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The 2007–2008 financial crisis, or the global financial crisis (GFC), was the most severe worldwide economic crisis since the 1929 Wall Street crash that began the Great Depression. Causes of the crisis included predatory lending in the form of subprime mortgages to low-income homebuyers and a resulting housing bubble, excessive risk-taking ...
- Overview
- Causes of the crisis
global economics
Also known as: global financial crisis
Written byBrian Duignan
Brian Duignan
Brian Duignan is a senior editor at Encyclopædia Britannica. His subject areas include philosophy, law, social science, politics, political theory, and religion.
Fact-checked byThe Editors of Encyclopaedia Britannica
Although the exact causes of the financial crisis are a matter of dispute among economists, there is general agreement regarding the factors that played a role (experts disagree about their relative importance).
First, the Federal Reserve (Fed), the central bank of the United States, having anticipated a mild recession that began in 2001, reduced the federal funds rate (the interest rate that banks charge each other for overnight loans of federal funds—i.e., balances held at a Federal Reserve bank) 11 times between May 2000 and December 2001, from 6.5 percent to 1.75 percent. That significant decrease enabled banks to extend consumer credit at a lower prime rate (the interest rate that banks charge to their “prime,” or low-risk, customers, generally three percentage points above the federal funds rate) and encouraged them to lend even to “subprime,” or high-risk, customers, though at higher interest rates (see subprime lending). Consumers took advantage of the cheap credit to purchase durable goods such as appliances, automobiles, and especially houses. The result was the creation in the late 1990s of a “housing bubble” (a rapid increase in home prices to levels well beyond their fundamental, or intrinsic, value, driven by excessive speculation).
Second, owing to changes in banking laws beginning in the 1980s, banks were able to offer to subprime customers mortgage loans that were structured with balloon payments (unusually large payments that are due at or near the end of a loan period) or adjustable interest rates (rates that remain fixed at relatively low levels for an initial period and float, generally with the federal funds rate, thereafter). As long as home prices continued to increase, subprime borrowers could protect themselves against high mortgage payments by refinancing, borrowing against the increased value of their homes, or selling their homes at a profit and paying off their mortgages. In the case of default, banks could repossess the property and sell it for more than the amount of the original loan. Subprime lending thus represented a lucrative investment for many banks. Accordingly, many banks aggressively marketed subprime loans to customers with poor credit or few assets, knowing that those borrowers could not afford to repay the loans and often misleading them about the risks involved. As a result, the share of subprime mortgages among all home loans increased from about 2.5 percent to nearly 15 percent per year from the late 1990s to 2004–07.
Third, contributing to the growth of subprime lending was the widespread practice of securitization, whereby banks bundled together hundreds or even thousands of subprime mortgages and other, less-risky forms of consumer debt and sold them (or pieces of them) in capital markets as securities (bonds) to other banks and investors, including hedge funds and pension funds. Bonds consisting primarily of mortgages became known as mortgage-backed securities, or MBSs, which entitled their purchasers to a share of the interest and principal payments on the underlying loans. Selling subprime mortgages as MBSs was considered a good way for banks to increase their liquidity and reduce their exposure to risky loans, while purchasing MBSs was viewed as a good way for banks and investors to diversify their portfolios and earn money. As home prices continued their meteoric rise through the early 2000s, MBSs became widely popular, and their prices in capital markets increased accordingly.
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May 13, 2015 · It is often claimed that the financial crisis that caused the Great Depression was a liquidity crisis, and the Federal Reserve’s refusal to act as a Lender of Last Resort in March 1933 caused the sequence of calamitous events that followed. 46 Thus, determining what caused this crisis and improving our diagnostic ability to assess the underlying nature of future crises based on this learning ...
- Anjan V. Thakor
- 2015
Aug 25, 2024 · The Fed cut its benchmark rate by three-quarters of a percentage point in January 2008. This was its biggest cut in a quarter-century as it sought to slow the economic slide. The bad news ...
- 2 min
May 26, 2024 · The global financial crisis of 2008 was the worst economic disaster since the Great Depression. It caused upheaval in financial markets around the world, brought down major banks, and left millions of people without homes, jobs or savings. At its core, the crisis was caused by a toxic combination of deregulation, excessive risk-taking, lax ...
Oct 8, 2022 · Risky adjustable-rate mortgages and lack of oversight on mortgage securitization created a crisis of global proportions in 2007 and 2008. The worst economic crisis since the Great Depression ...
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Aug 9, 2007 · The freezing of credit markets in August 2007 meant that Northern Rock’s aggressive funding model came to a juddering halt. In September 2007, the BBC’s economics editor Robert Peston broke the news that Northern Rock was in trouble. Following his report, depositors in the bank queued up outside its branches.
