The 2008 Global Financial Crisis
A bank that survived the Civil War, two world wars, and the Great Depression died on a Monday, and the credit that runs the planet froze within the week
Open
The story people tell is that two thousand and eight was a shock, a storm out of a clear sky, an accident nobody could have priced in.
Warren Buffett had already called the instruments at the center of it "financial weapons of mass destruction" in two thousand and two, six years before Lehman Brothers fell.
Raghuram Rajan, the IMF's chief economist, told a room of central bankers in two thousand and five that the financial system carried a real risk of a catastrophic meltdown, and was, by his own account, received as a Luddite.
The commission that spent two years investigating the wreckage did not call any of it an accident.
Scene 1A Manhattan courtroom, one forty five in the morning
One forty five in the morning, September fifteenth, two thousand and eight. In a Manhattan federal court, lawyers file the bankruptcy petition for Lehman Brothers.
The bank was founded in eighteen fifty. It survived the Civil War, two world wars, and the Great Depression.
It lists six hundred thirty nine billion dollars in assets and six hundred nineteen billion dollars in debt. It is the largest bankruptcy filing in United States history.
By the time markets open in Asia, the short term credit that moves through the global economy every day has begun to freeze.
Scene 2The machine, ten years in the building
Mortgage brokers wrote home loans to borrowers who could not document their income.
Investment banks bought those loans by the thousand, bundled them into mortgage backed securities, sliced the securities into collateralized debt obligations, and sold the pieces to pension funds, town councils, and banks from Dusseldorf to Reykjavik.
Credit rating agencies stamped much of this paper triple A, the same grade as United States Treasury bonds.
On top of it sat credit default swaps, a market of side bets on whether the mortgages would pay, grown into the tens of trillions of dollars.
Buffett had already written down what he thought of it, in his letter to Berkshire Hathaway's shareholders.
· Berkshire Hathaway Chairman's Letter to Shareholders · 2002
“In our view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
Almost no one who was buying stopped. The market kept growing for six more years.
Scene 3Eighteen months of dominoes
The dominoes fell for eighteen months. In March two thousand and eight, the Federal Reserve backstopped the fire sale of Bear Stearns to JPMorgan with a guarantee of roughly twenty nine billion dollars.
On September seventh, the Treasury seized Fannie Mae and Freddie Mac, which stood behind about half of all American mortgages.
Lehman fell on September fifteenth. The next day the government lent eighty five billion dollars to the insurer AIG, which had written credit default swaps it could not honor. The commitment eventually reached one hundred eighty two billion.
That same day, a large money market fund broke the buck, its shares falling below one dollar, and a quiet run began on the three point five trillion dollar market that businesses use to make payroll.
Scene 4Washington, September 29, 2008
The House of Representatives rejects a seven hundred billion dollar bank rescue. The Dow Jones Industrial Average falls seven hundred seventy seven point six eight points that afternoon, its largest single day point drop to that date, erasing more than one trillion dollars in value.
Four days later, Congress reverses itself and passes the Troubled Asset Relief Program.
Treasury Secretary Henry Paulson, a former chief executive of Goldman Sachs, and Federal Reserve Chairman Ben Bernanke, a scholar of the Great Depression, inject capital directly into the banks.
Bernanke later testifies that twelve of the thirteen most important American financial institutions had been at risk of failing within weeks.
Scene 5Reykjavik and beyond
The contagion does not respect borders. Iceland's three largest banks, holding assets nearly ten times the size of the country's economy, collapse within a single week in October two thousand and eight.
World trade falls roughly twelve percent in two thousand and nine, the steepest drop since the nineteen thirties.
The International Labour Organization estimates that global unemployment rises by more than thirty million.
In the United States alone, about eight point seven million jobs disappear, unemployment reaches ten percent, and roughly ten million families lose their homes to foreclosure.
Two months after Lehman fell, Queen Elizabeth the Second visited the London School of Economics and asked the economists there the question everyone was asking.
· Remark at the opening of a new building at the London School of Economics · November 5, 2008
“Why did nobody notice it?”
Buffett had noticed it in two thousand and two. Rajan had noticed it in two thousand and five and been called a Luddite for it.
Five accounts
Five accounts of one collapse, and each one answers a different question about what actually happened.
academicDeregulation and Wall Street Failure
The Deregulation Account
The Financial Crisis Inquiry Commission's majority report, released in January two thousand and eleven, located the cause in a system that had been deregulated, over leveraged, and left to police itself.
The nineteen ninety nine repeal of the Glass Steagall Act tore down the wall between deposit taking banks and investment banks, and a two thousand act exempted credit default swaps from regulation entirely.
In two thousand and four, the Securities and Exchange Commission loosened its leverage limits, letting the five biggest investment banks borrow more than thirty dollars for every dollar of their own capital.
Alan Greenspan, who had chaired the Federal Reserve for nineteen years and championed self regulation, told Congress in October two thousand and eight that he had found a flaw in his own understanding of how markets worked.
The Commission's own verdict, after two years and more than seven hundred witnesses, was blunt.
“We conclude this financial crisis was avoidable. The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire.”
Read the full account
Narrative
The majority report of the Financial Crisis Inquiry Commission, released January 27, 2011, located the cause in a system that had been deregulated, over-leveraged, and left to police itself. The Commission traced a chain: mortgage lending standards collapsed, the securitization pipeline carried the bad loans across the world, over-the-counter derivatives multiplied the bets, and the credit rating agencies waved it all through. Its verdict was blunt. The crisis was avoidable. It was not a storm or a computer error. It was the result of human choices.
Deregulation set the stage. The 1999 repeal of the Glass-Steagall Act tore down the wall between deposit-taking banks and investment banks. The Commodity Futures Modernization Act of 2000 exempted credit default swaps from regulation. The Securities and Exchange Commission's 2004 decision to loosen leverage limits let the five big investment banks borrow more than 30 dollars for every dollar of their own capital. When the mortgages soured, a small loss on the underlying assets was enough to wipe out the firms holding them.
The rating agencies were, in the Commission's words, "essential cogs in the wheel of financial destruction." Moody's had rated tens of thousands of mortgage-related products; when it downgraded much of that paper in 2007, the market for it vanished overnight. Alan Greenspan, who had chaired the Federal Reserve for nineteen years and championed self-regulation, told a congressional committee in October 2008 that he had found "a flaw" in his understanding of how markets worked. The regulatory-failure account holds that the tools to prevent the crisis existed and were deliberately set aside.
Arguments
- Repeal of Glass-Steagall (1999) and the exemption of derivatives (2000) dismantled the regulatory guardrails
- The SEC's 2004 leverage rule let investment banks borrow more than 30 dollars for every dollar of capital
- Credit rating agencies stamped AAA on mortgage securities that were quietly deteriorating
- The FCIC concluded the crisis was avoidable, a product of human action and inaction
Sources
- The Financial Crisis Inquiry Report
- Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System
- The Big Short: Inside the Doomsday Machine
- 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown
victorThe Firefighters and Bailout Defenders
The Firefighters
Henry Paulson, Ben Bernanke, and Timothy Geithner, the three officials most identified with the rescue, later wrote a joint book arguing they had been handed a burning building, not the matches.
By September two thousand and eight the panic was self fulfilling. Healthy institutions were failing because lenders, terrified of the next Lehman, refused to lend to anyone.
Bernanke had spent his academic career studying how the Federal Reserve's passivity turned the nineteen twenty nine crash into the Great Depression.
Unemployment peaked at ten percent, painful, but far short of the twenty five percent of the nineteen thirties, and the banks repaid the rescue program with interest.
Bernanke testified to the commission investigating the crisis about exactly how close the system had come to collapse.
“Out of maybe the thirteen most important financial institutions in the United States, twelve were at risk of failure within a period of a week or two.”
Read the full account
Narrative
Henry Paulson, Ben Bernanke, and Timothy Geithner, the three officials most identified with the rescue, later wrote a joint book titled Firefighting. Their argument is that they were handed a burning building, not the matches. By September 2008 the panic was self-fulfilling: healthy institutions were failing because lenders, terrified of the next Lehman, refused to lend to anyone. The choice, in their telling, was not between bailout and justice. It was between bailout and depression.
They point to the counterfactual. Bernanke, who had spent his academic career studying how the Federal Reserve's passivity turned the 1929 crash into the Great Depression, testified that twelve of the thirteen largest American financial firms were within weeks of collapse. TARP, the Federal Reserve's emergency lending, the guarantee of the money market funds, and the stress tests of 2009 stopped the run. Unemployment peaked at 10 percent, painful but far short of the 25 percent of the 1930s. The banks repaid TARP with interest, and Treasury booked a profit on the bank programs.
The defenders concede the political cost. Rescuing the firms that caused the crisis, while millions lost homes and jobs, was, in Geithner's phrase, deeply unfair, and it left a lasting bitterness. But they insist that letting the system fail in order to punish the guilty would have punished everyone. "Plan beats no plan," was Geithner's mantra through the worst weeks. The measure of success, they argue, is the depression that did not happen.
Arguments
- The panic was systemic; healthy firms were failing alongside insolvent ones
- Bernanke testified that 12 of the 13 largest US financial firms were near collapse within weeks
- TARP and Federal Reserve action prevented a second Great Depression; bank funds were repaid at a profit
- Letting the system fail to punish bankers would have punished ordinary people most
Sources
vanquishedMain Street and Occupy - No Accountability
Main Street and Occupy
On September seventeenth, two thousand and eleven, a few hundred people occupied Zuccotti Park, a block from Wall Street.
Their slogan, we are the ninety nine percent, named a grievance that the bailout had crystallized. The banks that crashed the economy had been rescued with public money, and no one had gone to jail.
The main program for homeowners reached only a fraction of the families it promised to help, while Treasury injected capital into the banks within weeks. Roughly ten million families lost their homes to foreclosure.
Richard Fuld, who had run Lehman into the largest bankruptcy in American history, had taken home close to five hundred million dollars in the years before it filed.
Neil Barofsky, the inspector general appointed to oversee the bailout, put the suspicion at the center of all of it into one sentence.
“The suspicions that the system is rigged in favor of the largest banks and their elites are true.”
Read the full account
Narrative
On September 17, 2011, a few hundred people occupied Zuccotti Park, a block from Wall Street. Their slogan, "We are the 99 percent," named a grievance that TARP had crystallized: the banks that crashed the economy had been rescued with public money, and no one had gone to jail. Neil Barofsky, the inspector general appointed to oversee TARP, wrote that the suspicions the system was rigged in favor of the largest banks were, in a word, true.
The numbers behind the anger were concrete. While Treasury injected capital into the banks within weeks, the main program for homeowners, HAMP, was designed, in Barofsky's account, to "foam the runway" for the banks rather than to keep families in their homes; it reached a fraction of those it promised. Roughly 10 million families lost homes to foreclosure. Executives who had steered their firms into collapse left with fortunes intact: Richard Fuld had taken home close to 500 million dollars in the years before Lehman filed for bankruptcy.
The economist Joseph Stiglitz and others argued that the bailouts socialized the losses of a boom whose gains had been private. The gap between the recovery of asset prices, which restored the wealth at the top, and the long stagnation of wages, which did not, became the defining inequality of the 2010s. Occupy dissolved within months, but its vocabulary did not. "The 1 percent" entered ordinary speech, and the demand for accountability, unmet, curdled into a distrust of elites that reshaped politics on the left and the right.
Arguments
- The banks were rescued while roughly 10 million families lost their homes
- Not one senior Wall Street executive was criminally convicted for the crisis
- Homeowner relief under HAMP reached only a fraction of those it promised
- The bailout privatized the boom's gains and socialized its losses, widening inequality
Sources
- Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street
- The Price of Inequality: How Today's Divided Society Endangers Our Future
- Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America
- The Democracy Project: A History, a Crisis, a Movement
revisionistThe Global Periphery and Emerging Markets
The Global Periphery
The crisis was made in the mortgage markets of the United States and Europe, but the bill arrived everywhere.
When Western banks pulled money home to cover their losses, capital fled the developing world. A study for the Asian Development Bank estimated that developing Asia alone lost nine point six trillion dollars in financial assets in two thousand and eight.
World trade fell about twelve percent in two thousand and nine, and migrant workers sent home less money to families who depended on it.
China met the collapse of its export markets with a stimulus of four trillion yuan, roughly five hundred eighty six billion dollars, and the G twenty, seating China, India, and Brazil, replaced the G seven as the venue where the crisis was managed.
Brazil's president, Luiz Inacio Lula da Silva, stood beside Britain's prime minister in two thousand and nine and said exactly who he blamed.
“This crisis was caused by the irrational behaviour of white people with blue eyes, who before the crisis appeared to know everything and now demonstrate that they know nothing.”
Read the full account
Narrative
The crisis was made in the mortgage markets of the United States and Europe, but the bill arrived everywhere. When Western banks pulled money home to cover their losses, capital fled the developing world. Currencies from Seoul to Sao Paulo dropped; stock markets crashed on continents that had never traded a subprime bond. A study for the Asian Development Bank estimated that developing Asia alone lost 9.6 trillion dollars in financial assets in 2008, more than a full year of its output.
The transmission ran through trade and remittances, not derivatives. Demand in the rich world collapsed, and world trade fell about 12 percent in 2009. Commodity exporters watched prices swing violently. Migrant workers sent home less money. Countries that had followed the deregulation advice of the Washington institutions, from Latvia to Ukraine, needed IMF rescues, and the conditions attached often demanded the same austerity that had deepened earlier crises. Brazil's president, Luiz Inacio Lula da Silva, standing beside Britain's prime minister in 2009, said the crisis had been caused by the irrational behaviour of "white people with blue eyes."
The response reordered the global economy. China met the collapse of its export markets with a stimulus of 4 trillion yuan, roughly 586 billion dollars, that pulled commodity exporters through the downturn and accelerated its rise as an economic power. The G20, a forum that seated China, India, and Brazil at the table, replaced the G7 as the venue where the crisis was managed. For much of the Global South the lesson of 2008 was not the danger of too little regulation but the danger of depending on a Northern financial system that could export its failures and then dictate the terms of recovery.
Arguments
- The crisis originated in the North but capital flight and trade collapse struck the developing world hard
- Developing Asia lost an estimated 9.6 trillion dollars in financial assets in 2008
- IMF rescues in the periphery again arrived with austerity conditions attached
- China's stimulus and the rise of the G20 shifted global economic power
Sources
- This Time Is Different: Eight Centuries of Financial Folly
- World Economic Outlook - Crisis and Recovery
- The Globalization Paradox: Democracy and the Future of the World Economy
- Crisis Economics: A Crash Course in the Future of Finance
academicThe Causes Debate - Deregulation, Imbalances, or Government
The Causes Debate
Historians and economists agree on the sequence of the collapse and disagree, still, on its root.
Ben Bernanke's rival explanation blamed a global saving glut. Surpluses from China, oil exporters, and aging economies poured into American assets and drove down long term interest rates, inflating the housing bubble from the outside.
Peter Wallison, in a solo dissent from the Commission's report, argued the true cause was government housing policy, the affordable housing mandates on Fannie Mae and Freddie Mac.
Critics answered that mortgages packaged by private Wall Street firms defaulted at many times the rate of those bought by Fannie and Freddie, and that the worst subprime lenders operated outside those mandates entirely.
Wallison put his own conclusion as plainly as it can be put.
“The sine qua non of the financial crisis was U.S. government housing policy.”
Read the full account
Narrative
Historians and economists agree on the sequence of the collapse and disagree, still, on its root. Three explanations compete. The first blames deregulation and Wall Street excess, the account the FCIC majority endorsed. The second, associated with Ben Bernanke, blames a "global saving glut": surpluses from China, oil exporters, and aging economies poured into American assets, drove down long-term interest rates, and inflated the housing bubble from the outside. In this reading the flood of foreign money, not just lax rules, made the boom.
The third explanation blames government. Peter Wallison, in a solo dissent from the FCIC report, argued that the "sine qua non of the financial crisis was U.S. government housing policy," specifically the affordable-housing mandates on Fannie Mae and Freddie Mac that, he wrote, produced 27 million risky loans. Critics answered that mortgages packaged by private Wall Street firms defaulted at many times the rate of those bought by Fannie and Freddie, and that the worst subprime lenders were unregulated firms operating outside those mandates. The economist John Taylor added a fourth thread: the Federal Reserve held interest rates too low for too long after 2001, feeding the bubble.
Raghuram Rajan had warned of the danger in 2005, at a conference honoring the retiring Alan Greenspan, arguing that financial innovation had exposed the system to a small but real probability of a catastrophic meltdown; he was, by his own account, received as a Luddite. His later book Fault Lines argued that the deepest cause was political: decades of stagnant wages had been papered over with cheap credit, so that a housing boom stood in for rising incomes. The debate is not academic in its stakes. Whether one blames the banks, the world's savers, the government, or the Fed determines what one thinks should be regulated next.
Arguments
- Deregulation and Wall Street risk-taking (FCIC majority) versus a global saving glut of foreign capital (Bernanke)
- Wallison's dissent blamed government affordable-housing mandates on Fannie Mae and Freddie Mac
- Critics note that private-label subprime defaulted at far higher rates than government-backed loans
- Rajan's Fault Lines argues that cheap credit substituted for stagnant wages, a political root
Sources
- Fault Lines: How Hidden Fractures Still Threaten the World Economy
- The Global Saving Glut and the U.S. Current Account Deficit
- Hidden in Plain Sight: What Really Caused the World's Worst Financial Crisis and Why It Could Happen Again
- Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis
The turn
And here is what each account cannot hold.
Deregulation and Wall Street Failure
The Deregulation account has little to say about the borrowers and brokers who falsified mortgage applications, or about the global savings glut pouring in from outside the country it blames.
From the record
Borrowers and brokers who falsified mortgage applicationsGlobal capital flows and the savings glut driving down interest ratesGovernment housing mandates on Fannie Mae and Freddie MacThat the acute panic was halted by the same officials the account faultsThe Firefighters and Bailout Defenders
The Firefighters account is quiet about moral hazard, about too big to fail entrenched rather than ended, and about the officials' own regulatory roles before the crisis they had to put out.
From the record
Moral hazard and the entrenchment of too-big-to-failHomeowners receiving far less help than banks under HAMPThe absence of accountability for those who caused the crisisThe officials' own regulatory roles before the crisisMain Street and Occupy - No Accountability
The Main Street and Occupy account has little patience for the legal difficulty of prosecuting recklessness that was not, technically, fraud, and it does not mention that the rescue program it condemns was repaid at a profit.
From the record
The systemic case for stabilizing the financial systemThe legal difficulty of prosecuting recklessness rather than fraudThat TARP's bank investments were repaid at a profitThe roles of borrowers, Congress, and regulators over the preceding decadeThe Global Periphery and Emerging Markets
The Global Periphery account counts the developing world's losses precisely, and says less about the emerging markets that recovered faster than the West did, or the debt China's own stimulus quietly built up.
From the record
Domestic vulnerabilities in some emerging economies before the crisisThat many emerging markets recovered faster than the WestThe debt buildup that China's own stimulus set in motionThe Causes Debate - Deregulation, Imbalances, or Government
And the Causes Debate account, generous to every theory, is the quietest of all about plain fraud at the level of the individual loan, the one explanation none of the three competing schools wants to own.
From the record
The broad consensus on the mechanics of the panic itselfThe possibility that several causes were jointly necessaryBehavioral and outright fraud dimensions at the loan level
Close
Treasury eventually recovered its investment in the banks, at a profit.
Not one senior Wall Street executive went to prison for the crisis.
The distance between those two facts became the politics of the next decade.
The record
By the numbers
- Span
- 2007
- Killed
- No mass casualties; a 2014 BMJ study…
- Displaced
- ~8.7MUS jobs lost, roughly 10 million US home foreclosures, an…
- Place
- United States
Key figures
- Henry PaulsonUS Treasury Secretary (2006-2009), former CEO of Goldman Sachs; architect of TARP1946 to ?
- Ben BernankeChairman of the Federal Reserve (2006-2014); Great Depression scholar who led the emergency response1953 to ?
- Timothy GeithnerPresident of the New York Fed during the crisis, later Treasury Secretary (2009-2013); ran the 2009 bank stress tests1961 to ?
- Richard S. Fuld Jr.Chairman and CEO of Lehman Brothers; presided over the largest bankruptcy in US history1946 to ?
- Alan GreenspanChairman of the Federal Reserve (1987-2006); champion of self-regulation who later admitted "a flaw"1926 to ?
- Phil AngelidesChairman of the Financial Crisis Inquiry Commission, which concluded the crisis was avoidable1953 to ?
- Raghuram RajanIMF chief economist who warned of a "catastrophic meltdown" in 2005; author of Fault Lines1963 to ?
Primary sources
· The Financial Crisis Inquiry Report, Conclusions · January 2011
“We conclude this financial crisis was avoidable. The crisis was the result of human action and inaction, not of Mother Nature or computer models gone haywire.”
· Testimony to the House Committee on Oversight and Government Reform · October 23, 2008
“Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity, myself included, are in a state of shocked disbelief.”
· Testimony to the Financial Crisis Inquiry Commission · 2009
“September and October of 2008 was the worst financial crisis in global history, including the Great Depression.”
· Berkshire Hathaway Chairman's Letter to Shareholders · 2002
“In our view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
· Remark at the opening of a new building at the London School of Economics · November 5, 2008
“Why did nobody notice it?”
Threads
- September 11 and the War on TerrorNineteen men with box cutters turned the world’s most powerful military against two countries that didn’t attack it.
- The Arab SpringA fruit vendor set himself on fire in a town of 40,000. Within 60 days, three presidents had fallen.
- The Great DepressionThe 1930s became the benchmark catastrophe. Ben Bernanke, who had studied how the Federal Reserve let the money supply collapse after 1929, ran the 2008 rescue precisely to avoid repeating it.