2008 financial crisis

Definition

The 2008 financial crisis was a severe worldwide economic downturn that began in the United States with the collapse of the housing market and the failure of major financial institutions. This crisis exposed vulnerabilities in the financial system, leading to massive government bailouts, significant declines in consumer wealth, and widespread unemployment, highlighting systemic issues within the economy.

5 Must Know Facts For Your Next Test

1. The crisis was triggered by a significant drop in housing prices, leading to high levels of mortgage defaults and foreclosures.
2. Major financial institutions like Lehman Brothers filed for bankruptcy in September 2008, which escalated fears about the global financial system.
3. Government interventions included the Troubled Asset Relief Program (TARP), which allocated $700 billion to purchase distressed assets and bolster banks.
4. The crisis led to widespread unemployment, with millions losing their jobs and homes, particularly impacting lower-income households.
5. Regulatory reforms such as the Dodd-Frank Act were introduced post-crisis to increase oversight of financial institutions and reduce systemic risks.

Review Questions

• How did subprime mortgages contribute to the 2008 financial crisis?
  • Subprime mortgages played a crucial role in the 2008 financial crisis as they were given to borrowers with poor credit histories, leading to high default rates. When housing prices began to fall, many borrowers could not meet their mortgage obligations, resulting in a wave of foreclosures. This collapse not only affected individual homeowners but also triggered a chain reaction that weakened financial institutions heavily invested in these risky loans.
• What were some of the key government interventions during the 2008 financial crisis, and what impact did they have on the economy?
  • Key government interventions included the Troubled Asset Relief Program (TARP), which provided $700 billion to purchase distressed assets and stabilize major banks. Other measures included lowering interest rates and implementing quantitative easing. These interventions aimed to restore confidence in the financial system and prevent further economic decline, but they also sparked debates about moral hazard and long-term effects on fiscal policy.
• Evaluate the long-term effects of the 2008 financial crisis on regulatory practices in the financial sector.
  • The 2008 financial crisis led to significant changes in regulatory practices within the financial sector, primarily through legislation like the Dodd-Frank Act. This act aimed to increase oversight of financial institutions, enhance consumer protections, and reduce systemic risks by implementing stricter capital requirements and stress tests for banks. While these reforms intended to prevent future crises, critics argue that they may have also stifled economic growth and innovation within the industry, raising ongoing questions about the balance between regulation and market freedom.

Related terms

Subprime mortgage: A type of mortgage offered to borrowers with poor credit histories, often leading to higher default rates and contributing significantly to the housing market collapse.

Derivatives: Financial instruments whose value is derived from an underlying asset, often used for hedging or speculation, but played a key role in amplifying the risks during the crisis.

Bailout: Financial support given by the government to prevent the collapse of institutions deemed 'too big to fail,' aimed at stabilizing the economy during the crisis.