History of the Global Financial Crisis

In the next three steps, we will look at the Global Financial Crisis that began in 2007. In the video, Paul and Peter discuss how the subprime mortgage began and explain some of the mistaken assumptions that the banks made in their new forms of financial engineering. This article then explains in more detail how the crash happened, and how it spread around the world.

How the crash happened

By 2006 some of the risky homeowners inevitably began to default on their loans. The supply of available housing now began to outstrip demand, a result of the wave of new building developments from Las Vegas to Ireland. House prices started to collapse. The value of the property that had provided collateral for the loans plummeted. Suddenly lots of investors were left holding pieces of paper for financial instruments whose value was far from clear. The investment banks had turned themselves into machines for generating and offloading these securitised loans. But none of them knew exactly what toxic assets they had on their own books. And they certainly didn’t trust what other banks might have lurking on their balance sheets. Banks started calling in loans, both from other financial institutions and from business customers.

The credit crunch

Credit dried up, and the whole highly financial system came to a grinding halt in September 2008. There was a run on the UK bank Northern Rock (that had got heavily into subprime loans), and the American investment banks Bear Stearns and Lehman Brothers collapsed. The crisis spread to other parts of the financial world. It was a house of cards that was in danger of complete collapse.

The weak suffer what they must?

As the entire financial system threatened to implode, the British and American governments stepped in. They created a massive bail-out of troubled banks, as well as a trillion-dollar economic stimulus plan. Even that was not enough to stop the crisis from spreading globally. Many countries around the world found themselves the casualties of a sovereign debt crisis. The banks that had been lending to countries such as Greece, Ireland and Italy began to get cold feet. They worried that those countries were the equivalent of delinquent homeowners, about to default on their loans. In a number of European countries, central banks lent vast sums to the governments keep them afloat. That allowed countries such as Greece and Ireland to pay back their loans to the big investment banks, most of which survived intact and didn’t suffer significant losses. But at the end of the day, it is ordinary citizens in those troubled countries who are paying the price for bailing out the banks. Large slices of tax revenues are taken up with repaying government debt.

• What do you think was the main cause of the crash in 2008?
• Do you think the crash was inevitable?
• What could have been done to prevent it?
• Why did the crisis spread to so many countries?

Further reading

• Tett, G. Fool’s Gold: How unrestrained greed corrupted a dream, shattered global markets and unleashed a catastrophe. London: Abacus; 2009.
• Tooze, A. How a decade of financial crises changed the world. Penguin Random House: London; 2018.