Financial crisis of 2007–08 is also called subprime mortgage crisis. The 2008 financial crisis was the worst economic disaster since the Great Depression of 1929. The collapse of Lehman Brothers, a sprawling global bank, in September 2008 almost brought down the world’s financial system. It took huge taxpayer-financed bail-outs to shore up the industry. It occurred despite the efforts of the Federal Reserve and U.S. Department of the Treasury. The crisis led to the Great Recession, where housing prices dropped more than the price plunge during the Great Depression. Two years after the recession ended, unemployment was still above 9%.
The Great Recession was a period of marked general decline observed in national economies globally that occurred between 2007–2009.
What caused the global financial crises?
The Federal Reserve, the central bank of the United States, having already anticipated the mild recession that began in 2001, reduced the federal funds rate 11 times between May 2000 and December 2001, from 6.5 percent to 1.75 percent. This significant decrease enabled banks to give consumer credit at a lower prime rate and encouraged them to lend even to high-risk customers, though at higher interest rates. Consumers took advantage of the cheap credit to purchase durable goods such as automobiles, and houses. The result was the creation in the late 1990s of a housing bubble.
The owing to the changes in banking laws beginning in the 1980s, banks were able to offer to subprime customer’s mortgage loans that were structured with balloon payments i.e, unusually large payments are due at or near the end of a loan period or adjustable interest. If home prices continued to increase, subprime borrowers could protect themselves against high mortgage payments by borrowing against the increased value of their homes or selling their homes at a profit. In the case of default, banks could repossess the property and sell it for more than the amount of the original loan. So, subprime lending represented a lucrative investment for many banks. And so many banks aggressively marketed subprime loans to customers with poor credit or few assets, knowing that those borrowers could not repay the loans and they also misleading them about the risks involved. As a result of this, the share of subprime mortgages among other home loans increased from about 2.5 percent to nearly 15 percent from the late 1990s to 2004–2007.
Contributing to the growth of subprime lending was the widespread practice of securitization, where banks bundled together hundreds of subprime mortgages and other less-risky forms of consumer debt and sold them in capital markets as bonds to investors, including hedge funds and pension funds. Bonds started being known as mortgage-backed securities, or MBSs, which guaranteed their purchasers to a share of the interest and principal payments on the underlying loans. Selling subprime mortgages as MBSs was said to be a good way for banks to increase liquidity and reduce risk exposure to loans. Purchasing MBSs was viewed as a good way for banks and investors to diversify their portfolios and earn money. As home prices continued to rise through the early 2000s, MBSs became widely popular, and their prices in capital markets increased accordingly.
Lastly, the long period of global economic stability and growth that came right before the crisis, began in the mid to late 1980s and is known as the Great Moderation, this had convinced many government officials, economists, and U.S. banking executives that extreme economic volatility was something of the past. That confidents together with an ideological climate emphasizing deregulation and the ability of financial firms to check themselves, led almost all of them to ignore clear signs of an impending crisis and bankers to continue reckless lending, borrowing, and securitization practices.
This was a tough time for the world and even after the crises was over, the after effect lasted a long time.