in the United States at that point were just over $6 trillion, and total assets of the entire banking system were about $10 trillion. The combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit cycles.[378]
This meant that nearly one-third of the U.S. lending mechanism was frozen and continued to be frozen into June 2009.[379] According to theBrookings Institution, at that time the traditional banking system did not have the capital to close this gap: "It would take a number of years of strong profits to generate sufficient capital to support that additional lending volume." The authors also indicate that some forms ofsecuritization were "likely to vanish forever, having been an artifact of excessively loose credit conditions". While traditional banks raised their lending standards, it was the collapse of the shadow banking system that was the primary cause of the reduction in funds available for borrowing.[29]
In a 2008 paper,Ricardo J. Caballero,Emmanuel Farhi, andPierre-Olivier Gourinchas argued that the financial crisis was attributable to "global asset scarcity, which led to large capital flows toward the United States and to the creation of asset bubbles that eventually burst".[380] Caballero, Farhi, and Gourinchas argued "that the sharp rise in oil prices following the subprime crisis – nearly 100 percent in just a matter of months and on the face of recessionary shocks – was the result of a speculative response to the financial crisis itself, in an attempt to rebuild asset supply. That is, the global economy was subject to one shock with multiple implications rather than to two separate shocks (financial and oil)."[380]
Long-only commodity index funds became popular – by one estimate investment increased from $90 billion in 2006 to $200 billion at the end of 2007, while commodity prices increased 71% – which raised concern as to whether these index funds caused the commodity bubble. The empirical research has been mixed.[381]
The cause of the global asset bubble can be partially attributable to the global savings glut. As theorized byAndrew Metrick, the demand for safe assets following the Asian Financial Crisis coupled with the lack of circulating treasuries created an unmet demand for "risk free" assets. Thus, institutional investors like sovereign wealth funds and pension funds began purchasing synthetic safe assets like Triple-A Mortgage Backed Securities.[382]
As a consequence, the demand for so-called safe assets fueled the free flow of capital into housing in the United States. This greatly worsened the crisis as banks and other financial institutions were incentivized to issue more mortgages than before.
Some commentators and economists associated with theAustrian School of economics, including formerU.S. Congressman Ron Paul and historianTom Woods, have offered alibertarian interpretation of the crisis which differs from the explanations centered on deregulation and government oversight. In Ron Paul's book,End the Fed, Paul argues that theFederal Reserve's prolonged policy ofartificially low interest rates in the early 2000s created acredit bubble that allowed for speculative investments and unsustainable levels of debt, particularly in housing.[383][384][385] In Tom Woods' bookMeltdown, he also contends that Federal Reserve manipulation of the money supply and credit markets distorted normal price signals, leading to widespread malinvestment, resulting in an inevitable correction.[386][387]
Paul and Woods also criticizedFannie Mae's andFreddie Mac's role in the crisis, asserting that the entities engaged in excessive risk-taking by expanding homeownership beyond sustainable levels.[388][389][383] In doing this, the government intervention createdmoral hazard by assuring large financial institutions that they would receive government support in times of crisis, which Paul and Woods believe encouraged riskier behavior.[386][390]
In his 1978 book,The Downfall of Capitalism and Communism,Ravi Batra suggests that growing inequality offinancial capitalism produces speculative bubbles that burst and result in depression and major political changes. He also suggested that a "demand gap" related to differing wage and productivity growth explains deficit and debt dynamics important to stock market developments.[392]
Marxian economics followersAndrew Kliman, Michael Roberts, and Guglielmo Carchedi, in contradistinction to theMonthly Review school represented by Foster, pointed to capitalism's long-term tendency of therate of profit to fall as the underlying cause of crises generally. From this point of view, the problem was the inability of capital to grow or accumulate at sufficient rates through productive investment alone. Low rates of profit in productive sectors led to speculative investment in riskier assets, where there was potential for greater return on investment. The speculative frenzy of the late 1990s and 2000s was, in this view, a consequence of a rising organic composition of capital, expressed through the fall in the rate of profit. According to Michael Roberts, the fall in the rate of profit "eventually triggered the credit crunch of 2007 when credit could no longer support profits".[394]
In 2005 book,The Battle for the Soul of Capitalism,John C. Bogle wrote that "Corporate America went astray largely because the power of managers went virtually unchecked by our gatekeepers for far too long". Echoing the central thesis ofJames Burnham's 1941 seminal book,The Managerial Revolution, Bogle cites issues, including:[395]
that "manager's capitalism" replaced "owner's capitalism", meaning management runs the firm for its benefit rather than for the shareholders, a variation on theprincipal–agent problem;
the burgeoning executive compensation;
the management of earnings, mainly a focus on share price rather than the creation of genuine value; and
the failure of gatekeepers, including auditors, boards of directors, Wall Street analysts, and career politicians.
In his bookThe Big Mo,Mark Roeder, a former executive at the Swiss-basedUBS Bank, suggested that large-scale momentum, orThe Big Mo, "played a pivotal role" in the financial crisis. Roeder suggested that "recent technological advances, such as computer-driven trading programs, together with the increasingly interconnected nature of markets, has magnified the momentum effect. This has made the financial sector inherently unstable."[396]
Robert Reich attributed the economic downturn to the stagnation of wages in the United States, particularly those of the hourly workers who comprise 80% of the workforce. This stagnation forced the population to borrow to meet the cost of living.[397]
EconomistsAilsa McKay andMargunn Bjørnholt argued that the financial crisis and the response to it revealed a crisis of ideas in mainstream economics and within the economics profession, and call for a reshaping of both the economy, economic theory and the economics profession.[398]
A report by theInternational Labour Organization concluded thatcooperative banking institutions were less likely to fail than their competitors during the crisis. The cooperative banking sector had 20% market share of the European banking sector, but accounted for only 7% of all the write-downs and losses between the third quarter of 2007 and first quarter of 2011.[399] In 2008, in the U.S., the rate of commercial bank failures was almost triple that ofcredit unions, and almost five times the credit union rate in 2010.[400] Credit unions increased their lending to small- and medium-sized businesses while overall lending to those businesses decreased.[401]
Economists, particularly followers ofmainstream economics, mostly failed to predict the crisis.[402] TheWharton School of the University of Pennsylvania's online business journal examined why economists failed to predict a major global financial crisis and concluded that economists used mathematical models that failed to account for the critical roles that banks and other financial institutions, as opposed to producers and consumers of goods and services, play in the economy.[403]
Shiller, a founder of theCase–Shiller index that measures home prices, wrote an article a year before the collapse of Lehman Brothers in which he predicted that a slowing U.S. housing market would cause the housing bubble to burst, leading to financial collapse.[406] Peter Schiff regularly appeared on television in the years before the crisis and warned of the impending real estate collapse.[407]
TheAustrian School regarded the crisis as a vindication and classic example of a predictable credit-fueled bubble caused by laxity in monetary supply.[408]
There were other economists that did warn of a pending crisis.[409]
The former Governor of theReserve Bank of India,Raghuram Rajan, had predicted the crisis in 2005 when he became chief economist at theInternational Monetary Fund. In 2005, at a celebration honoringAlan Greenspan, who was about to retire as chairman of theUS Federal Reserve, Rajan delivered a controversial paper that was critical of the financial sector.[410] In that paper, Rajan "argued that disaster might loom".[411] Rajan argued that financial sector managers were encouraged to "take risks that generate severe adverse consequences with small probability but, in return, offer generous compensation the rest of the time. These risks are known as tail risks. But perhaps the most important concern is whether banks will be able to provide liquidity to financial markets so that if the tail risk does materialize, financial positions can be unwound and losses allocated so that the consequences to the real economy are minimized."
Stock trader and financial risk engineerNassim Nicholas Taleb, author of the 2007 bookThe Black Swan, spent years warning against the breakdown of the banking system in particular and the economy in general owing to their use of and reliance on bad risk models and reliance on forecasting, and framed the problem as part of "robustness and fragility".[412][413] He also took action against the establishment view by making a big financial bet on banking stocks and making a fortune from the crisis ("They didn't listen, so I took their money").[414] According toDavid Brooks fromThe New York Times, "Taleb not only has an explanation for what's happening, he saw it coming."[415]
Popular articles published in the mass media have led the general public to believe that the majority of economists have failed in their obligation to predict the financial crisis. For example, an article inThe New York Times noted that economistNouriel Roubini warned of such crisis as early as September 2006, and stated that the profession of economics is bad at predicting recessions.[416] According toThe Guardian, Roubini was ridiculed for predicting a collapse of the housing market and worldwide recession, whileThe New York Times labelled him "Dr. Doom".[417]
In a 2012 article in the journalJapan and the World Economy, Andrew K. Rose and Mark M. Spiegel used a Multiple Indicator Multiple Cause (MIMIC) model on a cross-section of 107 countries to evaluate potential causes of the 2008 crisis. The authors examined various economic indicators, ignoringcontagion effects across countries. The authors concluded: "We include over sixty potential causes of the crisis, covering such categories as: financial system policies and conditions; asset price appreciation in real estate and equity markets; international imbalances and foreign reserve adequacy; macroeconomic policies; and institutional and geographic features. Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to link most of the commonly cited causes of the crisis to its incidence across countries. This negative finding in the cross-section makes us skeptical of the accuracy of 'early warning' systems of potential crises, which must also predict their timing."[418]
The first visible institution to run into trouble in the United States was the Southern California–basedIndyMac, a spin-off ofCountrywide Financial. Before its failure, IndyMac Bank was the largestsavings and loan association in the Los Angeles market and the seventh-largestmortgage loan originator in the United States.[419] The failure of IndyMac Bank on July 11, 2008, was (until the crisis precipitated even larger failures) the fourth-largestbank failure in United States history,[420] and the second-largest failure of a regulatedthrift.[421] IndyMac Bank's parent corporation was IndyMac Bancorp until the FDIC seized IndyMac Bank.[422] IndyMac Bancorp filed forChapter 7 bankruptcy in July 2008.[422]
IndyMac Bank was founded as Countrywide Mortgage Investment in 1985 byDavid S. Loeb andAngelo Mozilo[423][424] as a means ofcollateralizingCountrywide Financial loans too big to be sold to Freddie Mac and Fannie Mae. In 1997, Countrywide spun off IndyMac as an independent company run by Mike Perry, who remained its CEO until the downfall of the bank in July 2008.[425]
The primary causes of its failure were largely associated with its business strategy of originating and securitizingAlt-A loans on a large scale. This strategy resulted in rapid growth and a high concentration of risky assets. From its inception as a savings association in 2000, IndyMac grew to the seventh largest savings and loan and ninth largest originator of mortgage loans in the United States. During 2006, IndyMac originated over $90 billion (~$134 billion in 2024) of mortgages.
IndyMac's aggressive growth strategy, use of Alt-A and other nontraditional loan products, insufficient underwriting, credit concentrations in residential real estate in theCalifornia andFlorida markets—states, alongside Nevada and Arizona, where thehousing bubble was most pronounced—and heavy reliance on costly funds borrowed from aFederal Home Loan Bank (FHLB) and from brokered deposits, led to its demise when the mortgage market declined in 2007.
IndyMac often made loans without verification of the borrower's income or assets, and to borrowers with poor credit histories. Appraisals obtained by IndyMac on underlying collateral were often questionable as well. As an Alt-A lender, IndyMac's business model was to offer loan products to fit the borrower's needs, using an extensive array of risky option-adjustable-rate mortgages (option ARMs), subprime loans, 80/20 loans, and other nontraditional products. Ultimately, loans were made to many borrowers who simply could not afford to make their payments. The thrift remained profitable only as long as it was able to sell those loans in thesecondary mortgage market. IndyMac resisted efforts to regulate its involvement in those loans or tighten their issuing criteria: see the comment by Ruthann Melbourne, Chief Risk Officer, to the regulating agencies.[426][427][428]
On May 12, 2008, in the "Capital" section of its last 10-Q,IndyMac revealed that it may not be well capitalized in the future.[429]
IndyMac reported that during April 2008,Moody's andStandard & Poor's downgraded the ratings on a significant number ofMortgage-backed security (MBS) bonds—including $160 million (~$228 million in 2024) issued by IndyMac that the bank retained in its MBS portfolio. IndyMac concluded that these downgrades would have harmed its risk-based capital ratio as of June 30, 2008. Had these lowered ratings been in effect on March 31, 2008, IndyMac concluded that the bank's capital ratio would have been 9.27% total risk-based. IndyMac warned that if its regulators found its capital position to have fallen below "well capitalized" (minimum 10% risk-based capital ratio) to "adequately capitalized" (8–10% risk-based capital ratio) the bank might no longer be able to use brokered deposits as a source of funds.
SenatorCharles Schumer (D-NY) later pointed out that brokered deposits made up more than 37% of IndyMac's total deposits, and asked theFederal Deposit Insurance Corporation (FDIC) whether it had considered ordering IndyMac to reduce its reliance on these deposits.[430] With $18.9 billion in total deposits reported on March 31,[429] Senator Schumer would have been referring to a little over $7 billion in brokered deposits. While the breakout of maturities of these deposits is not known exactly, a simple averaging would have put the threat of brokered deposits loss to IndyMac at $500 million a month, had the regulator disallowed IndyMac from acquiring new brokered deposits on June 30.
IndyMac was taking new measures to preserve capital, such as deferring interest payments on some preferred securities. Dividends on common shares had already been suspended for the first quarter of 2008, after being cut in half the previous quarter. The company still had not secured a significant capital infusion nor found a ready buyer.[431]
IndyMac reported that the bank's risk-based capital was only $47 million above the minimum required for this 10% mark. But it did not reveal some of that $47 million (~$67 million in 2024) capital it claimed it had, as of March 31, 2008, was fabricated.[432]
When home prices declined in the latter half of 2007 and the secondary mortgage market collapsed, IndyMac was forced to hold $10.7 billion (~$15.5 billion in 2024) of loans it could not sell in the secondary market. Its reduced liquidity was further exacerbated in late June 2008 when account holders withdrew $1.55 billion (~$2.21 billion in 2024) or about 7.5% of IndyMac's deposits.[429] Thisbank run on the thrift followed the public release of a letter from Senator Charles Schumer to the FDIC and OTS. The letter outlined the Senator's concerns with IndyMac. While the run was a contributing factor in the timing of IndyMac's demise, the underlying cause of the failure was the unsafe and unsound way it was operated.[426]
On June 26, 2008, SenatorCharles Schumer (D-NY), a member of theSenate Banking Committee, chairman of Congress'Joint Economic Committee and the third-ranking Democrat in the Senate, released several letters he had sent to regulators, in which he was"concerned that IndyMac's financial deterioration poses significant risks to both taxpayers and borrowers." Some worried depositors began to withdraw money.[433][434]
On July 7, 2008, IndyMac announced on the company blog that it:
Had failed to raisecapital since its May 12, 2008, quarterly earnings report;
Had been notified by bank and thrift regulators that IndyMac Bank was no longer deemed "well-capitalized".
IndyMac announced the closure of both its retail lending and wholesale divisions, halted new loan submissions, and cut 3,800 jobs.[435]
On July 11, 2008, citing liquidity concerns, the FDIC put IndyMac Bank intoconservatorship. Abridge bank, IndyMac Federal Bank, FSB, was established to assume control of IndyMac Bank's assets, its secured liabilities, and its insured deposit accounts. The FDIC announced plans to open IndyMac Federal Bank, FSB on July 14, 2008. Until then, depositors would have access to their insured deposits through ATMs, their existing checks, and their existing debit cards. Telephone and Internet account access was restored when the bank reopened.[123][436][437] The FDIC guarantees the funds of all insured accounts up to US$100,000, and declared a special advance dividend to the roughly 10,000 depositors with funds in excess of the insured amount, guaranteeing 50% of any amounts in excess of $100,000.[421] Yet, even with the pending sale of Indymac to IMB Management Holdings, an estimated 10,000 uninsured depositors of Indymac are still at a loss of over $270 million.[438][439]
With $32 billion in assets, IndyMac Bank was one of the largest bank failures in American history.[440]
Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock andCountrywide Financial, as they could no longer obtain financing through the credit markets. Over 100 mortgage lenders went bankrupt during 2007 and 2008. Concerns that investment bankBear Stearns would collapse in March 2008 resulted in its fire-sale toJP Morgan Chase. The financial institution crisis hit its peak in September and October 2008. Several major institutions either failed, were acquired under duress, or were subject to government takeover. These includedLehman Brothers,Merrill Lynch, Fannie Mae, Freddie Mac,Washington Mutual,Wachovia,Citigroup, andAIG.[32] On October 6, 2008, three weeks after Lehman Brothers filed the largest bankruptcy in U.S. history, Lehman's former CEORichard S. Fuld Jr. found himself before RepresentativeHenry A. Waxman, the California Democrat who chaired theHouse Committee on Oversight and Government Reform. Fuld said he was a victim of the collapse, blaming a "crisis of confidence" in the markets for dooming his firm.[441]
A 2010 documentary film,Overdose: A Film about the Next Financial Crisis, describes how the financial crisis came about and how the solutions that have been applied by many governments are setting the stage for the next crisis. The film is based on the bookFinancial Fiasco byJohan Norberg and featuresAlan Greenspan, with funding from thelibertarian think tankCato Institute.[442]
Set on the night before the crisis broke, the 2011 filmMargin Call is a movie that follows traders through a sleepless 24 hours as they try to contain the damage after an analyst discovers information that is likely to ruin their firm, and possibly the whole economy.[444]
Michael Lewis authored a best-selling non-fiction book about the crisis, entitledThe Big Short. In 2015, it was adapted into afilm of the same name, which won theAcademy Award for Best Adapted Screenplay. One point raised is to what extent those outside of the markets themselves (i.e., not working for a mainstream investment bank) could forecast the events and be generally less myopic.
Simon Reid-Henry's 2019 bookEmpire of Democracy describes how liberal norms[which?] in the West were replaced by populism as a consequence of the 2007–08 financial crisis, as well asneoliberal policies[which?] that had emerged in previous decades which hollowed out government and changed voter expectations.
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^Demyank, Y.; Hemert, V. O. (June 2011). "Understanding the subprime mortgage crisis".Review of Financial Studies.24 (6):1848–1880.doi:10.1093/rfs/hhp033.
^Edey, M. (2009).The global financial crisis and its effects. Economics papers: A journal of applied economics and policy.{{cite book}}: CS1 maint: publisher location (link)
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^Brigo, Damiano; Pallavicini, Andrea; Torresetti, Roberto (May 2010).Credit Models and the Crisis: A Journey into CDOs, Copulas, Correlations and dynamic Models.Wiley.
John Lanchester,The Invention of Money: How the heresies of two bankers became the basis of our modern economy,The New Yorker, August 5 & 12, 2019, pp. 28–31
Julien Mercille & Enda Murphy, 2015,Deepening neoliberalism, austerity, and crisis: Europe's treasure Ireland,Palgrave Macmillan,Basingstoke.
Laura A. Patterson & Cynthia A. Koller (2011).Diffusion of Fraud Through Subprime Lending: The Perfect Storm. In Mathieu Deflem (ed.)Economic Crisis and Crime (Sociology of Crime Law and Deviance, Volume 16),Emerald Group Publishing, pp. 25–45.ISBN9780857248022.
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^David M. Kotz is Professor of Economics at the University of Massachusetts, Amherst, and Distinguished Professor, School of Economics, Shanghai University of Finance and Economics (source)
^18 high-ranking former ministers, Central Bank governors and/or officials in national or international institutions: Sergey Aleksashenko Former Deputy Governor, Central Bank of Russia.Hamad Al Sayari Former Governor, Saudi Arabian Monetary Agency.Jack T. Boorman Former Department Director and Special Advisor to the Managing Director, IMF.Michel Camdessus Former Managing Director, IMF.Andrew Crockett Former General Manager, BIS.Guillermo De la Dehesa Former State Secretary of Economy and Finance, Spain.Arminio Fraga Former Governor, Central Bank of Brazil.Toyoo Gyohten Former Vice Minister of Finance, Japan.Xiaolian Hu Vice President of China Society of Finance and Banking.André Icard Former Deputy General Manager, BIS.Horst Koehler Former Managing Director, IMF.Alexandre Lamfalussy Former General Manager, BIS.Guillermo Ortiz Former Governor, Banco de México.Tommaso Padoa-Schioppa (†) Former Minister of Finance, Italy.Maria Ramos Former Director General, National Treasury, South Africa.Y. Venugopal Reddy Former Governor, Reserve Bank of India.Edwin M. Truman Former Assistant Secretary for International Affairs of the U.S. Treasury.Paul A. Volcker Former Chairman, Federal Reserve Board.Joined by Isabelle Mateos y Lago Advisor, IMF. Pietro Catte Director, International Research Department, Banca d’Italia. Corrinne Ho Senior Economist, BIS. Irena Asmundson Economist, IMF.
