2007-2008-financial-crisis
Table of Contents
2007-2008 Financial Crisis
The 2007-2008 financial crisis was a severe global economic disruption originating in the United States, characterized by a collapse in housing prices, the failure or near-failure of major financial institutions, a freeze in credit markets, and a broader economic contraction that spread across much of the world. The crisis is generally dated from the summer of 2007, when stress in the subprime mortgage market became visible in credit markets, through late 2008 and into 2009, when economic output and employment fell sharply in the United States and internationally. The causes, the appropriate policy responses, and the degree to which regulatory failures, private-sector misconduct, or government policy each contributed remain subjects of active debate. See 2007-2008-financial-crisis-debate-primary-causes-debate for extended treatment of causation disputes.
Background
The crisis developed against a backdrop of rising U.S. housing prices through the late 1990s and early 2000s, an expansion of mortgage lending to borrowers with weak credit histories (subprime lending), and the widespread packaging of mortgage debt into complex financial instruments - mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) - that were sold to investors globally. Credit rating agencies assigned high ratings to many of these instruments, and financial institutions held them at substantial leverage. When U.S. housing prices began declining in 2006, default rates on subprime mortgages rose, and the value of mortgage-backed securities fell. For the full history of events, see 2007-2008-financial-crisis-history.
Current State of Knowledge
The sequence of events is well-documented: the failure of two Bear Stearns hedge funds in June 2007, a widening of credit spreads through late 2007, the collapse of Bear Stearns in March 2008 and its acquisition by JPMorgan Chase with Federal Reserve assistance, the failure of Lehman Brothers on 15 September 2008, the near-collapse of AIG and its government rescue, and the subsequent freezing of interbank lending markets. The U.S. Congress passed the Troubled Asset Relief Program (TARP) in October 2008, authorizing up to $700 billion for the Treasury to stabilize financial institutions.1) The Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted in July 2010 as the primary legislative response.2)
The global recession associated with the crisis resulted in significant job losses, a contraction in trade, and sovereign debt stress in several European countries. The U.S. unemployment rate peaked at 10 percent in October 2009.3)
Contested interpretations concern the relative weight of contributing factors: the role of government housing policy (particularly Fannie Mae, Freddie Mac, and the Community Reinvestment Act), the failures of private financial institutions and their risk models, the conduct of credit rating agencies, the role of deregulation or inadequate regulation, and the effectiveness and distributional consequences of the government response. These interpretations are treated in the Viewpoints and Controversies sections below.
Consensus Status
There is broad agreement among economists across institutions that the crisis involved a confluence of factors: excessive leverage in the financial system, mispriced and opaque mortgage-backed securities, failures of risk management at major institutions, and inadequate regulatory oversight of systemic risk.4)5) Agreement on this broad picture coexists with substantial disagreement about the weight of individual causes and the appropriateness of specific interventions. See 2007-2008-financial-crisis-consensus-contributing-factors-consensus.
Viewpoints
Market failure and deregulation: The crisis is best understood as the result of inadequate financial regulation, the repeal or erosion of Glass-Steagall-era constraints, and the failure to regulate derivatives markets - particularly credit default swaps. On this view, private actors exploited regulatory gaps and the implicit government guarantee backing large institutions. See 2007-2008-financial-crisis-market-failure-deregulation-viewpoint.
Government policy as primary driver: Federal housing policy - including mandates on Fannie Mae and Freddie Mac to expand lending to lower-income borrowers, Community Reinvestment Act pressure, and artificially low interest rates maintained by the Federal Reserve - distorted incentives and inflated the housing bubble. On this view, government intervention, not its absence, was the primary cause. See 2007-2008-financial-crisis-government-policy-primary-cause-viewpoint.
Financialization and systemic fragility: The crisis reflected deeper structural features of contemporary financial capitalism: the growth of shadow banking, excessive short-term debt financing of long-term assets, and the systemic risks created by financial complexity and concentration. Regulatory or policy reforms that do not address these features are insufficient. See 2007-2008-financial-crisis-financialization-systemic-fragility-viewpoint.
Bailout critique - moral hazard and distributional unfairness: The government response - TARP, the Fed's emergency lending facilities, and the rescue of specific institutions - socialized losses while leaving gains privatized. The rescues rewarded reckless behavior, entrenched too-big-to-fail institutions, and failed to protect homeowners, workers, and smaller investors who bore substantial losses. See 2007-2008-financial-crisis-bailout-moral-hazard-viewpoint.
Bailout defense - systemic necessity: The government interventions, however imperfect, prevented a systemic collapse that would have imposed far greater costs on the broader public. The counterfactual of non-intervention - including allowing major institutions to fail without managed resolution - posed risks of a second Great Depression. See 2007-2008-financial-crisis-bailout-systemic-necessity-viewpoint.
Controversies
Rating agency conduct: Credit rating agencies - Moody's, Standard & Poor's, and Fitch - assigned investment-grade ratings to mortgage-backed securities that subsequently suffered severe losses; the extent to which this reflected conflicts of interest, model failures, or fraud is disputed. See 2007-2008-financial-crisis-rating-agency-conduct-controversy.
Lehman Brothers decision: The Treasury and Federal Reserve's decision not to rescue Lehman Brothers - while intervening to rescue other institutions - has been disputed as to whether it was a deliberate policy choice, a legal and logistical impossibility, or a catastrophic error. See 2007-2008-financial-crisis-lehman-decision-controversy.
Prosecutorial response: The absence of criminal prosecutions of senior financial executives following the crisis, despite documented instances of misrepresentation and fraud, generated sustained public controversy and a significant body of legal and policy commentary. See 2007-2008-financial-crisis-prosecutorial-response-controversy.
Dodd-Frank scope and effectiveness: The Dodd-Frank Act was criticized by financial industry participants as excessive and by reform advocates as inadequate; subsequent modifications under the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 revived those disputes. See dodd-frank-act-scope-effectiveness-controversy.
Related Pages
1)
U.S. Department of the Treasury, “TARP Programs,” accessed 2024, https://home.treasury.gov/data/troubled-assets-relief-program.
2)
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).
3)
Bureau of Labor Statistics, “Labor Force Statistics from the Current Population Survey,” U.S. Department of Labor, accessed 2024.
4)
Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report (Washington, D.C.: U.S. Government Printing Office, 2011).
5)
Ben S. Bernanke, The Courage to Act: A Memoir of a Crisis and Its Aftermath (New York: W. W. Norton, 2015).
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