Financial Crisis of 2000s

Financial Crisis of the Late
2000s
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Contents
Articles
Finance critique 1
Financial innovation 1
FIRE economy 4
Shadow banking system 7
Criticism of capitalism 11
Late capitalism 27
Post-Fordism 29
Post-industrial society 33
History of the financial crisis 36

Subprime crisis impact timeline 36
Subprime mortgage crisis 54
Financial crisis of 2007–2010 85
Causes of the financial crisis of 2007–2010 112
2000s energy crisis 133
Automotive industry crisis of 2008–2010 145
2010 European sovereign debt crisis 157
References
Article Sources and Contributors 174
Image Sources, Licenses and Contributors 177
Article Licenses
License 178
1
Finance critique
Financial innovation
There are several interpretations of the phrase financial innovation. In general, it refers to the creating and
marketing of new types of securities.
Why does financial innovation occur?

Economic theory has much to say about what types of securities should exist, and why some may not exist (why
some markets should be "incomplete") but little to say about why new types of securities should come into existence.
One interpretation of the Modigliani-Miller theorem is that taxes and regulation are the only reasons for investors to
care what kinds of securities firms issue, whether debt, equity, or something else. The theorem states that the
structure of a firm's liabilities should have no bearing on its net worth (absent taxes, etc.). The securities may trade at
different prices depending on their composition, but they must ultimately add up to the same value.
Furthermore, there should be little demand for specific types of securities. The capital asset pricing model, first
developed by Markowitz, suggests that investors should fully diversify and their portfolios should be a mixture of
the "market" and a risk-free investment. Investors with different risk/return goals can use leverage to increase the
ratio of the market return to the risk-free return in their portfolios. However, Richard Roll argued that this model was
incorrect, because investors cannot invest in the entire market. This implies there should be demand for instruments
that open up new types of investment opportunities (since this gets investors closer to being able to buy the entire
market), but not for instruments that merely repackage existing risks (since investors already have as much exposure
to those risks in their portfolio).
If the world existed as the Arrow-Debreu model posits, then there would be no need for financial innovation. The
Arrow-Debreu model assumes that investors are able to purchase securities that pay off if and only if a certain state
of the world occurs. Investors can then combine these securities to create portfolios that have whatever payoff they
desire. The fundamental theorem of finance states that the price of assembling such a portfolio will be equal to its
expected value under the appropriate risk-neutral measure.
Academic literature
Tufano (2003) and Duffie and Rahi (1995) provide useful reviews of the literature.
The extensive literature on principal-agent problems, adverse selection, and information asymmetry points to why
investors might prefer some types of securities, such as debt, over others like equity. Myers and Majluf (1984)
develop an adverse selection model of equity issuance, in which firms (which are trying to maximize profits for
existing shareholders) issue equity only if they are desperate. This was an early article in the pecking order literature,
which states that firms prefer to finance investments out of retained earnings first, then debt, and finally equity,
because investors are reluctant to trust any firm that needs to issue equity.
Duffie and Rahi also devote a considerable section to examining the utility and efficiency implications of financial
innovation. This is also the topic of many of the papers in the special edition of the Journal of Economic Theory in
which theirs is the lead article. The usefulness of spanning the market appears to be limited (or, equivalently, the
disutility of incomplete markets is not great).
Allen and Gale (1988) is one of the first papers to endogenize security issuance contingent on financial
regulation—specifically, bans on short sales. In these circumstances, they find that the traditional split of cash flows
between debt and equity is not optimal, and that state-contingent securities are preferred. Ross (1989) develops a
model in which new financial products must overcome marketing and distribution costs. Persons and Warther (1997)
studied booms and busts associated with financial innovation.
The fixed costs of creating liquid markets for new financial instruments appears to be considerable. Black and
Scholes (1974) describe some of the difficulties they encountered when trying to market the forerunners to modern
index funds. These included regulatory problems, marketing costs, taxes, and fixed costs of management, personnel,
and trading. Shiller (2008) describes some of the frustrations involved with creating a market for house price futures.
Historical examples of financial innovation
Examples of spanning the market

Some types of financial instrument became prominent after macroeconomic conditions forced investors to be more
aware of the need to hedge certain types of risk.
• The development of interest rate swaps in the early 1980s after interest rates skyrocketed.
• The development of credit default swaps in the early 2000s after the recession beginning in 2001 led to the
highest corporate-bond default rate in 2002 since the Great Depression.
Examples of mathematical innovation

• The market in options exploded after the development of the Black–Scholes model in 1973.
• The development of the CDO was heavily influenced by the popularization of the copula technique (Li 2000).
Futures, options, and many other types of derivatives have been around for centuries: the Japanese rice futures
market started trading around 1730. However, recent decades have seen an explosion use of derivatives and
mathematically-complicated securitization techniques. MacKenzie (2006) argues from a sociological point of view
that mathematical formulas actually change the way that economic agents use and price assets. Economists, rather
than acting as a camera taking an objective picture of the way the world works, actively change behavior by
providing formulas that let dispersed agents agree on prices for new assets.
Examples of innovation to avoid taxes and regulation

Miller (1986) places great emphasis on the role of taxes and government regulation in stimulating financial
innovation. Modigliani and Miller (1958) explicitly considered taxes as a reason to prefer one type of security over
another, despite that corporations and investors should be indifferent to capital structure in a fractionless world.
The development of checking accounts at U.S. banks was in order to avoid punitive taxes on state bank notes that
were part of the National Banking Act.
Some investors use total return swaps to convert dividends into capital gains, which are taxed at a lower rate.[1]
Many times, regulators have explicitly discouraged or outlawed trading in certain types of financial securities. In the
United States, gambling is mostly illegal, and it can be difficult to tell whether financial contracts are illegal
gambling instruments or legitimate tools for investment and risk-sharing. The Commodity Futures Trading
Commission is in charge of making this determination. The difficulty that the Chicago Board of Trade faced in
attempting to trade futures on stocks and stock indexes is described in Melamed (1996).
In the United States, Regulation Q drove several types of financial innovation to get around its interest rate ceilings,
including eurodollars and NOW accounts.
The role of technology in financial innovation

Some types of financial innovation are driven by improvements in computer and telecommunication technology. For
example, Paul Volcker suggested that for most people, the creation of the ATM was a greater financial innovation
than asset-backed securitization.[2] Other types of financial innovation affecting the payments system include credit
and debit cards and online payment systems like PayPal.
These types of innovations are notable because they reduce transaction costs. Households need to keep lower cash
balances -- if the economy exhibits cash-in-advance constraints then these kinds of financial innovations can
contribute to greater efficiency. Alvarez and Lippi (2009), using data on Italian households' use of debit cards, find
that ownership of an ATM card results in benefits worth €17 annually.
These types of innovations may also have an impact on monetary policy by reducing real household balances.
Especially with the increased popularity of online banking, households are able to keep greater percentages of their
wealth in non-cash instruments. In a special edition of 'International Finance' devoted to the interaction of electronic
commerce and central banking, Goodhart (2000) and Woodford (2000) express confidence in the ability of a central
bank to maintain its policy goals by affecting the short-term interest rate even if electronic money has eliminated the
demand for central bank liabilities, while Friedman (2000) is less sanguine.
Criticism
Some economists argue that financial innovation has little to no productivity benefit: Paul Volcker states that "there
is little correlation between sophistication of a banking system and productivity growth,"[2] that there is no "neutral
evidence that financial innovation has led to economic growth",[3] and that financial innovation was a cause of the
financial crisis of 2007–2010,[4] while Paul Krugman states that "the rapid growth in finance since 1980 has largely
been a matter of rent-seeking, rather than true productivity."[5]
Notes
[1] http:/ / www. internationaltaxreview. com/ ?Page=10& PUBID=35& ISS=24454& SID=700023& SM=&
SearchStr=passive%20investment%20income
[2] Crisis may be worse than Depression, Volcker says (http:/ / uk. reuters. com/ article/ marketsNewsUS/ idUKN2029103720090220), Feb 20,
2009
[3] 'Wake up, gentlemen', world's top bankers warned by former Fed chairman Volcker (http:/ / business. timesonline. co. uk/ tol/ business/
industry_sectors/ banking_and_finance/ article6949387. ece), The Times of London, December 9, 2009, by Patrick Hosking and Suzy Jagger
[4] Paul Volcker: ATM Was the Peak of Financial Innovation (http:/ / seekingalpha. com/ article/
177300-paul-volcker-atm-was-the-peak-of-financial-innovation), Tim Iacono, Seeking Alpha December 09, 2009
[5] Darling, I love you (http:/ / krugman. blogs. nytimes. com/ 2009/ 12/ 09/ darling-i-love-you/ ), Paul Krugman, The Conscience of a Liberal,
New York Times, December 9, 2009
Bibliography
• Alvarez, Fernando; Francesco Lippi (2009). "Financial Innovation and the Transactions Demand for Cash".
Econometrica 77 (2): 363–402. doi:10.3982/ECTA7451.
• Allen, Franklin; Douglas Gale (1988). "Optimal Security Design". The Review of Financial Studies 1 (3):
229–263. doi:10.1093/rfs/1.3.229.
• Friedman, Benjamin M. (2000). "Decoupling at the Margin: The Threat to Monetary Policy from the Electronic
Revolution in Banking". International Finance 3 (2): 261–272. doi:10.1111/1468-2362.00051.
• Goodhart, Charles A. E. (2000). "Can Central Banking Survive the IT Revolution?". International Finance 3 (2):
189–209. doi:10.1111/1468-2362.00048.
• Li, David X. “On default correlation: A copula function approach.” Journal of Fixed Income 9, no. 4 (March
2000).
• Duffie, Darrell; Rohit Rahi (1995). "Financial Market Innovation and Security Design: An Introduction". Journal
of Economic Theory 65 (1): 1–42. doi:10.1006/jeth.1995.1001.
• Melamed, Leo (1996). Leo Melamed: Escape to the Futures (First ed.). Wiley. ISBN 0471112151.
• MacKenzie, Donald (2006). An Engine, Not a Camera: How Financial Models Shape Markets. The MIT Press.
ISBN 0262134608.
• Miller, Merton H. (1986). "Financial Innovation: The Last Twenty Years and the Next" (http://jstor.org/stable/
2330693). The Journal of Financial and Quantitative Analysis 21 (4): 459–471. doi:10.2307/2330693.
• Myers, Stewart C.; Nicholas S. Majluf (1984). "Corporate financing and investment decisions when firms have
information that investors do not have". Journal of Financial Economics 13 (2): 187–221.
doi:10.1016/0304-405X(84)90023-0.
• Shiller, Robert J. (2008). Derivatives Markets for Home Prices (http://cowles.econ.yale.edu/P/cd/d16a/
d1648.pdf). Cowles Foundation Discussion Paper no. 1648.
• Persons, John C.; Vincent A. Warther (1997). "Boom and Bust Patterns in the Adoption of Financial
Innovations". The Review of Financial Studies 10 (4): 939–967. doi:10.1093/rfs/10.4.939.
• Ross, Stephen A. (1989). "Institutional Markets, Financial Marketing, and Financial Innovation" (http://jstor.
org/stable/2328769). The Journal of Finance 44 (3): 541–556. doi:10.2307/2328769.
• Tufano, Peter (2003). "Chapter 6 Financial innovation". The Handbook of the Economics of Finance. Volume 1,
Part 1. Elsevier. pp. 307–335. ISBN 1574-0102.
• Woodford, Michael (2000). "Monetary Policy in a World Without Money". International Finance 3 (2): 229–260.
doi:10.1111/1468-2362.00050.
FIRE economy
A FIRE economy is any economy based primarily on the paper intensive sectors of Finance, Insurance, and Real
Estate (FIRE). The term is credited to Eric Janszen.[1]
It's New York City's largest industry and a prominent part of the service industry in the U.S. overall economy and
other Western, developed countries. FIRE activities are unique in that they generate relatively large profit margins
with little productive resources or capital employed other than people and paper.
In recent years, FIRE has created a positive-feedback loop for rapid suburban development in the U.S. as new real
estate developments generate finance (mortgage) activities and associated insurance activity. This activity in turn
creates demand for yet further real estate development and the cycle feeds upon itself.
This term is used in the financial press and blogs; its origin is in the realm of North American industrial
classification. "Finance, Insurance, and Real Estate" is the title of 1992 U.S. Census Bureau Standard Industrial
Classification (SIC) Division H [2]. Its coverage [3] was "All domestic establishments that provide financial,
insurance, or real estate services." Its coverage was elaborated [4] in two-digit SIC codes 60 through 67. The SIC was
replaced by the North American (Canada, USA, Mexico) Industry Classification System [5] (NAICS) starting in
1997. The SIC had ten top-level divisions, NAICS has twenty. The new NAICS essentially split the old Division H
into code 52 Finance and Insurance [6] and code 53 Real Estate and Rental and Leasing [7].
The newer NAIC two-digit codes, 52 and 53, are extensively elaborated – down to the five-digit level. They remain
largely unchanged in the 2007 NAICS drill down chart [8] whose details are this for code 52 [9] and this for code 53
[10]
.
The entire mapping from SIC to NAICS is shown in this table [11] or this one [12].
The second use of the term derives from the study of financial capital and income – as opposed to industrial capital
and income. To characterize the so-called financial services industries, economists carved out part of the SIC/NAIS
breakdown of types of industry: finance, insurance, and real estate. They contracted this to FIRE, deliberately
FIRE economy 5
invoking the negative connotations which were, at least then, contrary to conventional wisdom. The following table
elaborates on this dichotomy in the header row and gives examples in ensuing rows.
Financial sector, Real / Theses Authority

note 1) Productive /
Industrial
Sector, note
2)
Finance, Labor at the Political reform to bring market prices in line with socially necessary cost-value was the Michael Hudson.
insurance and bottom great economic issue of the 19th century. The labor theory of intrinsic cost-value found its Orwellian
real estate counterpart in the theory of economic rent: land rent, monopoly price gouging, interest and Doublethink:
(FIRE) at the top other returns to special privilege that increased market prices purely by institutional "Nationalize the
property claims. Prior to World War I, the classical economists, the American banks." "Free
Progressives, and others involved in discourse on political economy understood free Markets." – The
markets to mean markets free of economic rent and interest – free of rentier overhead language of
charges and monopoly pricing, free of land-rent, free of interest paid to bankers and [13]
deception
wealthy financial institutions, and free of taxes to support an oligarchy. Free of 'free
lunches'. A "free market" was an active political creation and required regulatory vigilance.
Since World War I, the term free markets has gradually come to mean markets free of
public regulation and free of empowered bureaucrats. In the redefinition of free market
self-regulatory organizations rather than oversight and regulation by government
implement any structuring or procedures necessary to maintain fair and orderly markets.
"Financial "Productive Capricious changes in marginal productivity, whether up or down, destroy productive Antal Fekete
capital" capital" capital. In the vast literature of mainstream economics there is not one sentence written Fekete home page
[16]
about the deleterious effects of destabilizing interest rates on the value of industrial capital.
[14]
This stems from a deliberate confusion between (productive) capital and credit. The
present banking crisis is the result of wiping out the capital of the financial sector, through
the same process that has wiped out the capital of the producing sector: the Federal
[15]
Reserve's deliberate and declared policy to drive down interest rates.
"Unearned Income from Most capital gains are land-value gains. The big players do not want their profits in rent, Michael Hudson.
income" / "industry and which is taxed as ordinary income, but in capital gains, taxed at a lower rate … in the era The Next Big Bail
"predatory labor" of progressive taxation more than two centuries of classical economic analysis had shown Outs: State, Local
wealth" the logic of taxing predatory wealth (land ownership, monopoly rights and financial claims and Private
on the economy) rather than labor and industry. The objective was to tax all forms of [17]
Pensions
income not necessary for production to take place. The early income tax captured such
"unearned income." To minimize their tax liability in an epoch when they were the major
parties being taxed, the FIRE sector opposed government spending as such, including
public services, medical care and even basic infrastructure. This set financial and property
interests in opposition to those of industry and labor. Ever since the United States enacted
its first modern income tax in 1913, finance and its major clients – real estate and
monopolies – have lobbied to distort the tax code to make their gains tax-exempt.
"Economy Bill Gross

"Finance-based Future finance-based consumption … is limited by our ability to keep pumping lower and
[18] based on
economy" lower yields, which in the past have led to higher and higher TIPS, home, stock, and
production" [19]
associated asset prices. "…during the past five years wealth has come more from
finance-based miracles than those based on productivity."
Earned No theses required These terms are

Unearned
[20] income definitional with
income
respect to financial
income and real
income
respectively.
Notes:
FIRE economy 6
1) Financial capital is money, particularly money based on debt, rather than money which is a commodity such as
silver. Financial income is interest on debt or capital gains based on rising asset prices.
2) Real capital is factories, commodities, intellectual property, and relevant labor pool. Real income is the value
added on goods and services produced, or the money paid for such.
The term may be subtly pejorative as the major output of a FIRE economy is paper; there is thus a corresponding
implication of paper burning, or of paper fueling a fire – indicating perhaps a false sense of economic well being
upon which these economies are based.
Criticisms
Much criticism exists on the internet and in the blogosphere for the shifting of the U.S. economy to a FIRE economy
at the expense of a manufacturing and export-based economy. As the consumer of last resort, many believe that the
United States has eschewed productive elements of its economy in favor of consumption to its long term detriment.
A common theme of these criticisms is that FIRE is really a non productive, paper-based system in which
participants trade pieces of paper and are not in fact involved in any real productive activity.
Particularly after 1973 … pundits of the status quo hailed the proliferation of the "FIRE" (finance,
insurance, real estate) economy as the coming of a new "service" "post-industrial" economy that would
replace the old "smokestack" economy and the jobs lost through plant closings, restructuring, and
down-sizing … Loren Goldner [21]
Examples of FIRE economies

• New York City
• Richmond, VA
See also
• Exurb
• Boomburbs
• Edge city
• Financialization
References
• Barry Popik, Oxford English Dictionary contributor [22]
[1] http:/ / harpers. org/ archive/ 2008/ 02/ 0081908
[2] http:/ / www. census. gov/ epcd/ www/ sic. html
[3] http:/ / www. census. gov/ econ/ www/ se0100. html
[4] http:/ / www. census. gov/ epcd/ ec97brdg/ INDXSIC2. HTM#H
[5] http:/ / www. census. gov/ eos/ www/ naics/
[6] http:/ / www. census. gov/ epcd/ www/ 97EC52. HTM
[7] http:/ / www. census. gov/ epcd/ www/ 97EC53. HTM
[8] http:/ / www. census. gov/ cgi-bin/ sssd/ naics/ naicsrch?chart=2007
[9] http:/ / www. census. gov/ cgi-bin/ sssd/ naics/ naicsrch?chart_code=52& search=2007%20NAICS%20Search
[10] http:/ / www. census. gov/ cgi-bin/ sssd/ naics/ naicsrch?chart_code=53& search=2007%20NAICS%20Search
[11] http:/ / www. census. gov/ epcd/ www/ naicsect. htm
[12] http:/ / www. census. gov/ epcd/ ec97brdg/
[13] http:/ / www. globalresearch. ca/ index. php?context=va& aid=12418
[14] Fiat Currency: Destroyer Of (Industrial) Capital (http:/ / www. professorfekete. com/ articles. asp)
[15] An Unhappy New Year (http:/ / www. professorfekete. com/ articles. asp)
[16] http:/ / www. professorfekete. com/
[17] http:/ / www. michael-hudson. com/ articles/ financial/ 080731NextBigBailOut. html
FIRE economy 7
[18] Bill Gross of PIMCO discussed the concept of an economy based on finance versus production using the term "Finance Based Economy" in
2006.
[19] This was written in 2005
[20] According to Adam Smith free market means "free of unearned income".
[21] http:/ / home. earthlink. net/ ~lrgoldner/ dollarcrisis. html
[22] http:/ / www. barrypopik. com/ index. php/ new_york_city/ entry/ fire_finance_insurance_real_estate_ice_intellectual_cultural_educational/
Shadow banking system

The shadow banking system or the shadow financial system consists of non-depository banks and other financial
entities (e.g., investment banks, hedge funds, and money market funds) that grew in size dramatically after the year
2000 and play an increasingly critical role in lending businesses the money necessary to operate. By June 2008, the
U.S. shadow banking system was approximately the same size as the U.S. traditional depository banking system. The
equivalent of a bank run occurred within the shadow banking system during 2007-2008, when investors stopped
providing funds to (or through) many entities in the system. Disruption in the shadow banking system is a key
component of the ongoing subprime mortgage crisis.
Entities that make up the system

By definition, shadow institutions do not accept deposits like a depository bank and therefore are not subject to the
same regulations. Familiar examples of shadow institutions included Bear Stearns and Lehman Brothers. Other
complex legal entities comprising the system include hedge funds, SIVs, conduits, money funds, monolines,
investment banks, and other non-bank financial institutions.
Shadow banking institutions are typically intermediaries between investors and borrowers. For example, an
institutional investor like a pension fund may be willing to lend money, while a corporation may be searching for
funds to borrow. The shadow banking institution will channel funds from the investor(s) to the corporation, profiting
either from fees or from the difference in interest rates between what it pays the investor(s) and what it receives from
the borrower.
Importance
Many "shadow bank" like institutions and vehicles have emerged in American and European markets, between the
years 2000 and 2008, and have come to play an important role in providing credit across the global financial
system.[1]
In a June 2008 speech, U.S. Treasury Secretary Timothy Geithner, then President and CEO of the NY Federal
Reserve Bank, described the growing importance of the shadow banking system: "In early 2007, asset-backed
commercial paper conduits, in structured investment vehicles, in auction-rate preferred securities, tender option
bonds and variable rate demand notes, had a combined asset size of roughly $2.2 trillion. Assets financed overnight
in triparty repo grew to $2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion. The combined balance
sheets of the then five major investment banks totaled $4 trillion. In comparison, the total assets of the top five bank
holding companies in the United States at that point were just over $6 trillion, and total assets of the entire banking
system were about $10 trillion."[2] In other words, lending through the shadow banking system slightly exceeded
lending via the traditional banking system based on outstanding balances.
Risks or vulnerability
Shadow institutions are not subject to
the same safety and soundness
regulations as depository banks,
meaning they do not have to keep as
much money in the proverbial vault
relative to what they borrow and lend.
In other words, they can have a very
high level of financial leverage, with a
high ratio of debt relative to the liquid
assets available to pay immediate
claims. High leverage magnifies profits
during boom periods and losses during
downturns.
Shadow institutions like investment

banks borrowed from investors in
Securitization markets were impaired during the crisis
short-term, liquid markets (such as the
money market and commercial paper
markets), meaning that they would have to frequently repay and borrow again from these investors. On the other
hand, they used the funds to lend to corporations or to invest in longer-term, less liquid (i.e., harder to sell) assets. In
many cases, the long-term assets purchased were the mortgage-backed securities sometimes called "toxic assets" or
"legacy assets" in the press. These assets declined significantly in value as housing prices declined and foreclosures
increased during 2007-2009.
In the case of investment banks, this reliance on short-term financing required them to return frequently to investors
in the capital markets to refinance their operations. When the housing market began to deteriorate and the ability to
obtain funds from investors through investments such as mortgage-backed securities declined, these investment
banks were unable to fund themselves. Investor refusal or inability to provide funds via the short-term markets was a
primary cause of the failure of Bear Stearns and Lehman Brothers during 2008.
In technical terms, these institutions are subject to market risk, credit risk and especially liquidity risk, since their
liabilities are short-term while their assets are more long term and illiquid. This creates a potential problem in that
they are not depositary institutions and do not have direct or indirect access to the support of their central bank in its
role as lender of last resort. Therefore, during periods of market illiquidity, they could go bankrupt if unable to
refinance their short-term liabilities. They were also highly leveraged. This meant that disruptions in credit markets
would make them subject to rapid deleveraging, meaning they would have to pay off their debts by selling their
long-term assets. [3]
The securitization markets frequently tapped by the shadow banking system started to close down in the spring of
2007 and nearly shut-down in the fall of 2008. More than a third of the private credit markets thus became
unavailable as a source of funds.[4] In February 2009, Ben Bernanke stated that securitization markets remained
effectively shut, with the exception of conforming mortgages, which could be sold to Fannie Mae and Freddie
Mac.[5]
U.S. Treasury Secretary Timothy Geithner stated that the "combined effect of these factors was a financial system
vulnerable to self-reinforcing asset price and credit cycles."[6]
History
The term "shadow banking system" is attributed to Paul McCulley of PIMCO, who coined it at the 2007 Jackson
Hole conference, where he defined it as "the whole alphabet soup of levered up non-bank investment conduits,
vehicles, and structures."[7] [8] [9] McCulley identifies the birth of the shadow banking system with the development
of money market funds in the 1970s – money market accounts function largely as bank deposits, but money market
funds are not regulated as banks.[10]
The concept of credit growth by unregulated institutions, though not the term "shadow banking system", date at least
to Prices and Production [11], by Friedrich Hayek, 1935, which includes:[12]
There can be no doubt that besides the regular types of the circulating medium, such as coin, notes and bank
deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by
some central authority or can at least be imagined to be so regulated, there exist still other forms of media of
exchange which occasionally or permanently do the service of money.
...
The characteristic peculiarity of these forms of credit is that they spring up without being subject to any central
control, but once they have come into existence their convertibility into other forms of money must be possible
if a collapse of credit is to be avoided.
Examples
During 1998, hedge fund Long-term Capital Management failed and was bailed-out by several major banks with
government urging, citing concerns of damage to the broader financial system. It was highly leveraged and
unregulated.[13]
Structured investment vehicles (SIVs) first came to light during the Enron scandal. Since then, their use has become
widespread in the financial world. In the years leading up to the crisis, the top four U.S. depository banks moved an
estimated $5.2 trillion in assets and liabilities off-balance sheet into special purpose vehicles or similar entities. This
enabled them to essentially bypass existing regulations regarding minimum capital ratios, thereby increasing
leverage and profits during the boom but increasing losses during the crisis. New accounting guidance will require
them to put some of these assets back onto their books during 2009, which will significantly reduce their capital
ratios. One news agency estimated this amount to be between $500 billion and $1 trillion. This effect was considered
as part of the stress tests performed by the government during 2009.[14]
The shadow banking system also conducts an enormous amount of trading activity in the OTC derivatives market,
which grew exponentially in the decade prior to the 2008 financial crisis, reaching upwards of $650 trillion dollars in
notional contracts traded (see the Bank for International Settlements (BIS.org) bi-annual report). Credit derivatives
in particular, collateralised debt obligations (CDOs), tranches of interest rate obligations derived from bundles of
mortgage securities, a variety of customized or synthetic innovations on the CDO model, and credit default swaps
(CDS's), a form of quasi-insurance against the default risk inherent in the assets underlying the CDO's, saw the most
rapid and explosive growth in this shadow market. The market in CDS's, for example, rose from insignificantly small
in 2004 to over $60 trillion dollars in a few short years[15] . Because credit default swaps were not regulated as actual
insurance contracts, companies selling them were not required to maintain sufficient capital reserves to pay off on
potential claims. Demands of settlement on hundreds of billions of dollars of credit default swaps contracts offered
by a division of AIG, the largest insurance company in the world, led to its financial collapse. Despite the prevalence
of this activity and the volume of contracts involved, it attracted little outside attention before 2007, and much of the
activity was off-balance sheet for the entities affiliated banks. The uncertainty this created among counterparties was
a contributing factor when credit conditions worsened.
Since then the shadow banking system has been blamed[1] for aggravating the subprime mortgage crisis and helping
to transform it into a global credit crunch.[16]
Contribution to the 2007–2010 financial crisis

The shadow banking system has been implicated as significantly contributing to the financial crisis of
2007–2010.[17] In a June 2008 speech, U.S. Treasury Secretary Timothy Geithner, then President and CEO of the
NY Federal Reserve Bank, placed significant blame for the freezing of credit markets on a "run" on the entities in the
shadow banking system by their counterparties. The rapid increase of the dependency of bank and non-bank
financial institutions on the use of these off-balance sheet entities to fund investment strategies had made them
critical to the credit markets underpinning the financial system as a whole, despite their existence in the shadows,
outside of the regulatory controls governing commercial banking activity. Furthermore, these entities were
vulnerable because they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This
meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term
assets at depressed prices.[18]
Nobel laureate Paul Krugman described the run on the shadow banking system as the "core of what happened" to
cause the crisis. "As the shadow banking system expanded to rival or even surpass conventional banking in
importance, politicians and government officials should have realized that they were re-creating the kind of financial
vulnerability that made the Great Depression possible—and they should have responded by extending regulations
and the financial safety net to cover these new institutions. Influential figures should have proclaimed a simple rule:
anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated
like a bank." He referred to this lack of controls as "malign neglect."[19]
See also
• Long-term Capital Management
• Recession
• Structured investment vehicle
• Subprime mortgage crisis
• Subprime crisis background information
• Subprime mortgage crisis solutions debate
References
[1] Out of the shadows: How banking’s secret system broke down (http:/ / www. ft. com/ cms/ s/ 0/ 42827c50-abfd-11dc-82f0-0000779fd2ac.
html?nclick_check=1) By Gillian Tett and Paul J Davies,December 16 2007 18:33
[2] Geithner-Speech Reducing Systemic Risk in a Dynamic Financial System (http:/ / www. newyorkfed. org/ newsevents/ speeches/ 2008/
tfg080609. html)
[3] FT Roubini - The Shadow Banking System is Unraveling (http:/ / www. ft. com/ cms/ s/ 0/ 622acc9e-87f1-11dd-b114-0000779fd18c. html)
[4] "Nicole Gelinas-Can the Fed's Uncrunch Credit?" (http:/ / www. city-journal. org/ 2009/ 19_1_credit. html). City-journal.org. . Retrieved
2009-02-27.
[5] "Bernanke" (http:/ / www. federalreserve. gov/ newsevents/ testimony/ bernanke20090224a. htm). . Retrieved 2009-02-24.
tfg080609. html)
[7] Teton Reflections (http:/ / www. pimco. com/ LeftNav/ Featured+ Market+ Commentary/ FF/ 2007/ GCBF+ August-+ September+ 2007.
htm), by Paul McCulley, August/September 2007
[8] Beware our shadow banking system, Bill Gross, November 28 2007 (http:/ / money. cnn. com/ 2007/ 11/ 27/ news/ newsmakers/
gross_banking. fortune/ )
[9] Comments Before the Money Marketeers Club: Playing Solitaire with a Deck of 51, with Number 52 on Offer (http:/ / www. pimco. com/
LeftNav/ Featured+ Market+ Commentary/ FF/ 2009/ Global+ Central+ Bank+ Focus+ April+ 2009+ Money+ Marketeers+ Solitaire+
McCulley. htm), Paul McCulley
[10] After the Crisis: Planning a New Financial Structure: Learning from the Bank of Dad (http:/ / www. pimco. com/ LeftNav/ Featured+
Market+ Commentary/ FF/ 2010/ Global+ Central+ Bank+ Focus+ May+ 2010+ After+ the+ Crisis+ Planning+ a+ New+ Financial+
Structure. htm) Paul McCulley, May 2010
[11] http:/ / mises. org/ books/ hayekcollection. pdf
[12] Chasing The Shadow Of Money (http:/ / zerohedge. blogspot. com/ 2009/ 05/ chasing-shadow-of-money. html), May 17, 2009, Zero Hedge
[13] Lowenstein, Roger (2000). When Genius Failed: The Rise and Fall of Long-Term Capital Management. Random House.
ISBN 0-375-50317-X.
[14] Bloomberg-Banks $1 trillion purge (http:/ / www. bloomberg. com/ apps/ news?pid=20601039& sid=akv_p6LBNIdw& refer=home)
[15] BIS.org
[16] Blackburn - Subprime Crisis (http:/ / www. newleftreview. org/ ?getpdf=NLR28403& pdflang=en)
[17] Harvey, David (2010). The Enigma of Capital: And the Crises of Capitalism. Oxford: Oxford University Press. ISBN: 978-0-19-975871-5
tfg080609. html)
[19] Krugman, Paul (2009). The Return of Depression Economics and the Crisis of 2008. W.W. Norton Company Limited.
ISBN 978-0-393-07101-6.
Criticism of capitalism
Capitalism has been criticized from many perspectives during its history. Criticisms range from people who
disagree with the principles of capitalism in its entirety, to those who disagree with particular outcomes of
capitalism. Among those wishing to replace capitalism with a different method of production and social
organization, a distinction can be made between those believing that capitalism can only be overcome with
revolution (e.g., Revolutionary socialism) and those believing that structural change can come slowly through
political reforms to capitalism (e.g., classic social democracy). Some critics recognize merits in capitalism and wish
to balance capitalism with some form of social control, typically through government regulation (e.g., Social market
movement and British Labour Party). Many aspects of capitalism have come under attack from the anti-globalization
movement, which is primarily opposed to corporate capitalism and the economic policies of neoliberalism.
History
According to contemporary critics of capitalism, rapid industrialization in Europe created working conditions viewed
as unfair, including: 14-hour work days, child labor, and shanty towns.[1] Some popular novels arose during this time
that took a critical view of the industrial revolution, such as some written by Charles Dickens. Some modern
economists argue that average living standards did not improve, or only very slowly improved, before 1840.[2]
Early socialist thinkers rejected capitalism altogether, attempting to create socialist communities free of the
perceived injustices of early capitalism. Among these utopian socialists were Charles Fourier and Robert Owen.
Other socialist thinkers argued that socialism could not be implemented before historical forces created the right
conditions. They saw promise in the industrial revolution, viewing it as a new system that could potentially produce
enough goods for the entire human population, but which was hampered by its inefficient method of distributing
goods. In 1848, Karl Marx and Frederick Engels released the Communist Manifesto, which outlined a political and
economic critique of capitalism based on the philiosophy of historical materialism. Pierre-Joseph Proudhon a
contemporary of Marx was another notable critic of capitalism, and was one of the first to call himself an anarchist.
By the early 20th century, a myriad of socialist tendencies had arisen based on different interpretations of current
events. Monopoly capital, accelerating colonialism, the spread of labor unions, the widening of the franchise, and
clearly increasing living standards were new trends which capitalist critics, such as Mikhail Bakunin, Vladimir Lenin
and Eduard Bernstein, worked to understand and which contributed to differences in organizational models (e.g.,
anarcho-syndicalism, social democracy, and Bolshevism). Identifying problems with free market capitalism,
governments also began placing restrictions on market operations and created interventionist programs which
attempted to ameliorate perceived market shortcomings (e.g., Keynesian economics and the New Deal). Starting
with the 1917 Russian revolution, Communist states increased in numbers and a Cold War started with the
developed capitalist nations. Following the Revolutions of 1989, many of these states adopted market economies.
Most of the remaining formally Communist states have implemented widespread market liberalizations.
Contemporary critics have argued for government interventions against capitalism in an age of globalization. These
can be in response to perceived market shortcomings around global warming, exploitation of citizens under
consumer capitalism, shifts away from production-based economies towards a dependence on financial markets, and
economic imperialism. Many current organizations, not necessarily rejecting capitalism outright, focus on changing
national and corporate policies (e.g., United Students Against Sweatshops or Greenpeace). Other organizations take
a holistic view, supporting social ecology or participatory economics.
Issues
Democracy and economic freedom

In Das Kapital, Karl Marx argued that the structure of capitalism necessarily leads to this exploitation of workers,
regardless of whether the political system is one of a bourgeois democracy. A common criticism that Marxists make
about capitalism is that it is only democratic for the capitalist class, citing examples such as people not being able to
criticize one's boss out of risk of getting fired, and not being able to express their opinions due to lack of funds to
afford access to the media. Modern criticisms include the argument that a profit-driven media industry tends to
broadcast profitable media rather than truth.
Capitalist systems have often functioned under unelected governments: the classic case is the United Kingdom,
where less than 20% of adult males could vote prior to 1885, and women did not receive the vote until 1918.[3] More
recent examples of non-democratic capitalist systems include: Hong Kong, Singapore, and Chile under the rule of
Augusto Pinochet. It is also argued by Marxists that governments espousing fascist or National Socialist rhetoric do
not make substantive changes to capitalist economies when they assume power.
Latin American intellectuals like Eduardo Galeano argue that capitalist practices do more to damage democracy in
peripheral countries than encourage it. He points to democratically elected leaders like João Goulart, Salvador
Allende, and Juan Peron, who he believes were forced out of office by U.S. and European capitalist interests, and
replaced with military dictators during the 1960s and 1970s.
Critics of capitalism argue that capitalism undermines true economic freedoms due to an unfair and inefficient
distribution of wealth and power; a tendency toward monopoly or oligopoly; imperialism, various forms of economic
exploitation; and phenomena such as social alienation, inequality, unemployment, and economic instability. Critics
have maintained that there is an inherent tendency towards oligolopolistic structures when laissez-faire economics
are combined with capitalist private property. Critics of capitalism believe that an essential aspect of economic
freedom is the extension of the freedom to have meaningful decision-making control over productive resources to
everyone. Economist Branko Horvat has stated:[4]
“
...it is now well known that capitalist development leads to the concentration of capital, employment and power. It is somewhat less known
that it leads to the almost complete destruction of economic freedom
”
Monetary democracy and corporate growth
Some skeptics of capitalism argue that public demand plays a

minor role in corporate growth and that expansion is rather
founded on corporate scandals, accounting scandals and corporate
crimes.
Advocates of free market capitalism hold that the free market is a
form of monetary democracy, where the purchasing of a product
by a consumer is tantamount to casting a monetary vote to the
producer (i.e. the company), who thus receives a mandate to
develop that product and expand business. In other words, they
allege that the mosaic of corporate growth is determined by, and is Market saturation: two Starbucks units in the same
in feedback with, the public's needs, preferences and free will, and shopping center, no more than 20 m apart.
project the Starbucks paradigm as an example. Starbucks
representatives have stated that high demand for gourmet coffee
was a "crucial factor" for the firm's growth.[5]
Skeptics focus on the unspoken and suppressed "non-crucial"

factors and their aggregate effect on growth. They note that
Starbucks have been systematically involved in controversial
though highly profitable issues which public perception, and not
merely the law, would judge as immoral, corrupt, conniving or
simply "wrong". Examples of such issues include:
• Severe political lobbying, intended to prevent Ethiopian coffee
companies from installing in the US.[6]
Part of the Forbidden City in Beijing. Starbucks
• Market saturation. This is a frowned upon marketing strategy managed to install a branch in an epitome of Chinese
wherein a corporation literally floods markets to block the heritage.
appearance of competitors.[7]
• Some US judiciary authorities have found the company "guilty of extensive union busting".[8]
• The Chinese people have accused Starbucks of invading their cultural heritage; the company backed off after
surging public outcry, organized through internet campaigning.[9] A similar situation, occurred in relation to a
London conservation area.[10]
• Much of the company's profits originate from wage slavery, surplus labor and child labor.[11] In 1994, in order to
earn the equivalent of 0.5 kg of US Starbucks coffee, a worker in Guatemala had to work for five days picking up
a total 250 kg of coffee beans.[12] In a more "domestic" form of labor exploitation, within the US, it is firm's
standard policy to administer part of the tips earned by the workers (coffee-makers, cashiers, waiters) directly to
their supervisors, a practice repeatedly challenged in courts.[13] [14]
Exploitation
Critics of capitalism view the system as inherently exploitative. In
an economic sense, exploitation is often related to the
expropriation of labor for profit and based on Marx's version of the
labor theory of value. The labor theory of value was supported by
classical economists like David Ricardo and Adam Smith who
believed that "the value of a commodity depends on the relative
quantity of labor which is necessary for its production."[15]
In Capital, Karl Marx identified the commodity as the basic unit of

capitalist organization. Marx noted a "common denominator"
between commodities, in particular that commodities are the
product of labor and are related to each other by an exchange
value (i.e., price).[16] By using the labor theory of value, Marxists
see a connection between labor and exchange value, in that
commodities are exchanged depending on the socially necessary
labor time needed to produce them.[17] However, due to the
productive forces of industrial organization, laborers are seen as
creating more exchange value during the course of the working
Of Usury, from Brant's Stultifera Navis (the Ship of
day than the cost of their survival (food, shelter, clothing, etc.).[18] Fools); woodcut attributed to Albrecht Dürer
Marxists argue that capitalists are thus able to pay for this cost of
survival, while expropriating the excess labor (i.e., surplus value).[17] In other words, workers are seen as producing
enough value to cover their wages during part of the working day, while the rest of the working day produces value
in excess of what they're paid (and results in profits).
Marxists further claim that due to economic inequality, the purchase of labor cannot occur under "free" conditions.
Since capitalists control the means of production (e.g., factories, businesses, machinery) and workers control only
their labor, the worker is naturally coerced into allowing their labor to be exploited.[19] Critics argue that exploitation
occurs even if the exploited consents, since the definition of exploitation is independent of consent. In essence,
workers must allow their labor to be exploited or face starvation. Since some degree of unemployment is typical in
modern economies, Marxists argue that wages are naturally driven down in free market systems. Hence, even if a
worker contests their wages, capitalists are able to find someone from the reserve army of labor who is more
desperate.[20]
Unions are the "traditional method" of giving workers more bargaining power in the marketplace. The act (or threat)
of striking has historically been an organized action to withhold labor from capitalists, without fear of individual
retaliation.[21] Some critics of capitalism, while acknowledging the necessity of trade unionism, believe that trade
unions simply reform an already exploitative system, leaving the system of exploitation intact.[22] [23]
Lysander Spooner argued that[24]
“
...almost all fortunes are made out of the capital and labour of other men than those who realize them. Indeed, except by his sponging capital
and labour from others.
”
Labor historian Immanuel Wallerstein has argued that unfree labor—by slaves, indentured servants, prisoners, and
other coerced persons—is compatible with capitalist relations.[25]
Modern skeptics of free market capitalism observe that while in major capitalist economies the minimum wage is
legislatively imposed by the state, there is no maximum wage limit, which is supposedly determined by the forces of
the free market. They further support that the minimum wage measure does not serve to set a lower limit in a
worker's earnings; it actually functions as an upper limit on the earnings of a person that just enters the workforce.
The existence of minimum wage, coupled with the absence of maximum, permits rapid wealth accumulation and
leads to a phenomenon termed "plutonomy" by Citigroup.[26] In effect, wages are kept low for almost all of the
population while the rest minute percentage is allowed to meet overwhelming profits.
Academics such as Howard Gardner have proposed the adoption of upper limits in individual wealth as "a solution
that would make the world a better place".[27]
Imperialism and political oppression

Critics[28] argue that the ills caused by capitalism include imperialism and oppression. They point systematic
violence against political opponents, participation in coups which have placed dictators in power (for example
Augusto Pinochet in Chile, Argentina with its "Dirty War"); and large scale democide (like in the Congo Free State).
Although some of these violations occurred during a time period and in states sometimes considered being more
capitalist than today since the government share of the economy was much smaller, U.S and European support of
multinational-friendly capitalist dictatorships in Latin America and Africa lasted until the mid 1980s.
Near the start of the 20th century, Vladimir Lenin claimed that state use of military power to defend capitalist
interests abroad was an inevitable corollary of monopoly capitalism.[29] Critics of capitalism allege the system is
responsible for not only economic exploitation, but imperialist, colonialist and counter-revolutionary wars,
repressions of workers and trade unionists, genocides and massacres.
Marxists, importantly Vladimir Lenin, argue that capitalism needs imperialism in order to survive. The unplanned
nature of capitalism, they say, inevitably overproduces commodities and overuses resources, which leads it to
expand its markets into and drain the resources out of other, less-developed nations. The wealthy nations, they say,
must maintain cheap access to third world natural resources and unfree labor, by force if necessary. They argue that
the capitalist countries like England initially were helped by the primitive accumulation of capital through the "theft"
of natural resources and exploitation of slave labor from large parts of Asia, Africa and the Americas which spurred
the industrial revolution. They see what they characterize as unjust exploitation, militarily (such as India in 19th
century) or economically (e.g., through International Monetary Fund structural adjustment programs during the
1980s), as part of the nature of capitalism. The constant, capitalist drive to expand markets is viewed by many as the
primary cause of globalization.
In his essay, Imperialism: The Highest Stage of Capitalism, Vladimir Lenin advanced the now widespread thesis that
the ‘New Imperialism’ of the late 19th and early 20th centuries was an inevitable correlary of monopoly
capitalism.[30] According to Lenin, the export of financial capital superseded the export of commodities; banking and
industrial capital merged to form large financial cartels and trusts in which production distribution are highly
centralized; and monopoly capitalists influenced state policy to carve up the world into spheres of interest
(Burnham). These trends led states to defend their capitalist interests abroad through military power.
Inefficiency and waste

Some opponents criticize capitalism's perceived inefficiency. They note a shift from pre-industrial reuse and
thriftiness before capitalism to a consumer-based economy that pushes "ready-made" materials.[31] It is argued that a
sanitation industry arose under capitalism that deemed trash valueless; a significant break from the past when much
"waste" was used and reused almost indefinitely.[31] In the process, critics say, capitalism has created a profit driven
system based on selling as many products as possible.[32] Critics relate the "ready-made" trend to a growing garbage
problem in which the average American throws out 4.5 pounds of trash per day (compared to 2.7 pounds in
1960).[33] Anti-capitalist groups with an emphasis on conservation include eco-socialists and social ecologists.
Planned obsolescence has also been criticized as a wasteful practice under capitalism. By designing products to wear
out faster than need be, new consumption is generated.[31] This would benefit corporations by increasing sales, while
at the same time generating excessive waste. A well-known example is the charge that Apple designed its iPod to fail
after 18 months.[34] Critics view planned obsolescence as wasteful and an inefficient use of resources.[35]
Derek Wall of another-green-world blog identifies marketing as wasteful in a post titled Another Green World:
Socialism today must be Green. He notes that American corporations spend upwards of $1 trillion on marketing, and
wonder whether this money could be better spent.[36] Other authors such as Naomi Klein have criticized brand-based
marketing for putting more emphasis on the company's name-brand than on manufacturing products.[37]
Inequality
Critics argue that capitalism is associated with the
unfair distribution of wealth and power; a tendency
toward market monopoly or oligopoly (and
government by oligarchy); imperialism,
counter-revolutionary wars and various forms of
economic and cultural exploitation; repression of
workers and trade unionists, and phenomena such as
social alienation, economic inequality,
unemployment, and economic instability. Critics
have argued that there is an inherent tendency toward
oligolopolistic structures when laissez-faire is
combined with capitalist private property. Capitalism
is regarded by many socialists to be irrational in that
production and the direction of the economy are
unplanned, creating many inconsistencies and
internal contradictions and thus should be controlled
through public policy.[38]
In the early 20th century, Vladimir Lenin argued that

state use of military power to defend capitalist
interests abroad was an inevitable corollary of
monopoly capitalism.[39]
Southern Methodist University Economics Professor “(Financial) Capital” (1920), a Soviet agitprop poster by Viktor Deni
Ravi Batra argues that excessive income and wealth (1893-1946).
inequalities are a fundamental cause of financial

crisis and economic depression, which will lead to the collapse of capitalism and the emergence of a new social
order.
Che Guevara wrote:[40]
The laws of capitalism, which are blind and are invisible to ordinary people, act upon the individual
without he or she being aware of it. One sees only the vastness of a seemingly infinite horizon ahead.
That is how it is painted by capitalist propagandists who purport to draw a lesson from the example of
Rockefeller — whether or not it is true — about the possibilities of individual success. The amount of
poverty and suffering required for a Rockefeller to emerge, and the amount of depravity entailed in the
accumulation of a fortune of such magnitude, are left out of the picture, and it is not always possible for
the popular forces to expose this clearly.... It is a contest among wolves. One can win only at the cost of
the failure of others.
In the United States, the shares of earnings and wealth of the households in the top 1 percent of the corresponding
distributions are 15 percent and 30 percent, respectively.[41] Critics claim that an untamed capitalist system has
inherent biases favoring those who already possess greater resources. They say rich people can give their children a
better education and inherited wealth, and that this can create or increase large differences in wealth between people
who do not differ in ability or effort. One study showed that in the U.S., 43.35% of the people in the Forbes
magazine "400 richest individuals" list were already rich enough at birth to qualify.[42] Another study indicated that
in the US, wealth, race, and schooling are important to the inheritance of economic status, but that IQ is not a major
contributor, and the genetic transmission of IQ is even less important.[43]
Market failure
Market failure is a term used by economists to describe the condition where the allocation of goods and services by a
market is not efficient. Keynesian economist[44] Paul Krugman views this scenario in which individuals' pursuit of
self-interest leads to bad results for society as a whole.[45] From this, some critics of capitalism prefer economic
intervention by government into free markets.[46] Some believe that the lack of perfect information and perfect
competition in a free market is grounds for government intervention. Others perceive certain unique problems with a
free market including: monopolies, monopsonies, insider trading, and price gouging. [47]
Legislation has been introduced to deal with these concerns (e.g., anti-trust legislation or financial regulation). Also,
governments overseeing capitalist economies have been known to set mandatory price floors or price ceilings at
times, thereby interfering with the free market mechanism. This usually occurs in times of crisis, or relating to goods
and services viewed as strategically important. Electricity, for example, is a good that has typically been subject to
price ceilings in many countries.[48] Some economists have analyzed market failures, and see governments as having
a legitimate role in mitigating these failures through regulation and compensation schemes.
Wages determined by a free market mechanism are also commonly seen as a problem by those who claim that some
wages are unjustifiably low or unjustifiably high. Another perceived failure is that free markets usually fail to deal
with the problem of externalities, where an action by an outside agent positively or negatively affects another agent
without any compensation.[49] An example of an externality is pollution. More generally, free market allocation of
resources in areas such as health care, unemployment, wealth inequality, and education are considered market
failures by some.[50]
Poor distribution of goods has also been identified as a market failure. One critic noted that 200 million Indians went
hungry in 1995, while the Indian economy was exporting $625 million worth of wheat and $1.3 billion worth of rice
that same year.[51]
Market instability
Critics of capitalism, particularly Marxists, identify market instability as a permanent feature of capitalist
economy.[52] [53] Marx believed that the unplanned and explosive growth of capitalism does not occur in a smooth
manner, but is interrupted by periods of overproduction in which stagnation or decline occur (i.e., recessions).[54] In
the view of Marxists, several contradictions in the capitalist mode of production are present, particularly the internal
contradiction between anarchy in the sphere of capital (i.e., free market) and socialised production in the sphere of
labor (i.e., industrialism).[55] Due to the unplanned nature of the system, capitalists produce without knowing in
advance what they can sell, while at the same time unleashing huge productive capabilities through industrial
organization. The result is that crises are not caused by shortages, like a crop failure, but rather from a production of
too many goods. Marx and Engels, in the Communist Manifesto, highlighted what they saw as a uniquely capitalist
juxtaposition of overabundance and poverty: "Society suddenly finds itself put back into a state of momentary
barbarism. And why? Because there is too much civilization, too much means of subsistence, too much industry, too
much commerce."[54]
Property
Pierre-Joseph Proudhon and Friedrich Engels argue that the free market is not necessarily free, but weighted towards
those who already own property.[20] [56] They view capitalist regulations, including the enforcement of private
property on land and exclusive rights to natural resources, as unjustly enclosing upon what should be owned by all,
forcing those without property to sell their labor to capitalists and landlords in a market favorable to the latter, thus
forcing workers to accept low wages in order to survive.[57] In his criticism of capitalism, Pierre-Joseph Proudhon
believed that the emphasis on property is the problem. He claimed that property is theft, arguing that property leads
to despotism: "Now, property necessarily engenders despotism—the government of caprice, the reign of libidinous
pleasure. That is so clearly the essence of property that, to be convinced of it, one need but remember what it is, and
observe what happens around him. Property is the right to use and abuse."[56] Many left-wing anarchists, such as
anarchist communists, believe in replacing capitalist private property with a system where people can lay claim to
things based on personal use and claim that "Property is the domination of an individual, or a coalition of
individuals, over things; it is not the claim of any person or persons to the use of things" and "this is, usufruct, a very
different matter. Property means the monopoly of wealth, the right to prevent others using it, whether the owner
needs it or not."[58]
Mutualists and some anarchists support markets and private property, but not in their present form.[59] They argue
that particular aspects of modern capitalism violate the ability of individuals to trade in the absence of coercion.
Mutualists support markets and private property in the product of labor, but only when these markets guarantee that
workers will realize for themselves the value of their labor.[56]
In recent times, most economies have extended property rights to include such things as patents and copyrights.
Critics see this as coercive against those with few prior resources. They argue that such regulations discourage the
sharing of ideas, and encourage nonproductive rent seeking behavior, both of which enact a deadweight loss on the
economy, erecting a prohibitive barrier to entry into the market.[60] Not all pro-capitalists support the concept of
copyrights, but those who do argue that compensation to the creator is necessary as an incentive.[60]
Sustainability
An economic system that produces strong economic growth and requires essentially free trade may have a large
effect on the environment. Some question the continued sustainability of this, arguing that many aspects of the
environment have been degraded since the industrial revolution. Defenders of capitalism note the many
environmental disasters in communist states and point out that there seems to be no viable alternative or intermediate
economic system to capitalism or state controlled economy.
One of the main modern criticisms to the sustainability of capitalism is related to the so called commodity chains, or
production/consumption chains.[61] [62] These terms refer to the network of transfers of materials and commodities
which is currently part of the functioning of the global capitalist system. Examples include high tech commodities
produced in countries with low average wages by multinational firms, and then being sold in distant high income
countries; materials and resources being extracted in some countries, turned into finished products in some others
and sold as commodities in further ones; countries exchanging with each other the same kind of commodities for the
sake of consumer's choice (e.g., Europe both exporting and importing cars to and from the U.S.). According to critics
such processes, all of which produce pollution and waste of resources, are an integral part of the functioning of
capitalism (i.e., its metabolism).[63] Furthermore, it is sometimes argued that such chains, being resistant to change,
may be partly responsible for persisting inequalities between different areas of the world. Nonetheless it is possible,
although by no means certain, that someday wages reach more or less similar levels worldwide, thus eliminating a
major cause which presently makes the environmental costs of commodity exchanges very different from their
economic costs, and by consequence producing a more rational structure of production/consumption chains. Also,
minimal restrictions on free trade (see Tobin Tax) have been proposed to induce a restructuring of the capitalist
network, but such measures are typically rejected by proponents of self regulation of capitalism through free trade.
Some leading conservation organizations such as the World Wide Fund for Nature and the United Nations
Environment Programme argue that the impact of humanity on Earth is continually increasing. In 2004 they jointly
reported that "humanity's Ecological Footprint grew by 150% between 1961 and 2000" and that most of this growth
occurred in the 27 wealthiest countries of the world, in other words, the leading capitalist countries.[64] Critics note
that the statistical methods used in calculating Ecological Footprint have been criticized and some find the whole
concept of counting how much land is used to be flawed, arguing that there is nothing intrinsically negative about
using more land to improve living standards.[65] [66]
Many environmentalists have long argued that the real dangers are due to the world's current social institutions that
they claim promote environmentally irresponsible consumption and production. Under what they call the "grow or
die" imperative of capitalism, they say, there is little reason to expect hazardous consumption and production
practices to change in a timely manner. They also claim that markets and states invariably drag their feet on
substantive environmental reform, and are notoriously slow to adopt viable sustainable technologies.[67] [68]
Immanuel Wallerstein, referring to the externalization of costs as the "dirty secret" of capitalism, claims that there
are built-in limits to ecological reform, and that the costs of doing business in the world capitalist economy are
ratcheting upward because of deruralization and democratization.[69]
Some critics claim that strong economic growth also requires increasingly greater amounts of natural resources and
energy and they question whether this can continue in the future. Those arguing for continued growth note that
numerous past predictions of shortages have failed since new technology has continuously allowed exploitation of
previously unavailable resources. That this continues in the future is considered to be of critical importance,
especially for world energy markets, which face a peak and subsequent decline in fossil fuel production. Since 1970,
each 1% increase in world GDP has yielded a 0.64% increase in energy consumption. See Future energy
development. On the other hand, it is accepted by the oil industry that world oil production will peak or has already.
Environmentalists have argued that capitalism requires continual economic growth, and will inevitably deplete the
finite natural resources of the earth, and other broadly utilized resources. Murray Bookchin has argued that capitalist
production externalizes environmental costs to all of society, and is unable to adequately mitigate its impact upon
ecosystems and the biosphere at large.
Unemployment
Since individuals typically earn their incomes from working for companies whose requirements are constantly
changing, at any given time, not all members of a country's potential workforce will be able to find paid work. It is
typical for capitalist economies to have rates of unemployment that fluctuate between 3% and 10%. Some
economists have used the term natural rate of unemployment to describe this phenomenon. Some critics have argued
that the "natural rate of unemployment" highlights the inefficiency of a capitalist economy, since not all its
resources—in this case human labor—are being allocated efficiently. Some critics blame central banks for
unemployment, as some have been known to intervene in the economy to prevent full employment out of fear of
driving wages up.[70] Depressed or stagnant economies have been known to reach unemployment rates as high as
30%. This would be less problematic in an economy in which such individuals had unlimited access to resources,
such as land in order to provide for themselves, but when the ownership of the bulk of its productive capacity resides
in relatively few hands, most individuals will be dependent on employment for their economic well-being.
Types of criticism
Socialist criticism
Socialists criticize capitalism for being inefficient and insufficient at meeting the material needs of society, as well as
the effects of the process of capital accumulation, the profit motive and business ethos have on society.
The business process, or the accumulation of capital, generates waste by creating externalities that require costly
corrective regulatory measures. This process also generates wasteful industries and practices that only exist to
generate sufficient demand for enough products to be sold at a profit (such as high-pressure advertisement).
Capitalism also consists of irrational activity, such as the purchasing of commodities only to sell at a later time when
their price appreciates, rather than for consumption, even if the commodity cannot be sold at a profit to individuals in
need. Therefore, a crucial criticism often made by socialists is that making money, or accumulation of capital, does
not correspond to the satisfaction of demand (the production of use-values).[71] Privately owned firms have
incentives to grow beyond their optimal size, creating a tendency toward monopoly or oligopoly and a
maldistribution of resources. This grants them considerable influence over government regulatory bodies and a
considerable amount of market power. Furthermore, private ownership imposes constraints on planning, leading to
uncoordinated economic decisions that result in business fluctuations, unemployment and a tremendous waste of
material resources during crisis of overproduction.[72]
Socialists view private property relations as limiting the potential of productive forces in the economy. Private
property becomes obsolete when it concentrates into centralized, socialized institutions based on private
appropriation of revenue (but based on cooperative work and internal planning in allocation of inputs) until the role
of the capitalist becomes redundant. With no need for capital accumulation and a class of owners, private property in
the means of production is perceived as being an outdated form of economic organization that should be replaced by
a free association of individuals based on public or common ownership of these socialized assets.[73] [74]
The inherent conflict of interests among classes prevent an optimal use of available human resources, and generates
inefficiencies related to the antagonistic interests of labor and capital. This leads to contradictory interest groups
(labor and business) striving to influence the state to intervene in their favor at the expense of economic efficiency
(for example, unions lobbying for the preservation of obsolete or unneeded jobs). This also results in a costly process
of reconciliation or supervision over the collective bargaining process, or the need for the government to create
unproductive jobs to stabilize the economy when unemployment reaches critical levels.
Excessive disparities in income distribution lead to social instability and require costly corrective measures in the
form of redistributive taxation, which incurs heavy administrative costs while weakening the incentive to work,
inviting dishonesty and increasing the likelihood of tax evasion while reducing the overall efficiency of the market
economy.[75]
Society and politics becomes dominated by various business interests, stifling genuine democracy and leading to a
situation where government policy is in favor of large business interests. Early socialists criticized capitalism for
concentrating power and wealth within a small segment of society that controls the means of production and derives
its wealth through a system of exploitation. This creates a stratified society based on unequal social relations that
fails to provide equal opportunities for every individual to maximize their potential,[76] and does not utilise available
technology and resources to their maximum potential in the interests of the public.[74]
Marxist criticism
"Capitalism uses force but it also educates the people to its
system. Direct propaganda is carried out by those entrusted with
explaining the inevitability of class society, either through some
theory of divine origin or through a mechanical theory of natural
law. This lulls the masses since they see themselves as being
oppressed by an evil against which it is impossible to struggle.
Immediately following comes the hope of improvement — and
in this, capitalism differed from the preceding caste systems,
which offered no possibilities for advancement."
— Che Guevara, Marxist revolutionary [40]
Title page of Karl Marx's Das Kapital, first

edition 1867. The book contains an influential
critique of political economy.
Marxists define capital as "a social, economic relation" between people

(rather than between people and things). In this sense they seek to abolish
capital. They believe that private ownership of the means of production
enriches capitalists (owners of capital) at the expense of workers ("the rich
get richer, and the poor get poorer"). In brief, they argue that the owners of
capital do not work and therefore steal from or exploit the workers.
Gradually, the capitalists will accumulate more and more capital and make
the workers continually poorer, in the end causing a revolution. The private
ownership of the means of production is therefore seen as a restriction on
freedom.
Marx and his followers have proffered various related lines of argument
Karl Marx saw capitalism as a historical suggesting that capitalism is a contradiction-laden system characterized by
stage which could be followed by
recurring crises having a tendency towards increasing severity. They have
socialism, with worker's dictatorship as
an intermediate stage.
claimed that this tendency of the system to unravel combined with a
socialization process which links workers in a worldwide market are two
major factors that create the objective conditions for revolutionary change.
Capitalism is seen as just one stage in the evolution of the economy of a society. Immanuel Wallerstein approaching
matters from a world-systems perspective, cites the intransigence of rising real wages, rising costs of material inputs,
and steadily rising tax rates, along with the rise of popular antisystemic movements as the most important global
secular trends creating unprecedented limiting pressures on the accumulation of capital. According to Wallerstein,
"the capitalist world-economy has now entered its terminal crisis, a crisis that may last up to fifty years. The real
question before us is what will happen during this crisis, this transition from the present world-system to some other
kind of historical system or systems." [77]
In mainland China differences in terminology sometimes confuse and complicate discussions of Chinese economic
reform. Under Marxist ideology, capitalism refers to a stage of history in which there is a class system in which the
proletariat is exploited by the bourgeoisie. Officially, according to the Chinese governments State ideology, China is
currently in the primary stage of socialism with Chinese characteristics. However, because of Deng Xiaoping's and
subsequent leaders Chinese economic reforms, instituting pragmatism within policy, China has undertaken policies
which are commonly considered capitalistic, including employing wage labor, increasing unemployment to motivate
those who are still working, transforming state owned enterprises into joint stock companies, and encouraging the
growth of the joint venture and private capitalist sectors. A contrary Marxist view would describe China as just
another variant of capitalism (state capitalism), much like the former USSR, which was also claiming to be operating
on principals of socialism. This is echoed by what Mao Tse-Tung termed "capitalist roaders" who he argued existed
within the ruling Party structures and would try to restore the bourgeoisie and thus their class interests to power
reflected in new policies, while only keeping the outer appearance of socialism for legitimacy purposes. Deng
Xiaoping was identified as one of these "capitalist roaders" during the Chinese Cultural Revolution, when he was
placed under house arrest.
Marxism advocated a revolutionary overthrow of capitalism that would lead to socialism, before eventually
transforming into communism after class antagonisms and the state ceased to exist. Marxism influenced social
democratic and labour parties as well as some moderate democratic socialists, who seek change through existing
democratic channels instead of revolution, and believe that capitalism should be regulated rather than abolished,
supplementing the market economy with a mixed economy.
Marxist and feminist geographers critique capitalism primarily on the basis of social and environmental justice.
Marxian development geographers analyse the "contractions" of capitalism, class struggle, uneven development and
imperialism in the global South by employing historical-material analysis (‘little d’ development). This work
investigates patterns of accumulation, class formation and politics in rural and urban areas, the role of the state,
struggles over resources and the articulation of peasant production with agrarian capitalism. Feminist
political-economy researchers are interested in the ways that these processes are gendered and also take into account
a serious consideration of social reproduction in concern with capitalist production processes.
Religious criticism
Many religions have criticized or opposed specific elements of
capitalism; traditional Judaism, Christianity, and Islam forbid lending
money at interest. Christianity has been a source of both praise and
criticism for capitalism, particularly its materialist aspects.[79] The first
socialists drew many of their principles from Christian values, against
"bourgeois" values of profiteering, greed, selfishness, and hoarding.
Some Christian critics of capitalism may not oppose capitalism

entirely, but support a mixed economy in order to ensure adequate
labor standards and relations, as well as economic justice. Pope
Benedict XVI issued an encyclical Caritas in veritate (Charity in Truth)
in 2009; he stated: "The dignity of the individual and the demands of
justice require, particularly today, that economic choices do not cause
disparities in wealth to increase in an excessive and morally
unacceptable manner"[80] and "Therefore, it must be borne in mind
Christ drives the Usurers out of the Temple, a
that grave imbalances are produced when economic action, conceived woodcut by Lucas Cranach the Elder in
[78]
merely as an engine for wealth creation, is detached from political Passionary of Christ and Antichrist.
action, conceived as a means for pursuing justice through
redistribution".[81]
Islamic law recognizes the right to private property but regulates economic activities. A 2.5% alms tax (Zakat) is
levied on all gold, crops, and cattle. Shia Twelver Muslims pay an additional 20% on all savings (defined as income
minus expenses on necessities like food and shelter.) Usury or riba is forbidden, and religious law encourages the use
of capital to spur economic activity while placing the burden of risk along with the benefit of profit with the owner
of the capital. Methods of Islamic banking have been developed. The Islamic constitution of Iran, which was drafted
mostly by Islamic clerics, criticizes "materialist schools of thought" that encourage "concentration and accumulation
of wealth and maximization of profit."[82] Sayyid Qutb, an Islamist writer, criticized capitalism in his 1951 book The
Battle Between Islam and Capitalism.[83]
Indian philosopher P.R. Sarkar, founder of the Ananda Marga movement, developed the Law of Social Cycle to
identify the problems of capitalism and proposed the Progressive Utilization Theory (PROUT) as a solution to its
ills.[84] [85]
Chomskian
Noam Chomsky has argued that the asymmetric application of free market principles creates a "privatized
tyranny":[86]
"The talk about labor mobility doesn't mean the right of people to move anywhere they want, as has
been required by free market theory ever since Adam Smith, but rather the right to fire employees at
will. And, under the current investor-based version of globalization, capital and corporations must be
free to move, but not people, because their rights are secondary, incidental."
Further, he emphasizes that it can matter what entities have rights in the market—"Do they inhere in persons of flesh
and blood, or only in small sectors of wealth and privilege? Or even in abstract constructions like corporations, or
capital, or states?"—and remarks that of what he sees as the three tyrannical systems of the 20th century,
Bolshevism, and fascism have "collapsed", but "private corporatism… is alive and flourishing… [a] system of state
corporate mercantilism disguised with various mantras like globalization and free trade."[87]
Chomsky argues that the wealthy use free-market rhetoric to justify imposing greater economic risk upon the lower
classes, while being insulated from the rigours of the market by the political and economic advantages that such
wealth affords.[88] He remarked, "the free market is socialism for the rich—[free] markets for the poor and state
protection for the rich."[89]
See also
• A Failure of Capitalism
• Anarchism
• Anarchism and Anarcho-Capitalism
• Anarchism and Capitalism
• Anti-capitalism
• Anti-globalisation
• Capitalism: A Love Story
• Capitalist mode of production
• Colonialism
• Communism
• Culture of capitalism
• Crisis (Marxian)
• Critique of technology
• Economic calculation problem
• Exploitation
• Freiwirtschaft
• Imperialism
• Labor theory of value
• Localism
• Market fundamentalism
• Marxism
• Marxian economics
• Netocracy
• Post-capitalism
• Socialism
• Social criticism
• Social democracy
• The Black Book of Capitalism
• Wage slavery
• Wealth distribution
Notes
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[77] Wallerstein, Immanuel- The Decline of American Power,New Press Books,66
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[81] Caritas in veritate paragraph 36 (http:/ / www. vatican. va/ holy_father/ benedict_xvi/ encyclicals/ documents/
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[82] ICL - Iran - Constitution (http:/ / www. servat. unibe. ch/ law/ icl/ ir00000_. html)
[83] Sayyid Qutb (http:/ / www. nndb. com/ people/ 551/ 000113212/ )
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External links
• A Reconsideration of the Theory of Entrepreneurship: a participatory approach - Critique of capitalism (http://
www.econ.boun.edu.tr/staff/adaman/research/adaman-devine.PDF)
• How The Miners Were Robbed (http://economicdemocracy.org/miners.html) 1907 anti-capitalist pamphlet by
John Wheatley.
• Critique of Competitive Freedom and the Bourgeois-Democratic State: Outline of a Form-analytic Extension of
Marx's Uncompleted System (http://www.arte-fact.org/ccfbdspf.html) by Michael Eldred, With an Appendix
'Value-form Analytic Reconstruction of the Capital-Analysis' by Michael Eldred, Marnie Hanlon, Lucia Kleiber
and Mike Roth, Kurasje, Copenhagen, 1984. Emended, digitized edition 2010 with new Preface. ISBN
8787437406, ISBN 9788787437400.
• Eldred, Michael (2000) 'Capital and Technology: Marx and Heidegger' (http://www.arte-fact.org/capiteen.
html), Left Curve (http://www.leftcurve.org/LC24WebPages/LC24toc.html) No.24, May 2000
ISSN:0160-1857 (Ver. 3.0 2010). Original German edition Kapital und Technik: Marx und Heidegger (http://
www.arte-fact.org/kapitech.html), Roell Verlag, Dettelbach, 2000 117 pp. ISBN 3-89754-171-8.
• Information and Economics: A Critique of Hayek (http://reality.gn.apc.org/econ/hayek.htm) by Allin F.

Cottrell and W. Paul Cockshott
• Marxists Internet Archive (http://www.marxists.org/) - Archive of Marxist and anti-capitalist literature.
• Ringmar, Erik. Surviving Capitalism: How We Learned to Live with the Market and Remained Almost Human
(http://www.archive.org/download/
SurvivingCapitallismHowWeLearnedToLiveWithTheMarketAndRemained/ErikRingmarSurvivingCapitalism.
pdf)
• Social economy: A Market Economy without Capitalism (http://www.sozialoekonomie.info/
Info_Foreign_Languages/info_foreign_languages.htm)
• Value, Price and Profit (http://libcom.org/library/value-price-and-profit-karl-marx) - Karl Marx on the basic
features of capitalism.
• Why Do Intellectuals Oppose Capitalism? (http://www.cato.org/pubs/policy_report/cpr-20n1-1.html) by
Robert Nozick
Late capitalism
"Late capitalism" is a term sometimes used to refer to capitalism from about 1950 onwards, often but not always,[1]
in the context of Marxism, with the implication that it is a historically limited stage rather than an eternal feature of
all future human society.
Capitalism has proved to be a flexible and adaptive system, able to survive terrible catastrophes including two world
wars and an enormous number of smaller wars - suggesting, for many thinkers, that the end is not yet near. Vladimir
Lenin and others have pointed to the subjective factor in revolutions that could explain the survival of capitalism
long past its expected demise; its fate depended on the outcome of class struggle and above all the development of
class consciousness by the masses. This, however, does not deter critics of the system, who point to its relative
newness, the rapid collapse of prior orders of much greater duration, the effects of modern communications on class
consciousness, and a general perceived inadequacy of its ability to deal with various crises of its own making and
other long term structural problems.
But there are also others, like Murray Bookchin, who argue that capitalism has already been superseded; in a modern
information society the old industrial system is a thing of the past, and the reference to capitalism is an anachronism
(although Marx never defined capitalism as being purely industrial). Similarly, Immanuel Wallerstein believes that
capitalism is in the process of being replaced by another world system in several of his works and lectures on
world-systems theory. Wallerstein places the time at which this process began as somewhere around 1968, during
the so-called revolutions of 1968 and as the hegemony of the United States began to move into a period of decline.
Wallerstein does not state what sort of system the world is theorized to be transitioning to, indeed he believes it is
impossible to know until the transition has already been made.
Origin of the term

The term "late capitalism" came into use in Europe towards the end of the 1930s when many economists believed
capitalism was doomed [2] and it was used in the 1960s particularly in Germany and Austria, among others by
Marxists writing in the tradition of the Frankfurt School and Austromarxism. At the end of World War II, many
economists such as Joseph Schumpeter believed the end of capitalism could well be nigh, in that the economic
problems might be insurmountable.
Late capitalism 28
Mandel
According to the Marxist economist Ernest Mandel, who popularised the term with his 1972 PhD dissertation,
late-stage capitalism will be dominated by the machinations – or perhaps better, fluidities – of financial capital.
In his work Late Capitalism, Mandel argues for three periods in the development of capitalism. First is market
capitalism, which occurred from 1700 to 1850 and is characterized largely by the growth of industrial capital in
domestic markets. Second is monopoly capitalism, which lasted until approximately 1960, and is characterized by
the imperialistic development of international markets as well as the exploitation of colonial territories. Third, is late
capitalism, which displays such features as the multinational corporation, globalized markets and labor, mass
consumption, and the space of liquid multinational flows of capital.
In the tradition of the classical Marxists, Mandel tried to characterize the nature of the modern epoch as a whole,
with reference to the main laws of motion of capitalism specified by Marx, in order to show how the same forces
which boosted profitability after the world war must ultimately turn into their dialectical opposites, and cause its
decline. Mandel's aim was to explain the unexpected revival of capitalism after World War II, and a long economic
boom which showed the fastest economic growth ever seen in human history.
For Mandel, profitability could be influenced by numerous different factors, and was only the general indicator of
the condition of the system as a whole; his critics (such as Paul Mattick) however argued that Mandel is too eclectic,
and failed to give an orthodox Marxist explanation of the famous "tendency of the rate of profit to fall".
Whereas Mandel organised his explanation of the long boom mainly in terms of factors counteracting the falling rate
of profit, he did not distinguish clearly between the rate and volume of profit and considered effective demand an
important variable. This invited the accusation that Mandel subscribed to a theory of underconsumptionism, i.e.
attributing crisis phenomena to a lack of buying power by workers. Such an approach, it was argued, is conducive to
a reformist redistribution of wealth, rather than total revolution.
Criticism of the Concept

Other critics, such as the Marxist-Leninists, preferred the concept of state monopoly capitalism, or reject any
periodisation of capitalism in terms of "early" and "late" stages as unscientific.
The American literary critic and cultural theorist, Fredric Jameson, also used Mandel's third stage designation as the
point of departure for his widely-cited Postmodernism, or the Cultural Logic of Late Capitalism, in which, among
other issues, Jameson argues that this period involves an emergence of a Cultural Dominant or Mode of Cultural
Production which differs markedly in its various manifestations (Jameson comments on developments in Literature,
Film, Fine Art, Video, Social Theory, etc.) from those of its predecessor, referred to collectively and broadly as
Modernism, mainly in its treatment of "subject position," temporality and narrative.
Cultural critique
Late capitalism is also an important component of Fredric Jameson's influential cultural analysis of postmodernity. A
section of Jameson's analysis [3] has been reproduced on the Marxists Internet Archive.
The theme of the end of history, recalling an idea from Hegel, was rekindled by A. Kojève in his Introduction to the
Reading of Hegel. It is discussed by Francis Fukuyama in a book of the same name, and criticised by Frank Furedi
[4]
A related term is late bourgeois society as contrasted with early bourgeois society in the 17th and 18th century, and
classical bourgeois society in the 19th and early 20th century.
Late capitalism 29
See also
• Advanced capitalism
• Periodizations of capitalism and state monopoly capitalism.
• Post-industrial society
• Wall Street
• Postmodernity
• Late modernity
Notes and References

[1] Scholarly treatments of the impact of world development use the term as in "Late capitalism and ethnic revivalism. A `New Middle Age'?"
Anthropological Theory (http:/ / ant. sagepub. com/ content/ 3/ 1/ 43. short)
[2] see, for example, Natalia Moszkowska's Zur Dynamik des Spätkapitalismus. Zurich: Verlag Der Aufbruch, 1943
[3] http:/ / www. marxists. org/ reference/ subject/ philosophy/ works/ us/ jameson. htm
[4] http:/ / www. spiked-online. com/ Articles/ 00000006D8EE. htm
Additional References
• Ernest Mandel. Late Capitalism (London: Humanities Press, 1975).
• Immanuel Wallerstein. The Essential Wallerstein (New York: The New Press, 2000), World-Systems Analysis:
An Introduction (Durham: Duke University Press, 2004).
Post-Fordism
Post-Fordism is the name given to the dominant system of economic production, consumption and associated
socio-economic phenomena, in most industrialized countries since the late 20th century. It is contrasted with
Fordism, the system formulated in Henry Ford's automotive factories, in which workers work on a production line,
performing specialized tasks repetitively. Definitions of the nature and scope of Post-Fordism vary considerably and
are a matter of debate among scholars.
Post-Fordism is characterized by the following attributes:[1]
• Small-batch production.
• Economies of scope.
• Specialized products and jobs.
• New information technologies.
• Emphasis on types of consumers in contrast to previous emphasis on social class.
• The rise of the service and the white-collar worker.
• The feminization of the work force.
Post-Fordism 30
Main Theories of post-Fordism

Post-Fordism can be applied in a wider context to describe a whole system of modern social processes. Because
Post-Fordism describes the world as it is today, various thinkers have different views of its form and implications.
As the theory continues to evolve, it is commonly divided into three schools of thought: Flexible Specialization,
Neo-Schumpeterianism, and the Regulation School.
Neo-Schumpeterianism
The Neo-Schumpeterian approach to post-Fordism is based upon the theory of Kondratiev Waves (also known as
Long Waves). The theory holds that a "techno-economic paradigm" (Perez) characterizes each long wave. Fordism
was the techno-economic paradigm of the fourth Kondratiev Wave, and post-Fordism is thus the techno-economic
paradigm of the fifth, which is dominated by Information and Communication Technology (ICT).
Notable Neo-Schumpeterian thinkers include Carlota Perez and Christopher Freeman, as well as Michael Storper and
Richard Walker.
Regulation School
The Regulation approach (also called the neo-Marxist or French Regulation School), was designed to address the
paradox of how capitalism has both a tendency towards crisis, change and instability as well as an ability to stabilize
institutions, rules and norms. The theory is based on two key concepts. "Regimes of Accumulation" refer to systems
of production and consumption, such as Fordism and post-Fordism. "Modes of Regulation" refer to the written and
unwritten laws of society which control the Regime of Accumulation and determine its form.
According to Regulation theory, every Regime of Accumulation will reach a crisis point at which the Mode of
Regulation will no longer support it, and society will be forced to find new rules and norms, forming a new Mode of
Regulation. This will begin a new Regime of Accumulation, which will eventually reach a crisis, and so forth.
Proponents of Regulation theory include Michel Aglietta, Robert Boyer, Bob Jessop, and Alain Lipietz.[2]
Changes from Fordism to post-Fordism

Post-Fordism brought on new ways of looking at consumption and production. The saturation of key markets
brought on a turn against mass consumption and a pursuit of higher living standards.[3] This shift brought a change in
how the market was viewed from a production standpoint. Rather than being viewed as a mass market to be served
by mass production, the consumers began to be viewed as different groups pursuing different goals who could be
better served with small batches of specialized goods[4] Mass markets became less important while markets for
luxury, custom, or positional good became more significant.[5] Production became less homogeneous and
standardized and more diverse and differentiated as organizations and economies of scale were replaced with
organizations and economies of scope.[6]
The changes in production with the shift from Fordism to post-Fordism were accompanied by changes in the
economy, politics, and prominent ideologies. In the economic realm, post-Fordism brought the decline of regulation
and production by the nation-state and the rise of global markets and corporations. Mass marketing was replaced by
flexible specialization, and organizations began to emphasize communication more than command. The workforce
changed with an increase in internal marketing, franchising, and subcontracting and a rise in part-time, temp,
self-employed, and home workers. Politically, class-based political parties declined and social movements based on
region, gender, or race increased. Mass unions began to vanish and were instead replaced by localized plant-based
bargaining. Cultural and ideological changes included the rise in individualist modes of thought and behavior and a
culture of entrepreneurialism. Following the shift in production and acknowledging the need for more
knowledge-based workers, education became less standardized and more specialized. Prominent ideologies that
arose included fragmentation and pluralism in values, post-modern eclecticism, and populist approaches to culture.[7]
Post-Fordism 31
Examples of post-Fordism
Italy
One of the primary examples of specialized post-Fordist production took place in a region known as the Third Italy.
The First Italy included the areas of large-scale mass production, such as Turin, Milan, and Genoa, and the Second
Italy described the undeveloped South. The Third Italy, however, was where clusters of small firms and workshops
developed in the 1970s and 1980s in the central and northeast regions of the country. Regions of the Third Italy
included Tuscany, Umbria, Marche, Emilia-Romagna, Veneto, Friuli, and Trentino-Alto Adige/Südtirol. Each region
specialized in a range of loosely related products and each workshop usually had five to fifty workers and often less
than ten. The range of products in each region reflected the post-Fordist shift to economies of scope. Additionally,
these workshops were known for producing high quality products and employing highly skilled, well-paid workers.
The workshops were very design-oriented and multidisciplinary, involving collaboration between entrepreneurs,
designers, engineers and workers.[8]
Japan
There were several post-World War II changes in production in Japan that caused post-Fordist conditions to develop.
First, there were changes to company structure, including the replacement of independent trade unions with
pro-management, company-based unions; the development of a core of permanent male multi-skilled workers; and
the development of a periphery of untrained temporary and part-time employees, who were mostly female. Second,
after World War II, Japan was somewhat isolated because of import barriers and foreign investment restrictions, and
as a result, Japan began to experiment with production techniques. Third, as imported technologies became more
available, Japan began to replicate, absorb, and improve them, with many improvements deriving from modifications
for local conditions. Fourth, Japan began to concentrate on the need for small-batch production and quick
changeover of product lines to serve the demand for a wide range of products in a relatively small market. Because
of informal price-fixing, competition was based not on price but rather on product differentiation. As a result,
production became less standardized and more specialized, particularly across different companies. Fifth, Japan
began to build long-term supply and subcontracting networks, which contrasted with the vertically integrated,
Fordist American corporations. Sixth, because small and medium-size manufacturers produced a wide range of
products, there was a need for affordable multipurpose equipment as opposed to the specialized, costly production
machinery in Fordist industries in the United States. Technology for flexible production was significant in Japan and
particularly necessary for smaller producers. The smaller producers also found it necessary to reduce costs. As a
result, Japan became one of the main users of robots and CNC.[9] Over time, these six changes in production in Japan
were institutionalized.
Criticisms of post-Fordism
The main criticism of post-Fordism asserts that post-Fordism mistakes the nature of the Fordist revolution and that
Fordism was not in crisis, but was simply evolving and will continue to evolve.[10] Other critics believe that
post-Fordism does exist, but coexists with Fordism. The automobile industry has combined Fordist and post-Fordist
strategies,[11] using both mass production and flexible specialization. Ford introduced flexibility into mass
production, so that Fordism could continue to evolve. Those who advocate post-Fordism, however, note that
criticism that focuses primarily on flexible specialization ignores post-Fordist changes in other areas of life and that
flexible specialization cannot be looked at alone when examining post-Fordism. Another criticism is that
post-Fordism relies too heavily on the examples of the Third Italy and Japan. Some believe that Japan is neither
Fordist nor post-Fordist and that vertical disintegration and mass production go hand in hand.[12] Others argue that
the new, smaller firms in Italy didn’t develop autonomously, but are a product of the vertical disintegration of the
large Fordist firms who contracted lower value-added work to smaller enterprises.[13] Other criticisms argue that
Post-Fordism 32
flexible specialization is not happening on any great scale, and smaller firms have always existed alongside mass
production. Another main criticism in that we are too much in the midst to just whether or not there really is a new
system of production.[14]
See also
• civil society
• social innovation
Notes
[1] Hall, S (1988) Brave new world. marxism today, October, page 24.
[2] Nilges 2008:
[3] Milani 2000: 33-35
[4] Kumar 1995: 43
[5] Milani 2000: 35
[6] Kumar 1995: 51
[7] Kumar 1995: 52
[8] Kumar 1995: 37-39
[9] Bernard 2000: 154-156
[10] Kumar 1995: 60
[11] Kiely 1998: 109
[12] Kumar 1995: 58-65
[13] Kiely 1998: 101
[14] Kumar 1995: 168
References
• Amin, Ash (1994). Post-fordism: A Reader. Blackwell Publishing. ISBN 0-631-18857-6.
• Baca, George (2004) "Legends of Fordism: Between Myth, History, and Foregone Conclusions," Social
Analysis,48(3): 169-178.
• Jessop, Bob (1995). The Regulation Approach, Governance and Post-fordism, Economy and Society. Blackwell
Publishing. ISBN 0-631-18857-6.
• Alain Lipietz (spring 1997). "The Post Fordist World: Labor Relations, International Hierarchy and Global
Ecology". Review of International Political Economy: 1–41.
• Scott, Allen J (1988). New Industrial Spaces: Flexible Production Organization and Regional Development in
North America and Western Europe. Pion Ltd..
• Kumar, Krishan (1995). N. From Post-Industrial to Post-Modern Society: New Theories of the Contemporary
World. Blackwell Publishing..
• Ray Kiely (spring 1998). "Globalization, Post-Fordism and the Contemporary Context of Development".
International Sociology 13 (1): 95–111. doi:10.1177/026858098013001008.
• Milani, Brian (2000). Designing the Green Economy: The Postindustrial Alternative to Corporate Globalization..
Rowman and Littlefield.
• Bernard, Mitchell (2000). "Post-Fordism and Global Restructuring". In Stubbs, Richard, and Geoffrey R.D.
Underhill. Political Economy and the Changing Global Order.. Oxford University Press Canada.
• Nilges, Mathias (2008). "The Anti-Anti-Oedipus: Representing Post-Fordist Subjectivity" (http://www.
mediationsjournal.org/articles/the-anti-anti-oedipus). Mediations Journal..
Post-industrial society
If a nation becomes "post-industrial" it passes through, or dodges, a phase of society predominated by a
manufacturing based economy and moves on to a structure of society based on the provision of information,
innovation, finance, and services.
Characteristics
As the term has been used, a few common themes (not limited to those below) have begun to emerge.
1. The economy undergoes a transition from the production of goods to the provision of services.
2. Knowledge becomes a valued form of capital (e.g., the knowledge produced through the Human Genome
Project).
3. Producing ideas is the main way to grow the economy.
4. Through processes of globalization and automation, the value and importance to the economy of blue-collar,
unionized work, including manual labor (e.g., assembly-line work) decline, and those of professional workers
(e.g. scientists, creative-industry professionals, and IT professionals) grow in value and prevalence.
5. Behavioral and information sciences and technologies are developed and implemented. (e.g. behavioral
economics, information architecture, cybernetics, Game theory and Information theory.)
Origins
Daniel Bell popularized the term through his 1973 work The Coming of Post-Industrial Society [1] . Before Bell, the
term was also used routinely by the Latin American social philosopher Ivan Illich in his book Tools for Conviviality.
Recently, the term has grown and changed as it became mainstream. The term is now used by admen such as Seth
Godin[2] , public policy PhD's such as Keith Boeckelman [3] , and sociologists such as Neil Fligstein and Ofer
Sharone[4] . Clinton even used the term to describe Chinese growth in a round-table discussion in Shanghai in
1998.[5]
Creativity culture
A virtual cult of 'creatives' have sprung up embodying and often describing and defending the post-industrial ethos.
They argue that businesses that create intangibles have taken a more prominent role in the wake of manufacturing's
decline and that in some countries, the production of creative intangibles produces more exports than manufacturing
alone.
Actor and artistic director of the Old Vic Theatre, Kevin Spacey, has argued the economic case for the arts in terms
of providing jobs and being of greater importance in exports than manufacturing (as well as an educational role) in a
guest column he wrote for The Times.[6]
Seth Godin in his recent book, "Linchpin" suggests that information technology and globalization will lead to
creative jobs being the only ones left in advanced economies.
This is the giant unwritten headline of our post-industrial economy. If your job isn't creative/interactive or
local, it's probably going to go away.
He suggests becoming creative before the market changes in your neighborhood.
Valuation of knowledge
Paul Romer, a professor of economics at Stanford, revolutionized the appreciation of knowledge as a valuable asset.
As he says it is not just the "ingredients" (supply) that makes good food, it is the "recipe" (knowledge) that counts
too. Better recipe, better food means better knowledge, more economic growth.[7]
More recently, economists at Berkeley studied the value of knowledge as a form of capital, like a factory or a truck.
Speaking along the same lines of their argument, the addition or 'production' of knowledge, could become the basis
of what would undoubtably be considered 'post-industrial' policies meant to deliver economic growth.[8]
In 2010, the OECD (the Organization of Economic Co-operation and Development) encouraged the governments of
advanced economies to embrace policies to increase innovation and knowledge in products and services as an
economical path to continued prosperity. [9]
Critiques
Neo-Logism
When historians and sociologists considered the revolution which followed the agricultural society they did not call
it a "post-agricultural society". "Post-industrial society" signifies only a departure, not a positive description.[10] [11]
One of the word's early users Ivan Illich prefigured this criticism and invented the word conviviality or the phrase
convivial society, to stand as a positive description of his version of a post-industrial society.
Social Critique
A group of geographers (such as Allen Scott and Edward Soja) argue that industry remains at the center of the whole
process of capitalist accumulation, with services not only becoming increasingly industrialized and automated but
also remaining highly dependent on industrial growth.
Some observers, including Soja (building on the theories of the French philosopher of urbanism Henri Lefebvre),
suggest that although industry may be based outside of a 'post-industrial' nation, that nation cannot ignore its
necessary sociological importance.
See also
• Alvin Toffler
• Alain Touraine
• Deindustrialization
• Heinz von Foerster
• Late modernity
• Late capitalism
• Industrial society
• Information society
• Information revolution
• Network society
• Post-capitalism
• Post-Marxism
• Sleepers, Wake!
• Sociocultural evolution
• Urban decay
References
[1] Bell, Daniel. The Coming of Post-Industrial Society. New York: Harper Colophon Books, 1974.
[2] Godin, Seth . Linchpin (2010)
[3] The American States in the Postindustrial Economy. The State and Local Government Review. on the web: http:/ / www. jstor. org/ pss/
4355128
[4] Work in the Postindustrial Economy of California. (2002) On the web http:/ / www. russellsage. org/ publications/ workingpapers/
workpostindcalif/ document
[5] 1999 Forward to "The Coming of the Post-Industrial Society" by Daniel Bell
[6] http:/ / www. timesonline. co. uk/ tol/ comment/ columnists/ guest_contributors/ article6251188. ece Kevin Spacey makes an economic case
for the arts
[7] Romer, Paul. The Concise Encyclopedia of Economics entry for "Economic Growth". on the web http:/ / www. econlib. org/ library/ Enc/
EconomicGrowth. html
[8] Czarnitzki, Dirk; Hall Bronwyn H. (Berkeley); Oriani Raffaele; The Market Valuation of Knowledge Assets in US and European Firms. On
the web at http:/ / elsa. berkeley. edu/ ~bhhall/ papers/ CHO05_mktval. pdf
[9] The Economist (May 27th 2010). on the web at http:/ / www. economist. com/ node/ 16219687?story_id=16219687
[10] Veneris, Yannis. The Informational Revolution, Cybernetics and Urban Modelling, PhD Thesis, University of Newcastle upon Tyne, UK,
1984. This thesis explored trends and theories (general economic and regional), and developed a large scale dynamic simulation model of the
transition from an industrial to an informational economy.
[11] Veneris, Yannis. Modeling the transition from the Industrial to the Informational Revolution, Environment and Planning A 22(3):399-416,
1990. (http:/ / www. envplan. com/ abstract. cgi?id=a220399)
External links
• Post Industrial Society Essay (http://www.technology-essays.com/essays/bells_post_industrial_society_essay.
htm) Bell’s ‘post-industrial society’, criticisms of his analysis of the role of information and knowledge in relation
to contemporary social change and the extent of these changes. (2005)
36
History of the financial crisis
Subprime crisis impact timeline

The subprime crisis impact timeline lists dates relevant to the creation of a United States housing bubble and the
2005 housing bubble burst (or market correction) and the subprime mortgage crisis which developed during 2007
and 2008. It includes United States enactment of government laws and regulations, as well as public and private
actions which affected the housing industry and related banking and investment activity. It also notes details of
important incidents in the United States, such as bankruptcies and takeovers, and information and statistics about
relevant trends. For more information on reverberations of this crisis throughout the global financial system see
Financial crisis of 2007–2010 or Global financial crisis of September–October 2008.
1938–1989
• 1938: The Federal National Mortgage Association, commonly known as Fannie Mae, is established (as part of
Franklin Delano Roosevelt's New Deal) to purchase and securitize mortgages to ensure that funds are consistently
available to the institutions that lend money to home buyers.
• 1968: Fannie Mae is converted from a federal government entity to a stand-alone government sponsored
enterprise (GSE) which purchases and securitizes mortgages to facilitate liquidity in the primary mortgage
market. The move takes the debt of Fannie Mae off of the books of the government.
• 1970: Federal Home Loan Mortgage Corporation (Freddie Mac) is created by an act of Congress, as a government
sponsored enterprise, to buy mortgages on the secondary market, pool them, and sell them as mortgage-backed
securities to investors on the open market; 1971 it issues its first Mortgage Participation Certificate security.[1]
• 1970s: Private companies begin mortgage asset securitization with the creation of private mortgage pools in the
1970s.[2]
• 1974: Equal Credit Opportunity Act imposes heavy sanctions for financial institutions found guilty of
discrimination on the basis of race, color, religion, national origin, sex, marital status, or age[3]
• 1977: Community Reinvestment Act is enacted to address historical discrimination in lending. The Act
encourages commercial banks and savings associations to meet the needs of borrowers in all segments of their
communities, including low- and moderate-income neighborhoods.[4] [5]
• 1980: The Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 granted all thrifts,
including savings and loan associations, the power to make consumer and commercial loans and to issue
transaction accounts and exempted federally chartered savings banks, installment plan sellers and chartered loan
companies from state usury (unlimited interest rates) limits.[6]
• 1981: Each of the 12 Federal Reserve banks establishes a Community Affairs Office to offer public and private
guidance in accordance with the Community Reinvestment Act.[7] [8]
• 1981: Salomon Brothers transitions from a private partnership to a public corporation, the first of the Wall St.
investment banks to do so. This shifts the risk of financial loss from the partners to shareholders, arguably
increasing the appetite for risk.[9]
• 1982: Alternative Mortgage Transaction Parity Act of 1982 (AMTPA) preempts state laws allows lenders to
originate mortgages with features such as adjustable-rate mortgages, balloon payments, and negative amortization
and "allows lenders to make loans with terms that may obscure the total cost of a loan".[10]
• 1986: Tax Reform Act of 1986 (TRA) ended prohibited taxpayers from deducting interest on consumer loans,
such as credit cards and auto loans, while allowing them to deduct interest paid on mortgage loans, providing an
incentive for homeowners to take out home equity loans to pay off consumer debt.[10] Household debt would
grow from $705 billion at year end 1974, 60% of disposable personal income, to $7.4 trillion at year end 2000,
and finally to $14.5 trillion in midyear 2008, 134% of disposable personal income.[11]
• 1987 The mezzanine CDO was invented at Drexel Burnham Lambert; Credit Suisse develops the
mortgage-backed CDO in 2000.[9]
• 1985–1989: The effects of Tax Reform Act of 1986, the elimination of Regulation Q which had capped interest
rates banks were allowed to pay, imprudent lending during the late 1970s inflationary period, as well as other
causes,[12] led to asset-liability mismatch for many Savings and Loans.,[13] This defacto insolvency led to the
Savings and Loan Crisis and the failure and/or closure of half of all federally insured savings and loans. The
number declined from 3,234 to 1,645.[14] [15]
• 1989-1995: Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") established the
Resolution Trust Corporation (RTC) which closed hundreds of insolvent savings and loans holding $519 billion
in assets and moved regulatory authority to the Office of Thrift Supervision (OTS). The U.S. government
ultimately appropriated 105 billion dollars to resolve the crisis. After banks repaid loans through various
procedures, there was a net loss to taxpayers of 40 billion dollars by the end of 1999.[16]
1990 - 2000
• 1992: Federal Housing Enterprises Financial Safety and Soundness Act of 1992 required Fannie Mae and Freddie
Mac to devote a percentage of their lending to support affordable housing increasing their pooling and selling of
such loans as securities; Office of Federal Housing Enterprise Oversight (OFHEO) created to oversee them[17] [18]
• 1993: The Federal Reserve Bank of Boston published "Closing the Gap: A Guide to Equal Opportunity Lending"
which recommended a series of measures to better serve low-income and minority households, including
loosening income thresholds for receiving a mortgage, influencing government policy and housing activist
demands on banks thereafter.[19] [20]
• 1994: Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (IBBEA) repeals the interstate
provisions of the Bank Holding Company Act of 1956 that regulated the actions of bank holding companies.
• 1995: New Community Reinvestment Act regulations break down home-loan data by neighborhood, income, and
race, enabling community groups to complain to banks and regulators about CRA compliance. Regulations also
allows community groups that market loans to collect a broker's fee.[21] Fannie Mae allowed to receive affordable
housing credit for buying subprime securities.[18]
• 1995–2001: Dot-com bubble and collapse
• 1997: Mortgage denial rate of 29 percent for conventional home purchase loans.[22] Investors purchased more
than $60 billion of subprime mortgage backed securities, six times more than 1991’s volume of $10 billion.[10]
(private label securities, not GSE backed)
• July: The Taxpayer Relief Act of 1997 expanded the capital-gains exclusion to $500,000 (per couple) from
$125,000, encouraging people to invest in second homes and investment properties.[23]
• November: Freddie Mac helped First Union Capital Markets and Bear Stearns & Co launch the first publicly
available securitization of CRA loans, issuing $384.6 million of such securities. All carried a Freddie Mac
guarantee as to timely interest and principal.[24] [25] First Union was not a subprime lender.[26]
• 1998: Incipient housing bubble as inflation-adjusted home price appreciation exceeds 10% per year in most West
Coast metropolitan areas.[27]
• May: Brooksley Born and the Commodity Futures Trading Commission release a report calling for regulation
of Over the Counter Derivatives. Born says that non-transparent trading could severely harm the economy.
Alan Greenspan, Robert Rubin, and Arthur Levitt of president Clinton's Working Group on Financial Markets,
and Larry Summers, fight against her plan and convince congress and others to take no action.[28] [29] [30] [31]
• October: "Financial Services Modernization Act" killed in Senate because of no restrictions on Community
Reinvestment Act-related community groups written into law[32]
• Federal Reserve Bank of New York rescues Long-Term Capital Management hedge fund in 1998, which a
Government Accountability Office critic said encouraged risky loans on assumption government will bail out
"too big to fail" banks and companies.[33]
• 1998-2008: With increase in sales of mortgage-backed securities, companies buy more Credit default swaps,
unregulated insurance contracts used to protect debt holders; these increased 100-fold from, with estimates of the
debt covered by such contracts, as of November 2008, ranging from $33 to $47 trillion.[34]
• 1999:
• September: Fannie Mae eases the credit requirements to encourage banks to extend home mortgages to
individuals whose credit is not good enough to qualify for conventional loans.[35]
• November: The Gramm-Leach-Bliley Act (or "Financial Services Modernization Act") is signed by president
Bill Clinton. It repeals the Glass-Steagall Act of 1933. It deregulates banking, insurance, securities, and the
financial services industry, allowing financial institutions to grow very large. It also limits Community
Reinvestment Coverage of smaller banks and makes community groups report certain financial relationships
with banks. Congressmen key to the effort include Phil Gramm, Jim Leach, Thomas J. Bliley, Jr., Chuck
Schumer, and Chris Dodd.[32]
• 2000: Lenders originating $160 billion worth of subprime, up from $40 billion in 1994. Fannie Mae buys $600
million of subprime mortgages, primarily on a flow basis. Freddie Mac, in that same year, purchases $18.6 billion
worth of subprime loans, mostly Alt A and A- mortgages. Freddie Mac guarantees another $7.7 billion worth of
subprime mortgages in structured transactions.[10]
• October: Fannie Mae commits to purchase and securitize $2 billion of Community Reinvestment Act eligible
loans,[36] [37]
• November: Fannie Mae announces that the Department of Housing and Urban Development (“HUD”) will
soon require it to dedicate 50% of its business to low- and moderate-income families" and its goal is to finance
over $500 billion in Community Reinvestment Act related business by 2010.[38]
• December:Commodity Futures Modernization Act of 2000 defines interest rates, currency prices, and stock
indexes as "excluded commodities," allowing trade of credit-default swaps by hedge funds, investment banks
or insurance companies with minimal oversight,[39] and contributing to 2008 crisis in Bear Stearns & Co,
Lehman Brothers, and AIG.[40] [41] [42]
2001-2006
• 2000–2003: Early 2000s recession spurs government action to rev up economy.
• 2000-2001: US Federal Reserve lowers Federal funds rate 11 times, from 6.5% (May 2000) to 1.75% (December
2001),[43] creating an easy-credit environment that fueled the growth of US subprime mortgages.[44]
• 2002-2006: Fannie Mae and Freddie Mac combined purchases of incorrectly rated AAA subprime
mortgage-backed securities rise from $38 billion to $90 billion per year.[45] [46] [47]
• Lenders began to offer loans to higher-risk borrowers,[48] Subprime mortgages amounted to $600 billion (20%)
by 2006.[49] [50]
• Speculation in residential real estate rose. During 2005, 28% of homes purchased were for investment
purposes, with an additional 12% purchased as vacation homes. During 2006, these figures were 22% and
14%, respectively.[51] As many as 85% of condominium properties purchased in Miami were for investment
purposes which the owners resold ("flipped") without the seller ever having lived in them.[52]
• 2002–2003: Mortgage denial rate of 14 percent for conventional home purchase loans, half of 1997.[22]
• 2002: Annual home price appreciation of 10% or more in California, Florida, and most Northeastern states.[53]
• June 17:President G.W. Bush sets goal of increasing minority home owners by at least 5.5 million by 2010
through billions of dollars in tax credits, subsidies and a Fannie Mae commitment of $440 billion to establish
NeighborWorks America with faith based organizations.[54]
• 2003: Federal Reserve Chair Alan Greenspan lowers federal reserve’s key interest rate to 1%, the lowest in 45
years.[55]
• August: Borio and White of Bank of International Settlements speak at the Jackson Hole Economic
Symposium, referencing BIS's "Credit Risk Transfer" 2003 report which warned about problems with
collateralized debt obligations and rating agencies. Their arguments are rejected or ignored by attendees,
including Alan Greenspan.[56]
• September: Bush administration recommend moving governmental supervision of Fannie Mae and Freddie
Mac under a new agency created within the Department of the Treasury. The changes are blocked by
Congress.[57]
• 2003-2007: U.S. subprime mortgages increased 292%, from $332 billion to $1.3 trillion, due primarily to the
private sector entering the mortgage bond market, once an almost exclusive domain of government sponsored
enterprises like Freddie Mac.[58] [59]
• The Federal Reserve fails to use its supervisory and regulatory authority over banks, mortgage underwriters
and other lenders, who abandoned loan standards (employment history, income, down payments, credit rating,
assets, property loan-to-value ratio and debt-servicing ability), emphasizing instead lender's ability to securitize
and repackage subprime loans.[39] [60]
• 2004-2007: Many financial institutions issued large amounts of debt and invested in mortgage-backed securities
(MBS), believing that house prices would continue to rise and that households would keep up on mortgage
payments.[61]
• 2004: U.S. homeownership rate peaks with an all time high of 69.2 percent.[62]
• Following example of Countrywide Financial, the largest U.S. mortgage lender, many lenders adopt automated
loan approvals that critics argued were not subjected to appropriate review and documentation according to
good mortgage underwriting standards.[63] In 2007, 40% of all subprime loans resulted from automated
underwriting.[64] [65] Mortgage fraud by borrowers increases.[66]
• HUD ratcheted up Fannie Mae and Freddie Mac affordable-housing goals for next four years, from 50 percent
to 56 percent, stating they lagged behind the private market; they purchased $175 billion in 2004—44 percent
of the market; from 2004 to 2006, they purchased $434 billion in securities backed by subprime loans[18]
• October:SEC effectively suspends net capital rule for five firms—Goldman Sachs, Merrill Lynch, Lehman
Brothers, Bear Stearns and Morgan Stanley. Freed from government imposed limits on the debt they can
assume, they levered up 20, 30 and even 40 to 1, buying massive amounts of mortgage-backed securities and
other risky investments.[67]
• 2005:
• The Securities and Exchange Commission ceases an investigation of Bear Stearns "pricing, valuation, and
analysis" of mortgage-backed collateralized debt obligations. No action is taken against Bear.[68]
• Robert Shiller gives talks warning about a housing bubble to the Office of the Comptroller of the Currency and
the Federal Deposit Insurance Corporation. He is ignored, and would later call it an incidence of Groupthink.
That same year, his second edition of "Irrational Exhuberance" warns that the housing bubble might lead to a
worldwide recession.[69]
• January:
• Federal Reserve Governor Edward Gramlich raises concerns over subprime lending practices, says
mortgage brokers might not have incentives for careful underwriting and that that portion of the subprime
industry was veering close to a breakdown, that it's possible that it is a bubble but that the housing market
did not qualify for specific monetary policy treatment at this point.[70]
• The Bank of International Settlements warns about the problems with structured financial products, and
points out the conflict of interest of credit rating agencies - that they are being payed by the same companies
they are supposed to be objectively evaluating.[56]
• February: The Office of Thrift Supervision implements new rules that allow savings and loans with over $1
billion in assets to meet their CRA obligations without investing in local communities, cutting availability of
subprime loans.[71]
• June: The International Swaps and Derivatives Association enables credit default swaps (quasi-insurance
contracts) to be taken out against asset-backed-security collateralized debt obligations (including ones backed
by subprime mortgages).[72]
• August: Raghuram Rajan delivers his paper "Has Financial Development Made the World Riskier?", warning
about credit default swaps, at the Jackson Hole Economic Symposium. His arguments are rejected by
attendees, including Alan Greenspan, Donald Kohn, and Lawrence Summers.[73] [74]
• September: The Mortgage Insurance Companies of America send a letter to the Federal Reserve, warning
about 'risky lending practices' in US real estate.[56]
• Fall 2005: Booming housing market halts abruptly; from the fourth quarter of 2005 to the first quarter of 2006,
median prices nationwide drop 3.3 percent.[75]
• 2006:
• May: The subprime lender Ameriquest announces it will cut 3,800 Jobs, close its 229 retail branches and rely
instead on the Web[76]
• May: Merit Financial Inc, based in Kirkland, Washington, files for bankruptcy and closes its doors, firing all
but 80 of its 410 employees; Merit’s marketplace decline about 40% and sales are not bringing in enough
revenue to support overhead.[55]
• August: U.S. Home Construction Index is down over 40% as of mid-August 2006 compared to a year
earlier.[77]
• September 7: Nouriel Roubini warns the International Monetary Fund about a coming US housing bust,
mortgage-backed securities failures, bank failures, and a recession. His work was based partly on his study of
recent economic crises in Russia (1998), Argentina (2000), Mexico (1994), and Asia (1997) [78]
• Fall 2006 J.P. Morgan CEO Jamie Dimon directs the firm to reduce its exposure to subprime mortgages.[9]
• December 2006 Goldman-Sachs claims after the fact that it began reducing its exposure to subprime
mortgages at this point. It also begins increasing its short positions. Others claim these risk decisions were
made in the spring and summer 2007.[9]
2007
Home sales continue to fall. The plunge in existing-home sales is the steepest since 1989. In Q1/2007,
S&P/Case-Shiller house price index records first year-over-year decline in nationwide house prices since 1991.[79]
The subprime mortgage industry collapses, and a surge of foreclosure activity (twice as bad as 2006)[80] and rising
interest rates threaten to depress prices further as problems in the subprime markets spread to the near-prime and
prime mortgage markets.[81]
• January 3: Ownit Mortgage Solutions Inc. files for Chapter 11. Records show that Ownit Mortgage Solutions
owed Merrill Lynch around $93 million at the time of filing.[55]
• February 5: Mortgage Lenders Network USA Inc., the country's 15th largest subprime lender with $3.3
billion in loans funded in third quarter 2006, files for Chapter 11.[55]
• February–March: Subprime industry collapse; several subprime lenders declaring bankruptcy, announcing
significant losses, or putting themselves up for sale.[82] These include Accredited Home Lenders Holding, New
Century Financial, DR Horton and Countrywide Financial [83]
• March: The value of USA subprime mortgages was estimated at $1.3 trillion as of March 2007.[84]
• March 6: In a speech before the Independent Community Bankers of America's Annual Convention and
Techworld, Honolulu, Hawaii, Ben Bernanke, quoting Alan Greenspan, warns that the Government Sponsored
Enterprises (GSEs), Fannie Mae and Freddie Mac, were a source of "systemic risk" and suggest legislation to
head off a possible crisis[85]

• April 2: New Century Financial, largest U.S. subprime lender, files for chapter 11 bankruptcy.[86]
• April 3: According to CNN Money, business sources report lenders made $640 billion in subprime loans in
2006, nearly twice the level 3 years earlier; subprime loans amounted to about 20 percent of the nation's
mortgage lending and about 17 percent of home purchases; financial firms and hedge funds likely own more
than $1 trillion in securities backed by subprime mortgage; about 13 percent of subprime loans are now
delinquent, more than five times the delinquency rate for home loans to borrowers with top credit; more than 2
percent of subprime loans had foreclosure proceedings start in the fourth quarter.[86]
• April 18: Freddie Mac fined $3.8 million by the Federal Election Commission as a result of illegal campaign
contributions, much of it to members of the United States House Committee on Financial Services which
oversees Freddie Mac.[87]
• June 7: Bear Stearns & Co informs investors in two of its funds, the High-Grade Structured Credit Strategies
Enhanced Leverage Fund and the High-Grade Structured Credit Fund that it was halting redemptions.[88]
• June 20: Merrill Lynch seized $800 million in assets from two Bear Stearns hedge funds that were involved in
securities backed by subprime loans.[89]
• June 25: FDIC Chair Shelia Bair cautioned against the more flexible risk management standards of the Basel
II international accord and lowering bank capital requirements generally: "There are strong reasons for
believing that banks left to their own devices would maintain less capital -- not more -- than would be prudent.
The fact is, banks do benefit from implicit and explicit government safety nets...In short, regulators can't leave
capital decisions totally to the banks."[90]
• July 19: Dow Jones Industrial Average closes above 14,000 for the first time in its history.[91]
• August: worldwide "credit crunch" as subprime mortgage backed securities are discovered in portfolios of
banks and hedge funds around the world, from BNP Paribas to Bank of China. Many lenders stop offering
home equity loans and "stated income" loans. Federal Reserve injects about $100 billion into the money supply
for banks to borrow at a low rate.
• August 6:American Home Mortgage Investment Corporation (AHMI) files Chapter 11 bankruptcy. The
company expects to see up to a $60 million loss for the first quarter 2007.[92]
• August 7: Numerous quantitative long/short equity hedge funds suddenly begin experiencing unprecedented
losses as a result of what is believed to be liquidations by some managers eager to access cash during the
liquidity crisis. It highlights one of the first examples of the contagion effect of the subprime crisis spilling
over into a radically different business area.[93]
• August 8: Mortgage Guaranty Insurance Corporation (MGIC, Milwaukee, Wisconsin) announces it will
discontinue its purchase of Radian Group [94] after suffering a billion-dollar loss[95] of its investment in
Credit-Based Asset Servicing and Securitization (C-BASS, New York]).[96]
• August 9: French investment bank BNP Paribas suspends three investment funds that invested in subprime
mortgage debt,[97] due to a "complete evaporation of liquidity" [98] in the market. The bank's announcement is
the first of many credit-loss and write-down announcements by banks, mortgage lenders and other institutional
investors, as subprime assets went bad, due to defaults by subprime mortgage payers.[99] This announcement
compels the intervention of the European Central Bank, pumping 95 billion euros into the European banking
market.[100] [101]
• August 10: Central banks coordinate efforts to increase liquidity for first time since the aftermath of the
September 11, 2001 terrorist attacks.[102] The United States Federal Reserve (Fed) injects a combined 43
billion USD, the European Central Bank (ECB) 156 billion euros (214.6 billion USD), and the Bank of Japan 1
trillion Yen (8.4 billion USD). Smaller amounts come from the central banks of Australia, and Canada.[102]
• August 14: Sentinel Management Group suspends redemptions for investors and sells off $312 million worth
of assets; three days later Sentinel files for Chapter 11 bankruptcy protection.[103] US and European stock
indices continue to fall.[104]
• August 15: The stock of Countrywide Financial, which is the largest mortgage lender in the United States,
falls around 13% on the New York Stock Exchange after Countrywide says foreclosures and mortgage
delinquencies have risen to their highest levels since early 2002.[105]
• August 16: Countrywide Financial Corporation, the biggest U.S. mortgage lender, narrowly avoids bankruptcy
by taking out an emergency loan of $11 billion from a group of banks.[106]
• August 17: the Federal Reserve cuts the discount rate by half a percent to 5.75% from 6.25% while leaving the
federal funds rate unchanged in an attempt to stabilize financial markets.[107]
• August 31: President Bush announces a limited bailout of U.S. homeowners unable to pay the rising costs of
their debts.[108] Ameriquest, once the largest subprime lender in the U.S., goes out of business;[109]
• September 1–3: Fed Economic Symposium in Jackson Hole, WY addressed the housing recession that
jeopardizes U.S. growth. Several critics argue that the Fed should use regulation and interest rates to prevent
asset-price bubbles,[110] blamed former Fed-chairman Alan Greenspan's low interest rate policies for stoking
the U.S. housing boom and subsequent bust,[111] and Yale University economist Robert Shiller warned of
possible home price declines of fifty percent.[112]
• September 4: The Libor rate rises to its highest level since December 1998, at 6.7975%, above the Bank of
England's 5.75% base rate.[113] [114]
• September 6: the Federal Reserve adds $31.25 billion in temporary reserves (loans) to the US money markets
which has to be repaid in two weeks.[115]
• September 7: US Labor Department announces that non-farm payrolls fell by 4,000 in August 2007, the first
month of negative job growth since August 2003, due in large part to problems in the housing and credit
markets.[116]
• September 17: Former Fed Chairman Alan Greenspan said "we had a bubble in housing" [117] and warns of
"large double digit declines" in home values "larger than most people expect."
• September 18: The Fed lowers interest rates by half a point (0.5%) in an attempt to limit damage to the
economy from the housing and credit crises.[118]
• September 28: Television finance personality Jim Cramer warns Americans on The Today Show, "don't you
dare buy a home—you'll lose money," causing a furor among Realtors.[119]
• September 30: Affected by the spiraling mortgage and credit crises, Internet banking pioneer NetBank goes
bankrupt,[120] and the Swiss bank UBS announces that it lost US$690 million in the third quarter.[121]
• October 5: Merrill Lynch announces a US$5.5 billion loss as a consequence of the subprime crisis, which is
revised to $8.4 billion on October 24, a sum that credit rating firm Standard & Poor's called "startling".[122]
• October 10: Hope Now Alliance is created by the US Government and private industry to help some
sub-prime borrowers.[123]
• October 15–17: A consortium of U.S. banks backed by the U.S. government announces a "super fund" of
$100 billion to purchase mortgage-backed securities whose mark-to-market value plummeted in the subprime
collapse.[124] Both Fed chairman Ben Bernanke and Treasury Secretary Hank Paulson express alarm about the
dangers posed by the bursting housing bubble; Paulson says "the housing decline is still unfolding and I view it
as the most significant risk to our economy. … The longer housing prices remain stagnant or fall, the greater
the penalty to our future economic growth."[125]
• October 31: Federal Reserve lowers the federal funds rate by 25 basis points to 4.5%.
• November 1: Federal Reserve injects $41B into the money supply for banks to borrow at a low rate. The
largest single expansion by the Fed since $50.35B on September 19, 2001.
• November 15: Financial Accounting Standards Board "Fair Value Measurements" standards upgrade the
quality of financial reporting through greater transparency.[126] [127] However, this "mark-to-market"
accounting may exaggerate the loss in value of an asset, as shown on balance sheets, and trigger a cascade of
unnecessary financial losses.[128]
• December 6: President Bush announces a plan to voluntarily and temporarily freeze the mortgages of a limited
number of mortgage debtors holding adjustable rate mortgages (ARM). He also asked Members Of Congress
to: 1. pass legislation to modernize the FHA. 2. temporarily reform the tax code to help homeowners refinance
during this time of housing market stress. 3. pass funding to support mortgage counseling. 4. pass legislation to
reform Government Sponsored Enterprises (GSEs) like Freddie Mac and Fannie Mae.[129]
• December 24: A consortium of banks officially abandons the U.S. government-supported "super-SIV"
mortgage crisis bail-out plan announced in mid-October,[130] citing a lack of demand for the risky mortgage
products on which the plan was based, and widespread criticism that the fund was a flawed idea that would
have been difficult to execute.[130]
2008
2008 in general
Starting in late 2007, and throughout 2008, the 'monoline' municipal bond insurance companies, such as AMBAC,
MBIA, and ACA, have their credit ratings downgraded by the credit rating agencies because they had also gotten
'insurance' policies (via credit default swaps) on mortgage-based CDOs. Since the entire 'municipal bond insurance'
business model depends on the insurer having a very high credit rating, these companies begin to collapse, and the
value of many of the bonds they insured also falls.[131] [132] [133] [134] [135]
January 2008 to August 2008

Financial crisis escalates with collapse of major lenders and investors.
• January 2–21: January 2008 stock market downturn.
• January 24: The National Association of Realtors (NAR)
announces that 2007 had the largest drop in existing home sales
in 25 years,[136] and "the first price decline in many, many years
and possibly going back to the Great Depression."[137]
• March 1–June 18: 406 people are arrested for mortgage fraud in
an FBI sting across the U.S., including buyers, sellers and others
across the wide-ranging mortgage industry.[138]
• March 10: Dow Jones Industrial Average at the lowest level
since October 2006, falling more than 20% from its peak just
five months prior.
• March 14: Bear Stearns gets Fed funding as shares
plummet.[139]
• March 16: Bear Stearns is acquired for $2 a share by JPMorgan
The New York City headquarters of Lehman
Chase in a fire sale avoiding bankruptcy. The deal is backed by Brothers.
the Federal Reserve, providing up to $30B to cover possible Bear
Stearn losses.[140]
• May 6: UBS AG Swiss bank announces plans to cut 5500 jobs by the middle of 2009.[141]
• June 18: As the chairman of the Senate Banking Committee Connecticut's Christopher Dodd proposes a
housing bailout to the Senate floor that would assist troubled subprime mortgage lenders such as Countrywide
Bank, Dodd admitted that he received special treatment, perks, and campaign donations from Countrywide,
who regarded Dodd as a "special" customer and a "Friend of Angelo." Dodd received a $75,000 reduction in
mortgage payments from Countrywide.[142] [143] The Chairman of the Senate Finance Committee Kent Conrad
and the head of head of Fannie Mae Jim Johnson also received mortgages on favorable terms due to their
association with Countrywide CEO Angelo R. Mozilo.[142] [144]
• June 19: Ex-Bear Stearns fund managers arrested by the FBI for their allegedly fraudulent role in the subprime
mortgage collapse. The managers purportedly misrepresented the fiscal health of their funds to investors
publicly while privately withdrawing their own money.[145]
• July 11 Indymac Bank, a subsidiary of Independent National Mortgage Corporation (Indymac), is placed into
the receivership of the FDIC by the Office of Thrift Supervision. It was the fourth-largest bank failure in
United States history,[146] and the second-largest failure of a regulated thrift.[147] [148] Before its failure,
IndyMac Bank was the largest savings and loan association in the Los Angeles area and the seventh-largest
mortgage originator in the United States.[149]
• July 14: Barney Frank characterizes future prospects of Fannie Mae and Freddie Mac as "solid" going
forward.
• July 17: Major banks and financial institutions had borrowed and invested heavily in mortgage backed
securities and reported losses of approximately $435 billion as of 17 July 2008.[150]
• July 30: President Bush signs into law the Housing and Economic Recovery Act of 2008, which authorizes the
Federal Housing Administration to guarantee up to $300 billion in new 30-year fixed rate mortgages for
subprime borrowers if lenders write-down principal loan balances to 90 percent of current appraisal value.
September 2008
• September 7: Federal takeover of Fannie Mae and Freddie Mac, which at that point owned or guaranteed
about half of the U.S.'s $12 trillion mortgage market, effectively nationalizing them. This causes panic because
almost every home mortgage lender and Wall Street bank relied on them to facilitate the mortgage market and
investors worldwide owned $5.2 trillion of debt securities backed by them.[151] [152]
• September 14: Merrill Lynch is sold to Bank of America amidst fears of a liquidity crisis and Lehman
Brothers collapse[153]
• September 15: Lehman Brothers files for bankruptcy protection[154]
• September 16: Moody's and Standard and Poor's downgrade ratings on AIG's credit on concerns over
continuing losses to mortgage-backed securities, sending the company into fears of insolvency.[155] [156] In
addition, the Reserve Primary Fund "breaks the buck" leading to a run on the money market funds. Over $140
billion is withdrawn vs. $7 billion the week prior. This leads to problems for the commercial paper market, a
key source of funding for corporations, which suddenly could not get funds or had to pay much higher interest
rates.[157]
• September 17: The US Federal Reserve lends $85 billion to American International Group (AIG) to avoid
bankruptcy.
• September 18: Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke meet with key legislators
to propose a $700 billion emergency bailout through the purchase of toxic assets. Bernanke tells them: "If we
don't do this, we may not have an economy on Monday."[158]
• September 19: Paulson financial rescue plan is unveiled after a volatile week in stock and debt markets.
• September 23: The FBI discloses that it had been investigating the possibility of fraud by mortgage financing
companies Fannie Mae and Freddie Mac, Lehman Brothers, and insurer American International Group,
bringing to 26 the number of corporate lenders under investigation.[159]
• September 25: Washington Mutual is seized by the Federal Deposit Insurance Corporation, and its banking
assets are sold to JP MorganChase for $1.9 billion.
• September 29: Emergency Economic Stabilization Act is defeated 228-205 in the United States House of
Representatives; Federal Deposit Insurance Corporation announces that Citigroup Inc. would acquire banking
operations of Wachovia.[160]
• September 30: US Treasury changes tax law to allow a bank acquiring another to write off all of the acquired
bank's losses for tax purposes []
October 2008
• October 1: The U.S. Senate passes HR1424, their version of the $700 billion bailout bill.[161]
• October 1: The financial crisis spreads to Europe.[162] [163]
• October 3: President George W. Bush signs the Emergency Economic Stabilization Act, creating a $700
billion Troubled Assets Relief Program to purchase failing bank assets.[164] It contains also easing of the
accounting rules that forced companies to collapse because of the existence of toxic mortgage-related
investments.[165] Also key to winning GOP support was a decision by the Securities and Exchange
Commission to ease mark-to-market accounting rules that require financial institutions to show the deflated
value of assets on their balance sheets."[127] [166]
• October 3: Using tax law change made September 30, Wells makes a higher offer for Wachovia, scooping it
from Citigroup [167]
• October 6–10: Worst week for the stock market in 75 years. The Dow Jones loses 22.1 percent, its worst week
on record, down 40.3 percent since reaching a record high of 14,164.53 October 9, 2007. The Standard &
Poor's 500 index loses 18.2 percent, its worst week since 1933, down 42.5 percent in since its own high
October 9, 2007.[168]
• October 6: Fed announces that it will provide $900 billion in short-term cash loans to banks.[169]
• October 7: Fed makes emergency move to lend around $1.3 trillion directly to companies outside the financial
sector.[170]
• October 7: The Internal Revenue Service (IRS) relaxes rules on US corporations repatriating money held
oversees in an attempt to inject liquidity into the US financial market. The new ruling allows the companies to
receive loans from their foreign subsidiaries for longer periods and more times a year without triggering the
35% corporate income tax.[55]
• October 8: Central banks in USA (Fed), England, China, Canada, Sweden, Switzerland and the European
Central Bank cut rates in a coordinated effort to aid world economy.[171]
• October 8: Fed also reduces its emergency lending rate to banks by half a percentage point, to 1.75
percent.[172]
• October 8: White House considers taking ownership stakes in private banks as a part of the bailout bill.[173]
Warren Buffett and George Soros criticized the original approach of the bailout bill.[174] [175]
• October 11: The Dow Jones Industrial Average caps its worst week ever with its highest volatility day ever
recorded in its 112 year history. Over the last eight trading days, the DJIA has dropped 22% amid worries of
worsening credit crisis and global recession. Paper losses now on US stocks now total $8.4 trillion from the
market highs last year.[55]
• October 11: The G7, a group of central bankers and finance ministers from the Group of Seven leading
economies, meet in Washington and agree to urgent and exceptional coordinated action to prevent the credit
crisis from throwing the world into depression. The G7 did not agree on the concrete plan that was hoped
for.[55]
• October 14: The US taps into the $700 billion available from the Emergency Economic Stabilization Act and
announces the injection of $250 billion of public money into the US banking system. The form of the rescue
will include the US government taking an equity position in banks that choose to participate in the program in
exchange for certain restrictions such as executive compensation. Nine banks agreed to participate in the
program and will receive half of the total funds: 1) Bank of America, 2) JPMorgan Chase, 3) Wells Fargo, 4)
Citigroup, 5) Merrill Lynch, 6) Goldman Sachs, 7) Morgan Stanley, 8) Bank of New York Mellon and 9) State
Street. Other US financial institutions eligible for the plan have until November 14 to agree to the terms.[55]
• October 21: The US Federal Reserve announces that it will spend $540 billion to purchase short-term debt
from money market mutual funds. The large amount of redemption requests during the credit crisis have
caused the money market funds to scale back lending to banks contributing to the credit freeze on interbank
lending markets. This government is hoping the injection will help unfreeze the credit markets making it easier
for businesses and banks to obtain loans. The structure of the plan involves the Fed setting up four special
purpose vehicles that will purchase the assets.[55]
November 2008
• November 12: Treasury Secretary Paulson abandons plan to buy toxic assets under the $700 billion Troubled
Asset Relief Program (TARP). Mr. Paulson said the remaining $410 billion in the fund would be better spent
on recapitalizing financial companies.[55]
• November 15: The group of 20 of the world’s largest economies meets in Washington DC and releases a
statement of the meeting. Although no detailed plans were agreed upon, the meeting focused on implementing
policies consistent with five principles: strengthening transparency and accountability, improving regulation,
promoting market integrity, reinforcing cooperation and reforming international institutions.[55]
• November 17: The Treasury gives out $33.6 billion to 21 banks in the second round of disbursements from the
$700 billion bailout fund. This payout brings the total to $158.56 billion so far.[176]
• November 24: The US government agrees to rescue Citigroup after an attack by investors causes the stock
price to plummet 60% over the last week under a detailed plan that including injecting another $20 billion of
capital into Citigroup bringing the total infusion to $45 billion.[176]
• November 25: The US Federal Reserve pledges $800 billion more to help revive the financial system. $600
billion will be used to buy mortgage bonds issued or guaranteed by Fannie Mae, Freddie Mac, and the Federal
Home Loan Banks.[176]
• November 28: The Bank for International Settlements (BIS), the global organization behind the Basel Accord,
issues a consultative paper providing supervisory guidance on the valuation of assets. The paper provides ten
principles that should be used by banks to value assets at fair market value.[176]
2010
• April 16: The Securities and Exchange Commission sues Goldman Sachs for fraud, for allegedly having failed to
disclose vital information to investors in one of its "Abacus" mortgage-backed CDOs in 2007. The CDO was
allegedly 'designed to fail' by the hedge fund of John Paulson, so that Paulson could make large profits by betting
against it. Allegedly this was not disclosed to investors by Goldman, and they lost roughly a billion dollars, while
Paulson & Co profited.[177] [178]
See also
• Timeline of the United States housing bubble for the pre-subprime crisis timeline
• Financial crisis of 2007–2010
• Global financial crisis in September 2008
• Global financial crisis in October 2008
• Global financial crisis in November 2008
• Global financial crisis in December 2008
• Global financial crisis in 2009
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Further reading
• Reuters - Timeline: The credit crunch of • New York Times - How a Market Crisis Unfolded (http:/ / www. nytimes. com/
2007/2008 (http:/ / www. reuters. com/ article/ interactive/ 2008/ 09/ 15/ business/ 20080915_TURMOIL_TIMELINE. html)
gc06/ idUSL155564520080805)
• Reuters - Events leading up to August market • CNN Money - Subprime crisis: A timeline (http:/ / money. cnn. com/ 2008/ 09/ 15/ news/
volatility (http:/ / www. reuters. com/ article/ economy/ subprime_timeline/ index. htm)
businessNews/ idUSN2325105220070824)
• Reuters - Timeline-Subprime crisis affects • CNN Money - The crisis: A timeline (http:/ / money. cnn. com/ galleries/ 2008/ news/
banks worldwide (http:/ / uk. reuters. com/ 0809/ gallery. week_that_broke_wall_street/ index. html)
article/ topNews/ idUKL0172888320080401)
• Reuters - Timeline: World economies slide into • Financial Post - Credit Crunch Timeline (http:/ / www. financialpost. com/ news/ story.
recession (http:/ / www. reuters. com/ article/ html?id=774342)
GCA-Economy/ idUSTRE4BM0NU20081223)
• Reuters - Timeline: Financial crisis since • Mortgages - Credit Crunch Timeline (http:/ / www. mortgages. co. uk/ credit-crunch/
October (http:/ / www. reuters. com/ article/ credit-crunch-timeline. html)
newsOne/ idUSTRE4AP46X20081126)
• Times - Banking crisis: timeline of the turmoil • Telegraph - Credit Crunch timeline: From Northern Rock to Lehman Brothers (http:/ /
(http:/ / business. timesonline. co. uk/ tol/ www. telegraph. co. uk/ finance/ newsbysector/ banksandfinance/ 2963415/
business/ industry_sectors/ Credit-Crunch-timeline-From-Northern-Rock-to-Lehman-Brothers. html)
banking_and_finance/ article4912497. ece)
• Financial Times - In depth: Subprime (http:/ / • Telegraph - Timeline: The sub-prime mortgage crisis (http:/ / www. telegraph. co. uk/
www. ft. com/ indepth/ subprime) finance/ 2815755/ Timeline-The-sub-prime-mortgage-crisis. html)
• Washington Post - Timeline: Crisis on Wall • The Guardian - Credit crisis - how it all began (http:/ / www. guardian. co. uk/ business/
Street (http:/ / www. washingtonpost. com/ 2008/ aug/ 05/ northernrock. banking)
wp-srv/ business/ economy-watch/ timeline/ )
• Bloomberg - Subprime Collapse to Global • BBC - Timeline: Sub-prime losses (http:/ / news. bbc. co. uk/ 2/ hi/ business/ 7096845.
Financial Meltdown (http:/ / www. bloomberg. stm)
com/ apps/ news?pid=newsarchive&
sid=aleqkSjAAw10)
• MSNBC - How the global financial crisis has • BBC - Timeline: Global credit crunch (http:/ / news. bbc. co. uk/ 2/ hi/ business/ 7521250.
unfold (http:/ / www. msnbc. msn. com/ id/ stm)
26797480)
• New York Times - Credit Crisis — The • PBS - Inside the Meltdown (http:/ / www. pbs. org/ wgbh/ pages/ frontline/ meltdown/ )
Essentials (http:/ / topics. nytimes. com/ topics/
reference/ timestopics/ subjects/ c/ credit_crisis/
index. html)
External links
• Credit crisis timeline (http://www.creditwritedowns.com/2008/05/credit-crisis-timeline.html)
• Detailed Financial Crisis Timeline (http://www.uiowa.edu/ifdebook/timeline/Financial_Crisis_Timeline.pdf)
• Financial Crisis Timeline at the St. Louis Fed (http://www.stlouisfed.org/timeline/timeline.cfm)
Subprime mortgage crisis

The subprime mortgage crisis is an ongoing real estate and financial crisis, characterized by a fall in U.S. housing
prices, a rise in mortgage delinquencies and foreclosures, and severe disruption in the shadow banking system, with
major adverse consequences for the economies of the U.S. and Europe.
Approximately 80% of U.S. mortgages issued to subprime borrowers were adjustable-rate mortgages[1] . After U.S.
house prices peaked in mid-2006 and began their steep decline thereafter, refinancing became more difficult. As
adjustable-rate mortgages began to reset at higher rates, mortgage delinquencies soared. Securities backed with
subprime mortgages, widely held by financial firms, lost most of their value. Global investors also drastically
reduced purchases of riskier mortgage-backed debt and other securities. The result has been a decline in the capacity
and willingness of the private financial system to support lending, tightening credit around the world and slowing
economic growth in the U.S. and Europe.
Background and timeline of events

The immediate cause or trigger of the crisis was the bursting of the
United States housing bubble which peaked in approximately
2005–2006.[2] [3] High default rates on "subprime" and adjustable rate
mortgages (ARM), began to increase quickly thereafter. An increase in
loan incentives such as easy initial terms and a long-term trend of
rising housing prices had encouraged borrowers to assume difficult
mortgages in the belief they would be able to quickly refinance at more
favorable terms. However, once interest rates began to rise and housing
prices started to drop moderately in 2006–2007 in many parts of the
Factors contributing to housing bubble
U.S., refinancing became more difficult. Defaults and foreclosure
activity increased dramatically as easy initial terms expired, home
prices failed to go up as anticipated, and ARM interest rates reset
higher. Falling prices also resulted in homes worth less than the
mortgage loan, providing a financial incentive for borrowers to enter
foreclosure. The ongoing foreclosure epidemic that began in late 2006
in the U.S. continues to be a key factor in the global economic crisis,
because it drains wealth from consumers and erodes the financial
strength of banking institutions.
In the years leading up to the crisis, significant amounts of foreign

Domino effect as housing prices declined money flowed into the U.S. from fast-growing economies in Asia and
oil-producing countries. This inflow of funds combined with low U.S.
interest rates from 2002-2004 contributed to easy credit conditions, which fueled both housing and credit bubbles.
Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an
unprecedented debt load.[4] [5] As part of the housing and credit booms, the amount of financial agreements called
mortgage-backed securities (MBS), which derive their value from mortgage payments and housing prices, greatly
increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing
market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in
subprime MBS reported significant losses. Defaults and losses on other loan types also increased significantly as the
crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of
U.S. dollars globally.[6]
While the housing and credit bubbles were growing, a series of factors caused the financial system to become
increasingly fragile. Policymakers did not recognize the increasingly important role played by financial institutions
such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these
institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but
they were not subject to the same regulations.[7] These institutions as well as certain regulated banks had also
assumed significant debt burdens while providing the loans described above and did not have a financial cushion
sufficient to absorb large loan defaults or MBS losses.[8] These losses impacted the ability of financial institutions to
lend, slowing economic activity. Concerns regarding the stability of key financial institutions drove central banks to
take action to provide funds to encourage lending and to restore faith in the commercial paper markets, which are
integral to funding business operations. Governments also bailed out key financial institutions, assuming significant
additional financial commitments.
The risks to the broader economy created by the housing market downturn and subsequent financial market crisis
were primary factors in several decisions by central banks around the world to cut interest rates and governments to
implement economic stimulus packages. Effects on global stock markets due to the crisis have been dramatic.
Between 1 January and 11 October 2008, owners of stocks in U.S. corporations had suffered about $8 trillion in
losses, as their holdings declined in value from $20 trillion to $12 trillion. Losses in other countries have averaged
about 40%.[9] Losses in the stock markets and housing value declines place further downward pressure on consumer
spending, a key economic engine.[10] Leaders of the larger developed and emerging nations met in November 2008
and March 2009 to formulate strategies for addressing the crisis.[11] As of April 2009, many of the root causes of the
crisis had yet to be addressed. A variety of solutions have been proposed by government officials, central bankers,
economists, and business executives.[12] [13] [14]
Mortgage market
Subprime borrowers typically have weakened credit histories and
reduced repayment capacity. Subprime loans have a higher risk of
default than loans to prime borrowers.[15] If a borrower is delinquent in
making timely mortgage payments to the loan servicer (a bank or other
financial firm), the lender may take possession of the property, in a
process called foreclosure.
The value of American subprime mortgages was estimated at $1.3

trillion as of March 2007, [16] with over 7.5 million first-lien subprime
Number of U.S. residential properties subject to
mortgages outstanding.[17] Between 2004-2006 the share of subprime
foreclosure actions by quarter (2007-2010). mortgages relative to total originations ranged from 18%-21%, versus
less than 10% in 2001-2003 and during 2007.[18] [19] In the third
quarter of 2007, subprime ARMs making up only 6.8% of USA mortgages outstanding also accounted for 43% of
the foreclosures which began during that quarter.[20] By October 2007, approximately 16% of subprime adjustable
rate mortgages (ARM) were either 90-days delinquent or the lender had begun foreclosure proceedings, roughly
triple the rate of 2005.[21] By January 2008, the delinquency rate had risen to 21%[22] and by May 2008 it was
25%.[23]
The value of all outstanding residential mortgages, owed by U.S. households to purchase residences housing at most
four families, was US$9.9 trillion as of year-end 2006, and US$10.6 trillion as of midyear 2008.[24] During 2007,
lenders had begun foreclosure proceedings on nearly 1.3 million properties, a 79% increase over 2006.[25] This
increased to 2.3 million in 2008, an 81% increase vs. 2007,[26] and again to 2.8 million in 2009, a 21% increase vs.
2008.[27]
By August 2008, 9.2% of all U.S. mortgages outstanding were either delinquent or in foreclosure.[28] By September
2009, this had risen to 14.4%.[29] Between August 2007 and October 2008, 936,439 USA residences completed
foreclosure.[30] Foreclosures are concentrated in particular states both in terms of the number and rate of foreclosure
filings.[31] Ten states accounted for 74% of the foreclosure filings during 2008; the top two (California and Florida)
represented 41%. Nine states were above the national foreclosure rate average of 1.84% of households.[32]
Causes
The crisis can be attributed to a number of factors pervasive in both housing and credit markets, factors which
emerged over a number of years. Causes proposed include the inability of homeowners to make their mortgage
payments, due primarily to adjustable-rate mortgages resetting, borrowers overextending, predatory lending,
speculation and overbuilding during the boom period, risky mortgage products, high personal and corporate debt
levels, financial products that distributed and perhaps concealed the risk of mortgage default, bad monetary and
housing policies, international trade imbalances, and inappropriate government regulation.[33] [34] [35] [36] Three
important catalysts of the subprime crisis were the influx of moneys from the private sector, the banks entering into
the mortgage bond market and the predatory lending practices of the mortgage lenders, specifically the
adjustable-rate mortgage, 2-28 loan, that Mortgage Lenders sold directly or indirectly via Mortgage Brokers.[1] [37]
On Wall Street and in the financial industry, moral hazard lay at the core of many of the causes.[38]
In its "Declaration of the Summit on Financial Markets and the World Economy," dated 15 November 2008, leaders
of the Group of 20 cited the following causes:
During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade,
market participants sought higher yields without an adequate appreciation of the risks and failed to exercise
proper due diligence. At the same time, weak underwriting standards, unsound risk management practices,
increasingly complex and opaque financial products, and consequent excessive leverage combined to create
vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not
adequately appreciate and address the risks building up in financial markets, keep pace with financial
innovation, or take into account the systemic ramifications of domestic regulatory actions.[39]
During May 2010, Warren Buffett and Paul Volcker separately described questionable assumptions or judgments
underlying the U.S. financial and economic system that contributed to the crisis. These assumptions included: 1)
Housing prices would not fall dramatically;[40] 2) Free and open financial markets supported by sophisticated
financial engineering would most effectively support market efficiency and stability, directing funds to the most
profitable and productive uses; 3) Concepts embedded in mathematics and physics could be directly adapted to
markets, in the form of various financial models used to evaluate credit risk; 4) Economic imbalances, such as large
trade deficits and low savings rates indicative of over-consumption, were sustainable; and 5) Stronger regulation of
the shadow banking system and derivatives markets was not needed.[41]
Boom and bust in the housing market

Low interest rates and large inflows of foreign funds created easy
credit conditions for a number of years prior to the crisis, fueling a
housing market boom and encouraging debt-financed consumption.[42]
The USA home ownership rate increased from 64% in 1994 (about
where it had been since 1980) to an all-time high of 69.2% in 2004.[43]
Subprime lending was a major contributor to this increase in home
ownership rates and in the overall demand for housing, which drove
prices higher.
Between 1997 and 2006, the price of the typical American house Existing homes sales, inventory, and months
increased by 124%.[44] During the two decades ending in 2001, the supply, by quarter.
national median home price ranged from 2.9 to 3.1 times median
household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006.[45]
This housing bubble resulted in quite a few homeowners refinancing
their homes at lower interest rates, or financing consumer spending by
taking out second mortgages secured by the price appreciation. USA
household debt as a percentage of annual disposable personal income
was 127% at the end of 2007, versus 77% in 1990.[46]
While housing prices were increasing, consumers were saving less[47]

and both borrowing and spending more. Household debt grew from
$705 billion at yearend 1974, 60% of disposable personal income, to
Vicious Cycles in the Housing & Financial
$7.4 trillion at yearend 2000, and finally to $14.5 trillion in midyear
Markets
2008, 134% of disposable personal income.[48] During 2008, the
typical USA household owned 13 credit cards, with 40% of households
carrying a balance, up from 6% in 1970.[49] Free cash used by consumers from home equity extraction doubled from
$627 billion in 2001 to $1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion dollars over the
period.[50] [51] [52] U.S. home mortgage debt relative to GDP increased from an average of 46% during the 1990s to
73% during 2008, reaching $10.5 trillion.[53]
This credit and house price explosion led to a building boom and eventually to a surplus of unsold homes, which
caused U.S. housing prices to peak and begin declining in mid-2006.[54] Easy credit, and a belief that house prices
would continue to appreciate, had encouraged many subprime borrowers to obtain adjustable-rate mortgages. These
mortgages enticed borrowers with a below market interest rate for some predetermined period, followed by market
interest rates for the remainder of the mortgage's term. Borrowers who could not make the higher payments once the
initial grace period ended would try to refinance their mortgages. Refinancing became more difficult, once house
prices began to decline in many parts of the USA. Borrowers who found themselves unable to escape higher monthly
payments by refinancing began to default.
As more borrowers stop paying their mortgage payments (this is an on-going crisis), foreclosures and the supply of
homes for sale increases. This places downward pressure on housing prices, which further lowers homeowners'
equity. The decline in mortgage payments also reduces the value of mortgage-backed securities, which erodes the net
worth and financial health of banks. This vicious cycle is at the heart of the crisis.[55]
By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak.[56] [57] This
major and unexpected decline in house prices means that many borrowers have zero or negative equity in their
homes, meaning their homes were worth less than their mortgages. As of March 2008, an estimated 8.8 million
borrowers — 10.8% of all homeowners — had negative equity in their homes, a number that is believed to have
risen to 12 million by November 2008. Borrowers in this situation have an incentive to default on their mortgages as
a mortgage is typically nonrecourse debt secured against the property.[58] Economist Stan Leibowitz argued in the
Wall Street Journal that although only 12% of homes had negative equity, they comprised 47% of foreclosures
during the second half of 2008. He concluded that the extent of equity in the home was the key factor in foreclosure,
rather than the type of loan, credit worthiness of the borrower, or ability to pay.[59]
Increasing foreclosure rates increases the inventory of houses offered for sale. The number of new homes sold in
2007 was 26.4% less than in the preceding year. By January 2008, the inventory of unsold new homes was 9.8 times
the December 2007 sales volume, the highest value of this ratio since 1981.[60] Furthermore, nearly four million
existing homes were for sale,[61] of which almost 2.9 million were vacant.[62] This overhang of unsold homes
lowered house prices. As prices declined, more homeowners were at risk of default or foreclosure. House prices are
expected to continue declining until this inventory of unsold homes (an instance of excess supply) declines to normal
levels.[63]
Homeowner Speculation
Speculative borrowing in residential real estate has been cited as a contributing factor to the subprime mortgage
crisis.[64] During 2006, 22% of homes purchased (1.65 million units) were for investment purposes, with an
additional 14% (1.07 million units) purchased as vacation homes. During 2005, these figures were 28% and 12%,
respectively. In other words, a record level of nearly 40% of homes purchases were not intended as primary
residences. David Lereah, NAR's chief economist at the time, stated that the 2006 decline in investment buying was
expected: "Speculators left the market in 2006, which caused investment sales to fall much faster than the primary
market."[65]
Housing prices nearly doubled between 2000 and 2006, a vastly different trend from the historical appreciation at
roughly the rate of inflation. While homes had not traditionally been treated as investments subject to speculation,
this behavior changed during the housing boom. Media widely reported condominiums being purchased while under
construction, then being "flipped" (sold) for a profit without the seller ever having lived in them.[66] Some mortgage
companies identified risks inherent in this activity as early as 2005, after identifying investors assuming highly
leveraged positions in multiple properties.[67]
Nicole Gelinas of the Manhattan Institute described the negative consequences of not adjusting tax and mortgage
policies to the shifting treatment of a home from conservative inflation hedge to speculative investment.[68]
Economist Robert Shiller argued that speculative bubbles are fueled by "contagious optimism, seemingly impervious
to facts, that often takes hold when prices are rising. Bubbles are primarily social phenomena; until we understand
and address the psychology that fuels them, they're going to keep forming."[69] Keynesian economist Hyman Minsky
described how speculative borrowing contributed to rising debt and an eventual collapse of asset values.[70] [71]
New York State prosecutors are examining whether eight banks hoodwinked credit ratings agencies, to inflate the
grades of subprime-linked investments. The Securities and Exchange Commission, the Justice Department, the
United States attorney’s office and more are examining how banks created, rated, sold and traded mortgage securities
that turned out to be some of the worst investments ever devised. In 2010, virtually all of the investigations, criminal
as well as civil, are in their early stages.[72]
Warren Buffett testified to the Financial Crisis Inquiry Commission: "There was the greatest bubble I've ever seen in
my life...The entire American public eventually was caught up in a belief that housing prices could not fall
dramatically."[40]
High-risk mortgage loans and lending/borrowing practices

In the years before the crisis, the behavior of lenders changed dramatically. Lenders offered more and more loans to
higher-risk borrowers,[73] including undocumented immigrants.[74] Subprime mortgages amounted to $35 billion
(5% of total originations) in 1994,[75] 9% in 1996,[76] $160 billion (13%) in 1999,[75] and $600 billion (20%) in
2006.[76] [77] [78] A study by the Federal Reserve found that the average difference between subprime and prime
mortgage interest rates (the "subprime markup") declined significantly between 2001 and 2007. The combination of
declining risk premia and credit standards is common to boom and bust credit cycles.[79]
In addition to considering higher-risk borrowers, lenders have offered increasingly risky loan options and borrowing
incentives. In 2005, the median down payment for first-time home buyers was 2%, with 43% of those buyers making
no down payment whatsoever.[80] By comparison, China has down payment requirements that exceed 20%, with
higher amounts for non-primary residences.[81]
The mortgage qualification guidelines began to change. At first, the
stated income, verified assets (SIVA) loans came out. Proof of income
was no longer needed. Borrowers just needed to "state" it and show
that they had money in the bank. Then, the no income, verified assets
(NIVA) loans came out. The lender no longer required proof of
employment. Borrowers just needed to show proof of money in their
bank accounts. The qualification guidelines kept getting looser in order
Growth in mortgage loan fraud based upon US
to produce more mortgages and more securities. This led to the
Department of the Treasury Suspicious Activity
creation of NINA. NINA is an abbreviation of No Income No Assets Report Analysis.
(sometimes referred to as Ninja loans). Basically, NINA loans are
official loan products and let you borrow money without having to prove or even state any owned assets. All that
was required for a mortgage was a credit score. [82]
Another example is the interest-only adjustable-rate mortgage (ARM), which allows the homeowner to pay just the
interest (not principal) during an initial period. Still another is a "payment option" loan, in which the homeowner can
pay a variable amount, but any interest not paid is added to the principal. An estimated one-third of ARMs originated
between 2004 and 2006 had "teaser" rates below 4%, which then increased significantly after some initial period, as
much as doubling the monthly payment.[83]
The proportion of subprime ARM loans made to people with credit scores high enough to qualify for conventional
mortgages with better terms increased from 41% in 2000 to 61% by 2006. However, there are many factors other
than credit score that affect lending. In addition, mortgage brokers in some cases received incentives from lenders to
offer subprime ARM's even to those with credit ratings that merited a conforming (i.e., non-subprime) loan.[84]
Mortgage underwriting standards declined precipitously during the boom period. The use of automated loan
approvals allowed loans to be made without appropriate review and documentation.[85] In 2007, 40% of all subprime
loans resulted from automated underwriting.[86] [87] The chairman of the Mortgage Bankers Association claimed that
mortgage brokers, while profiting from the home loan boom, did not do enough to examine whether borrowers could
repay.[88] Mortgage fraud by lenders and borrowers increased enormously.[89] In 2004, the Federal Bureau of
Investigation warned of an "epidemic" in mortgage fraud, an important credit risk of nonprime mortgage lending,
which, they said, could lead to "a problem that could have as much impact as the S&L crisis".[90] [91] [92] [93]
So why did lending standards decline? In a Peabody Award winning program, NPR correspondents argued that a
"Giant Pool of Money" (represented by $70 trillion in worldwide fixed income investments) sought higher yields
than those offered by U.S. Treasury bonds early in the decade. Further, this pool of money had roughly doubled in
size from 2000 to 2007, yet the supply of relatively safe, income generating investments had not grown as fast.
Investment banks on Wall Street answered this demand with financial innovation such as the mortgage-backed
security (MBS) and collateralized debt obligation (CDO), which were assigned safe ratings by the credit rating
agencies. In effect, Wall Street connected this pool of money to the mortgage market in the U.S., with enormous fees
accruing to those throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks
that funded the brokers, to the giant investment banks behind them. By approximately 2003, the supply of mortgages
originated at traditional lending standards had been exhausted. However, continued strong demand for MBS and
CDO began to drive down lending standards, as long as mortgages could still be sold along the supply chain.
Eventually, this speculative bubble proved unsustainable. NPR described it this way:[94]
The problem was that even though housing prices were going through the roof, people weren't making any
more money. From 2000 to 2007, the median household income stayed flat. And so the more prices rose, the
more tenuous the whole thing became. No matter how lax lending standards got, no matter how many exotic
mortgage products were created to shoehorn people into homes they couldn't possibly afford, no matter what
the mortgage machine tried, the people just couldn't swing it. By late 2006, the average home cost nearly four
times what the average family made. Historically it was between two and three times. And mortgage lenders
noticed something that they'd almost never seen before. People would close on a house, sign all the mortgage
papers, and then default on their very first payment. No loss of a job, no medical emergency, they were
underwater before they even started. And although no one could really hear it, that was probably the moment
when one of the biggest speculative bubbles in American history popped.
Securitization practices
The traditional mortgage model involved a bank originating a loan to
the borrower/homeowner and retaining the credit (default) risk. With
the advent of securitization, the traditional model has given way to the
"originate to distribute" model, in which banks essentially sell the
mortgages and distribute credit risk to investors through
mortgage-backed securities. Securitization meant that those issuing
mortgages were no longer required to hold them to maturity. By selling
the mortgages to investors, the originating banks replenished their
funds, enabling them to issue more loans and generating transaction
fees. This created a moral hazard in which an increased focus on
Borrowing under a securitization structure. processing mortgage transactions was incentivized but ensuring their
credit quality was not.[95] [96]
Securitization accelerated in the mid-1990s. The total amount of mortgage-backed securities issued almost tripled
between 1996 and 2007, to $7.3 trillion. The securitized share of subprime mortgages (i.e., those passed to
third-party investors via MBS) increased from 54% in 2001, to 75% in 2006.[79] American homeowners, consumers,
and corporations owed roughly $25 trillion during 2008. American banks retained about $8 trillion of that total
directly as traditional mortgage loans. Bondholders and other traditional lenders provided another $7 trillion. The
remaining $10 trillion came from the securitization markets. The securitization markets started to close down in the
spring of 2007 and nearly shut-down in the fall of 2008. More than a third of the private credit markets thus became
unavailable as a source of funds.[97] [98] In February 2009, Ben Bernanke stated that securitization markets remained
effectively shut, with the exception of conforming mortgages, which could be sold to Fannie Mae and Freddie
Mac.[99]
A more direct connection between securitization and the subprime crisis relates to a fundamental fault in the way
that underwriters, rating agencies and investors modeled the correlation of risks among loans in securitization pools.
Correlation modeling—determining how the default risk of one loan in a pool is statistically related to the default
risk for other loans—was based on a "Gaussian copula" technique developed by statistician David X. Li. This
technique, widely adopted as a means of evaluating the risk associated with securitization transactions, used what
turned out to be an overly simplistic approach to correlation. Unfortunately, the flaws in this technique did not
become apparent to market participants until after many hundreds of billions of dollars of ABS and CDOs backed by
subprime loans had been rated and sold. By the time investors stopped buying subprime-backed securities—which
halted the ability of mortgage originators to extend subprime loans—the effects of the crisis were already beginning
to emerge.[100]
Nobel laureate Dr. A. Michael Spence wrote: "Financial innovation, intended to redistribute and reduce risk, appears
mainly to have hidden it from view. An important challenge going forward is to better understand these dynamics as
the analytical underpinning of an early warning system with respect to financial instability." [101]
Inaccurate credit ratings

Credit rating agencies are now under scrutiny for having given
investment-grade ratings to MBSs based on risky subprime mortgage
loans. These high ratings enabled these MBS to be sold to investors,
thereby financing the housing boom. These ratings were believed
justified because of risk reducing practices, such as credit default
insurance and equity investors willing to bear the first losses. However,
there are also indications that some involved in rating subprime-related
securities knew at the time that the rating process was faulty.[102]
Critics allege that the rating agencies suffered from conflicts of MBS credit rating downgrades, by quarter.
interest, as they were paid by investment banks and other firms that
organize and sell structured securities to investors.[103] On 11 June 2008, the SEC proposed rules designed to
mitigate perceived conflicts of interest between rating agencies and issuers of structured securities.[104] On 3
December 2008, the SEC approved measures to strengthen oversight of credit rating agencies, following a ten-month
investigation that found "significant weaknesses in ratings practices," including conflicts of interest.[105]
Between Q3 2007 and Q2 2008, rating agencies lowered the credit ratings on $1.9 trillion in mortgage backed
securities. Financial institutions felt they had to lower the value of their MBS and acquire additional capital so as to
maintain capital ratios. If this involved the sale of new shares of stock, the value of the existing shares was reduced.
Thus ratings downgrades lowered the stock prices of many financial firms.[106]
Government policies
Both government failed regulation and deregulation contributed to the
crisis. In testimony before Congress both the Securities and Exchange
Commission (SEC) and Alan Greenspan conceded failure in allowing
the self-regulation of investment banks.[107] [108]
Increasing home ownership has been the goal of several presidents
including Roosevelt, Reagan, Clinton and G.W.Bush.[109] In 1982,
Congress passed the Alternative Mortgage Transactions Parity Act
(AMTPA), which allowed non-federally chartered housing creditors to
write adjustable-rate mortgages. Among the new mortgage loan types
U.S. Subprime lending expanded dramatically
created and gaining in popularity in the early 1980s were 2004-2006
adjustable-rate, option adjustable-rate, balloon-payment and
interest-only mortgages. These new loan types are credited with replacing the long standing practice of banks
making conventional fixed-rate, amortizing mortgages. Among the criticisms of banking industry deregulation that
contributed to the savings and loan crisis was that Congress failed to enact regulations that would have prevented
exploitations by these loan types. Subsequent widespread abuses of predatory lending occurred with the use of
adjustable-rate mortgages.[1] [37] [110] Approximately 80% of subprime mortgages are adjustable-rate mortgages.[1]
In 1995, the GSEs like Fannie Mae began receiving government tax incentives for purchasing mortgage backed
securities which included loans to low income borrowers. Thus began the involvement of the Fannie Mae and
Freddie Mac with the subprime market.[111] In 1996, HUD set a goal for Fannie Mae and Freddie Mac that at least
42% of the mortgages they purchase be issued to borrowers whose household income was below the median in their
area. This target was increased to 50% in 2000 and 52% in 2005.[112] From 2002 to 2006, as the U.S. subprime
market grew 292% over previous years, Fannie Mae and Freddie Mac combined purchases of subprime securities
rose from $38 billion to around $175 billion per year before dropping to $90 billion per year, which included $350
billion of Alt-A securities. Fannie Mae had stopped buying Alt-A products in the early 1990s because of the high
risk of default. By 2008, the Fannie Mae and Freddie Mac owned, either directly or through mortgage pools they
sponsored, $5.1 trillion in residential mortgages, about half the total U.S. mortgage market.[113] The GSE have
always been highly leveraged, their net worth as of 30 June 2008 being a mere US$114 billion.[114] When concerns
arose in September 2008 regarding the ability of the GSE to make good on their guarantees, the Federal government
was forced to place the companies into a conservatorship, effectively nationalizing them at the taxpayers'
expense.[115] [116]
The Glass-Steagall Act was enacted after the Great Depression. It separated commercial banks and investment
banks, in part to avoid potential conflicts of interest between the lending activities of the former and rating activities
of the latter. Economist Joseph Stiglitz criticized the repeal of the Act. He called its repeal the "culmination of a
$300 million lobbying effort by the banking and financial services industries...spearheaded in Congress by Senator
Phil Gramm." He believes it contributed to this crisis because the risk-taking culture of investment banking
dominated the more conservative commercial banking culture, leading to increased levels of risk-taking and leverage
during the boom period.[117] The Federal government bailout of thrifts during the savings and loan crisis of the late
1980s may have encouraged other lenders to make risky loans, and thus given rise to moral hazard.[38] [118]
Conservatives and Libertarians have also debated the possible effects of the Community Reinvestment Act (CRA),
with detractors claiming that the Act encouraged lending to uncreditworthy borrowers,[119] [120] [121] [122] and
defenders claiming a thirty year history of lending without increased risk.[123] [124] [125] [126] Detractors also claim
that amendments to the CRA in the mid-1990s, raised the amount of mortgages issued to otherwise unqualified
low-income borrowers, and allowed the securitization of CRA-regulated mortgages, even though a fair number of
them were subprime.[127] [128]
Both Federal Reserve Governor Randall Kroszner and FDIC Chairman Sheila Bair have stated their belief that the
CRA was not to blame for the crisis.[129] [130]
Economist Paul Krugman argued in January 2010 that the simultaneous growth of the residential and commercial
real estate pricing bubbles undermines the case made by those who argue that Fannie Mae, Freddie Mac, CRA or
predatory lending were primary causes of the crisis. In other words, bubbles in both markets developed even though
only the residential market was affected by these potential causes.[131]
Policies of central banks

Central banks manage monetary policy and may target the rate of
inflation. They have some authority over commercial banks and
possibly other financial institutions. They are less concerned with
avoiding asset price bubbles, such as the housing bubble and dot-com
bubble. Central banks have generally chosen to react after such bubbles
burst so as to minimize collateral damage to the economy, rather than
trying to prevent or stop the bubble itself. This is because identifying
an asset bubble and determining the proper monetary policy to deflate
it are matters of debate among economists.[132] [133]
Federal Funds Rate and Various Mortgage Rates
Some market observers have been concerned that Federal Reserve
actions could give rise to moral hazard.[38] A Government Accountability Office critic said that the Federal Reserve
Bank of New York's rescue of Long-Term Capital Management in 1998 would encourage large financial institutions
to believe that the Federal Reserve would intervene on their behalf if risky loans went sour because they were “too
big to fail.”[134]
A contributing factor to the rise in house prices was the Federal Reserve's lowering of interest rates early in the
decade. From 2000 to 2003, the Federal Reserve lowered the federal funds rate target from 6.5% to 1.0%.[135] This
was done to soften the effects of the collapse of the dot-com bubble and of the September 2001 terrorist attacks, and
to combat the perceived risk of deflation.[132] The Fed believed that interest rates could be lowered safely primarily
because the rate of inflation was low; it disregarded other important factors. Richard W. Fisher, President and CEO
of the Federal Reserve Bank of Dallas, said that the Fed's interest rate policy during the early 2000s was misguided,
because measured inflation in those years was below true inflation, which led to a monetary policy that contributed
to the housing bubble.[136] According to Ben Bernanke, now chairman of the Federal Reserve, it was capital or
savings pushing into the United States, due to a world wide "saving glut", which kept long term interest rates low
independently of Central Bank action.[137]
The Fed then raised the Fed funds rate significantly between July 2004 and July 2006.[138] This contributed to an
increase in 1-year and 5-year ARM rates, making ARM interest rate resets more expensive for homeowners.[139]
This may have also contributed to the deflating of the housing bubble, as asset prices generally move inversely to
interest rates and it became riskier to speculate in housing.[140] [141]
Financial institution debt levels and incentives

Many financial institutions, investment banks in particular, issued large
amounts of debt during 2004–2007, and invested the proceeds in
mortgage-backed securities (MBS), essentially betting that house
prices would continue to rise, and that households would continue to
make their mortgage payments. Borrowing at a lower interest rate and
investing the proceeds at a higher interest rate is a form of financial
leverage. This is analogous to an individual taking out a second
mortgage on his residence to invest in the stock market. This strategy
proved profitable during the housing boom, but resulted in large losses
Leverage Ratios of Investment Banks Increased
when house prices began to decline and mortgages began to default.
Significantly 2003–2007
Beginning in 2007, financial institutions and individual investors
holding MBS also suffered significant losses from mortgage payment
defaults and the resulting decline in the value of MBS.[142]
A 2004 U.S. Securities and Exchange Commission (SEC) decision related to the net capital rule allowed USA
investment banks to issue substantially more debt, which was then used to purchase MBS. Over 2004-07, the top five
US investment banks each significantly increased their financial leverage (see diagram), which increased their
vulnerability to the declining value of MBSs. These five institutions reported over $4.1 trillion in debt for fiscal year
2007, about 30% of USA nominal GDP for 2007. Further, the percentage of subprime mortgages originated to total
originations increased from below 10% in 2001-2003 to between 18-20% from 2004–2006, due in-part to financing
from investment banks.[18] [19]
During 2008, three of the largest U.S. investment banks either went bankrupt (Lehman Brothers) or were sold at fire
sale prices to other banks (Bear Stearns and Merrill Lynch). These failures augmented the instability in the global
financial system. The remaining two investment banks, Morgan Stanley and Goldman Sachs, opted to become
commercial banks, thereby subjecting themselves to more stringent regulation.[143] [144]
In the years leading up to the crisis, the top four U.S. depository banks moved an estimated $5.2 trillion in assets and
liabilities off-balance sheet into special purpose vehicles or other entities in the shadow banking system. This
enabled them to essentially bypass existing regulations regarding minimum capital ratios, thereby increasing
leverage and profits during the boom but increasing losses during the crisis. New accounting guidance will require
them to put some of these assets back onto their books during 2009, which will significantly reduce their capital
ratios. One news agency estimated this amount to be between $500 billion and $1 trillion. This effect was considered
as part of the stress tests performed by the government during 2009.[145]
Martin Wolf wrote in June 2009: "...an enormous part of what banks did in the early part of this decade – the
off-balance-sheet vehicles, the derivatives and the 'shadow banking system' itself – was to find a way round
regulation."[146]
The New York State Comptroller's Office has said that in 2006, Wall Street executives took home bonuses totaling
$23.9 billion. "Wall Street traders were thinking of the bonus at the end of the year, not the long-term health of their
firm. The whole system—from mortgage brokers to Wall Street risk managers—seemed tilted toward taking
short-term risks while ignoring long-term obligations. The most damning evidence is that most of the people at the
top of the banks didn't really understand how those [investments] worked."[45] [147]
Investment banker incentive compensation was focused on fees generated from assembling financial products, rather
than the performance of those products and profits generated over time. Their bonuses were heavily skewed towards
cash rather than stock and not subject to "claw-back" (recovery of the bonus from the employee by the firm) in the
event the MBS or CDO created did not perform. In addition, the increased risk (in the form of financial leverage)
taken by the major investment banks was not adequately factored into the compensation of senior executives.[148]
Credit default swaps

Credit default swaps (CDS) are financial instruments used as a hedge and protection for debtholders, in particular
MBS investors, from the risk of default. As the net worth of banks and other financial institutions deteriorated
because of losses related to subprime mortgages, the likelihood increased that those providing the insurance would
have to pay their counterparties. This created uncertainty across the system, as investors wondered which companies
would be required to pay to cover mortgage defaults.
Like all swaps and other financial derivatives, CDS may either be used to hedge risks (specifically, to insure
creditors against default) or to profit from speculation. The volume of CDS outstanding increased 100-fold from
1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to
$47 trillion. CDS are lightly regulated. As of 2008, there was no central clearing house to honor CDS in the event a
party to a CDS proved unable to perform his obligations under the CDS contract. Required disclosure of
CDS-related obligations has been criticized as inadequate. Insurance companies such as American International
Group (AIG), MBIA, and Ambac faced ratings downgrades because widespread mortgage defaults increased their
potential exposure to CDS losses. These firms had to obtain additional funds (capital) to offset this exposure. AIG's
having CDSs insuring $440 billion of MBS resulted in its seeking and obtaining a Federal government bailout.[149]
When investment bank Lehman Brothers went bankrupt in September 2008, there was much uncertainty as to which
financial firms would be required to honor the CDS contracts on its $600 billion of bonds outstanding.[150] [151]
Merrill Lynch's large losses in 2008 were attributed in part to the drop in value of its unhedged portfolio of
collateralized debt obligations (CDOs) after AIG ceased offering CDS on Merrill's CDOs. The loss of confidence of
trading partners in Merrill Lynch's solvency and its ability to refinance its short-term debt led to its acquisition by the
Bank of America.[152] [153]
Economist Joseph Stiglitz summarized how credit default swaps contributed to the systemic meltdown: "With this
complicated intertwining of bets of great magnitude, no one could be sure of the financial position of anyone else-or
even of one's own position. Not surprisingly, the credit markets froze."[154]
Author Michael Lewis wrote that CDS enabled speculators to stack bets on the same mortgage bonds and CDO's.
This is analogous to allowing many persons to buy insurance on the same house. Speculators that bought CDS
insurance were betting that significant defaults would occur, while the sellers (such as AIG) bet they would not. A
theoretically infinite amount could be wagered on the same housing-related securities, provided buyers and sellers of
the CDS could be found.[155] In addition, Chicago Public Radio, Huffington Post, and ProPublica reported in April
2010 that market participants, including a hedge fund called Magnetar Capital, encouraged the creation of CDO's
containing low quality mortgages, so they could bet against them using CDS. NPR reported that Magnetar
encouraged investors to purchase CDO's while simultaneously betting against them, without disclosing the latter
bet.[156] [157] [158] Instruments called synthetic CDO, which are portfolios of credit default swaps, were also involved
in allegations by the SEC against Goldman-Sachs in April 2010.[159]
US Balance of Payments
In 2005, Ben Bernanke addressed the implications of the USA's high
and rising current account deficit, resulting from USA investment
exceeding its savings, or imports exceeding exports.[160] Between 1996
and 2004, the USA current account deficit increased by $650 billion,
from 1.5% to 5.8% of GDP. The US attracted a great deal of foreign
investment, mainly from the emerging economies in Asia and
oil-exporting nations. The balance of payments identity requires that a
country (such as the USA) running a current account deficit also have a
capital account (investment) surplus of the same amount. Foreign
U.S. Current Account or Trade Deficit
investors had these funds to lend, either because they had very high
personal savings rates (as high as 40% in China), or because of high oil
prices. Bernanke referred to this as a "saving glut"[137] that may have pushed capital into the USA, a view differing
from that of some other economists, who view such capital as having been pulled into the USA by its high
consumption levels. In other words, a nation cannot consume more than its income unless it sells assets to foreigners,
or foreigners are willing to lend to it. Alternatively, if a nation wishes to increase domestic investment in plant and
equipment, it will also increase its level of imports to maintain balance if it has a floating exchange rate.
Regardless of the push or pull view, a "flood" of funds (capital or liquidity) reached the USA financial markets.
Foreign governments supplied funds by purchasing USA Treasury bonds and thus avoided much of the direct impact
of the crisis. USA households, on the other hand, used funds borrowed from foreigners to finance consumption or to
bid up the prices of housing and financial assets. Financial institutions invested foreign funds in mortgage-backed
securities. USA housing and financial assets dramatically declined in value after the housing bubble burst.[161] [162]
Boom and collapse of the shadow banking system

In a June 2008 speech, President of the
NY Federal Reserve Bank Timothy
Geithner, who later became Secretary
of the Treasury, placed significant
blame for the freezing of credit
markets on a "run" on the entities in
the "parallel" banking system, also
called the shadow banking system.
These entities became critical to the
credit markets underpinning the
financial system, but were not subject
to the same regulatory controls as
depository banks. Further, these
entities were vulnerable because they
borrowed short-term in liquid markets
to purchase long-term, illiquid and Securitization markets were impaired during the crisis
risky assets. This meant that
disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at
depressed prices. He described the significance of these entities: "In early 2007, asset-backed commercial paper
conduits, in structured investment vehicles, in auction-rate preferred securities, tender option bonds and variable rate
demand notes, had a combined asset size of roughly $2.2 trillion. Assets financed overnight in triparty repo grew to
$2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the then five
major investment banks totaled $4 trillion. In comparison, the total assets of the top five bank holding companies in
the United States at that point were just over $6 trillion, and total assets of the entire banking system were about $10
trillion." He stated that the "combined effect of these factors was a financial system vulnerable to self-reinforcing
asset price and credit cycles."[7]
like a bank." He referred to this lack of controls as "malign neglect."[163] [164]
The securitization markets supported by the shadow banking system started to close down in the spring of 2007 and
nearly shut-down in the fall of 2008. More than a third of the private credit markets thus became unavailable as a
source of funds.[97] According to the Brookings Institution, the traditional banking system does not have the capital
to close this gap as of June 2009: "It would take a number of years of strong profits to generate sufficient capital to
support that additional lending volume." The authors also indicate that some forms of securitization are "likely to
vanish forever, having been an artifact of excessively loose credit conditions."[98]
Economist Mark Zandi testified to the Financial Crisis Inquiry Commission in January 2010: "The securitization
markets also remain impaired, as investors anticipate more loan losses. Investors are also uncertain about coming
legal and accounting rule changes and regulatory reforms. Private bond issuance of residential and commercial
mortgage-backed securities, asset-backed securities, and CDOs peaked in 2006 at close to $2 trillion...In 2009,
private issuance was less than $150 billion, and almost all of it was asset-backed issuance supported by the Federal
Reserve's TALF program to aid credit card, auto and small-business lenders. Issuance of residential and commercial
mortgage-backed securities and CDOs remains dormant."[165]
The Economist reported in March 2010: "Bear Stearns and Lehman Brothers were non-banks that were crippled by a
silent run among panicky overnight "repo" lenders, many of them money market funds uncertain about the quality of
securitized collateral they were holding. Mass redemptions from these funds after Lehman's failure froze short-term
funding for big firms."[166]
Impacts
Impact in the U.S.

Between June 2007 and November 2008, Americans lost more than a
quarter of their net worth. By early November 2008, a broad U.S. stock
index, the S&P 500, was down 45 percent from its 2007 high. Housing
prices had dropped 20% from their 2006 peak, with futures markets
signaling a 30-35% potential drop. Total home equity in the United
States, which was valued at $13 trillion at its peak in 2006, had
dropped to $8.8 trillion by mid-2008 and was still falling in late 2008.
Total retirement assets, Americans' second-largest household asset,
dropped by 22 percent, from $10.3 trillion in 2006 to $8 trillion in
Impacts from the Crisis on Key Wealth Measures
mid-2008. During the same period, savings and investment assets
(apart from retirement savings) lost $1.2 trillion and pension assets lost
$1.3 trillion. Taken together, these losses total a staggering $8.3 trillion.[167] Members of USA minority groups
received a disproportionate number of subprime mortgages, and so have experienced a disproportionate level of the
resulting foreclosures.[168] [169] [170]
Financial market impacts, 2007

The crisis began to affect the financial sector in February 2007, when
HSBC, the world's largest (2008) bank, wrote down its holdings of
subprime-related MBS by $10.5 billion, the first major subprime
related loss to be reported.[171] During 2007, at least 100 mortgage
companies either shut down, suspended operations or were sold.[172]
Top management has not escaped unscathed, as the CEOs of Merrill
Lynch and Citigroup resigned within a week of each other in late
2007.[173] As the crisis deepened, more and more financial firms either
merged, or announced that they were negotiating seeking merger
FDIC Graph - U.S. Bank & Thrift Profitability
partners.[174]
By Quarter
During 2007, the crisis caused panic in financial markets and
encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities
as "stores of value".[175] Financial speculation in commodity futures following the collapse of the financial
derivatives markets has contributed to the world food price crisis and oil price increases due to a "commodities
super-cycle."[176] [177] Financial speculators seeking quick returns have removed trillions of dollars from equities
and mortgage bonds, some of which has been invested into food and raw materials.[178]
Mortgage defaults and provisions for future defaults caused profits at the 8533 USA depository institutions insured
by the FDIC to decline from $35.2 billion in 2006 Q4 to $646 million in the same quarter a year later, a decline of
98%. 2007 Q4 saw the worst bank and thrift quarterly performance since 1990. In all of 2007, insured depository
institutions earned approximately $100 billion, down 31% from a record profit of $145 billion in 2006. Profits
declined from $35.6 billion in 2007 Q1 to $19.3 billion in 2008 Q1, a decline of 46%.[179] [180]
Financial market impacts, 2008

As of August 2008, financial firms around the globe have written down
their holdings of subprime related securities by US$501 billion.[181]
The IMF estimates that financial institutions around the globe will
eventually have to write off $1.5 trillion of their holdings of subprime
MBSs. About $750 billion in such losses had been recognized as of
November 2008. These losses have wiped out much of the capital of
the world banking system. Banks headquartered in nations that have
signed the Basel Accords must have so many cents of capital for every
dollar of credit extended to consumers and businesses. Thus the
The TED spread – an indicator of credit risk –
massive reduction in bank capital just described has reduced the credit
increased dramatically during September 2008.
available to businesses and households.[182]
When Lehman Brothers and other important financial institutions failed in September 2008, the crisis hit a key
point.[183] During a two day period in September 2008, $150 billion were withdrawn from USA money funds. The
average two day outflow had been $5 billion. In effect, the money market was subject to a bank run. The money
market had been a key source of credit for banks (CDs) and nonfinancial firms (commercial paper). The TED spread
(see graph above), a measure of the risk of interbank lending, quadrupled shortly after the Lehman failure. This
credit freeze brought the global financial system to the brink of collapse. The response of the USA Federal Reserve,
the European Central Bank, and other central banks was immediate and dramatic. During the last quarter of 2008,
these central banks purchased US$2.5 trillion of government debt and troubled private assets from banks. This was
the largest liquidity injection into the credit market, and the largest monetary policy action, in world history. The
governments of European nations and the USA also raised the capital of their national banking systems by $1.5
trillion, by purchasing newly issued preferred stock in their major banks. [182]
However, some economists state that Third-World economies, such as the Brazilian and Chinese ones, will not suffer
as much as those from more developed countries.[184]
The International Monetary Fund estimated that large U.S. and European banks lost more than $1 trillion on toxic
assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from
2007-10. U.S. banks losses were forecast to hit $1 trillion and European bank losses will reach $1.6 trillion. The IMF
estimated that U.S. banks were about 60 percent through their losses, but British and eurozone banks only 40
percent.[185]
Responses
Various actions have been taken since the crisis became apparent in August 2007. In September 2008, major
instability in world financial markets increased awareness and attention to the crisis. Various agencies and
regulators, as well as political officials, began to take additional, more comprehensive steps to handle the crisis.
To date, various government agencies have committed or spent trillions of dollars in loans, asset purchases,
guarantees, and direct spending. For a summary of U.S. government financial commitments and investments related
to the crisis, see CNN - Bailout Scorecard [186].
Federal Reserve and central banks

The central bank of the USA, the Federal Reserve, in partnership with central banks around the world, has taken
several steps to address the crisis. Federal Reserve Chairman Ben Bernanke stated in early 2008: "Broadly, the
Federal Reserve's response has followed two tracks: efforts to support market liquidity and functioning and the
pursuit of our macroeconomic objectives through monetary policy."[22] The Fed has:
• Lowered the target for the Federal funds rate from 5.25% to 2%, and the discount rate from 5.75% to 2.25%. This
took place in six steps occurring between 18 September 2007 and 30 April 2008;[187] [188] In December 2008, the
Fed further lowered the federal funds rate target to a range of 0-0.25% (25 basis points).[189]
• Undertaken, along with other central banks, open market operations to ensure member banks remain liquid. These
are effectively short-term loans to member banks collateralized by government securities. Central banks have also
lowered the interest rates (called the discount rate in the USA) they charge member banks for short-term
loans;[190]
• Created a variety of lending facilities to enable the Fed to lend directly to banks and non-bank institutions, against
specific types of collateral of varying credit quality. These include the Term Auction Facility (TAF) and Term
Asset-Backed Securities Loan Facility (TALF).[191]
• In November 2008, the Fed announced a $600 billion program to purchase the MBS of the GSE, to help lower
mortgage rates.[192]
• In March 2009, the FOMC decided to increase the size of the Federal Reserve’s balance sheet further by
purchasing up to an additional $750 billion of agency (GSE) mortgage-backed securities, bringing its total
purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year
by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit
markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities during
2009.[193]
According to Ben Bernanke, expansion of the Fed balance sheet means the Fed is electronically creating money,
necessary "...because our economy is very weak and inflation is very low. When the economy begins to recover, that
will be the time that we need to unwind those programs, raise interest rates, reduce the money supply, and make sure
that we have a recovery that does not involve inflation."[194]
Economic stimulus
On 13 February 2008, President Bush signed into law a $168 billion economic stimulus package, mainly taking the
form of income tax rebate checks mailed directly to taxpayers.[195] Checks were mailed starting the week of 28 April
2008. However, this rebate coincided with an unexpected jump in gasoline and food prices. This coincidence led
some to wonder whether the stimulus package would have the intended effect, or whether consumers would simply
spend their rebates to cover higher food and fuel prices.
On 17 February 2009, U.S. President Barack Obama signed the American Recovery and Reinvestment Act of 2009,
an $787 billion stimulus package with a broad spectrum of spending and tax cuts.[196] Over $75 billion of which was
specifically allocated to programs which help struggling homeowners. This program is referred to as the Homeowner
Affordability and Stability Plan.[197]
Bank solvency and capital replenishment

Losses on mortgage-backed securities and other assets purchased with
borrowed money have dramatically reduced the capital base of
financial institutions, rendering many either insolvent or less capable
of lending. Governments have provided funds to banks. Some banks
have taken significant steps to acquire additional capital from private
sources.
The U.S. government passed the Emergency Economic Stabilization
Act of 2008 (EESA or TARP) during October 2008. This law included
$700 billion in funding for the "Troubled Assets Relief Program"
Common Equity to Total Assets Ratios for Major
(TARP), which was used to lend funds to banks in exchange for USA Banks
dividend-paying preferred stock.[198] [199]
Another method of recapitalizing banks is for government and private investors to provide cash in exchange for
mortgage-related assets (i.e., "toxic" or "legacy" assets), improving the quality of bank capital while reducing
uncertainty regarding the financial position of banks. U.S. Treasury Secretary Timothy Geithner announced a plan
during March 2009 to purchase "legacy" or "toxic" assets from banks. The Public-Private Partnership Investment
Program involves government loans and guarantees to encourage private investors to provide funds to purchase toxic
assets from banks.[200]
For a summary of U.S. government financial commitments and investments related to the crisis, see CNN - Bailout
Scorecard [186].
For a summary of TARP funds provided to U.S. banks as of December 2008, see Reuters-TARP Funds [201].
Bailouts and failures of financial firms

Several major financial institutions either failed, were bailed-out by
governments, or merged (voluntarily or otherwise) during the crisis.
While the specific circumstances varied, in general the decline in the
value of mortgage-backed securities held by these companies resulted
in either their insolvency, the equivalent of bank runs as investors
pulled funds from them, or inability to secure new funding in the credit
markets. These firms had typically borrowed and invested large sums
of money relative to their cash or equity capital, meaning they were
highly leveraged and vulnerable to unanticipated credit market
People queuing outside a Northern Rock bank
disruptions.[202]
branch in Birmingham, United Kingdom on
The five largest U.S. investment banks, with combined liabilities or September 15, 2007, to withdraw their savings
because of the subprime crisis.
debts of $4 trillion, either went bankrupt (Lehman Brothers), were
taken over by other companies (Bear Stearns and Merrill Lynch), or
were bailed-out by the U.S. government (Goldman Sachs and Morgan Stanley) during 2008.[203]
Government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac either directly owed or guaranteed nearly $5
trillion in mortgage obligations, with a similarly weak capital base, when they were placed into receivership in
September 2008.[204] For scale, this $9 trillion in obligations concentrated in seven highly leveraged institutions can
be compared to the $14 trillion size of the U.S. economy (GDP)[205] or to the total national debt of $10 trillion in
September 2008.[206]
Major depository banks around the world had also used financial innovations such as structured investment vehicles
to circumvent capital ratio regulations.[207] Notable global failures included Northern Rock, which was nationalized
at an estimated cost of £87 billion ($150 billion).[208] In the U.S., Washington Mutual (WaMu) was seized in
September 2008 by the USA Office of Thrift Supervision (OTS).[209] Dozens of U.S. banks received funds as part of
the TARP or $700 billion bailout.[210]
As a result of the financial crisis in 2008, twenty five U.S. banks became insolvent and were taken over by the
FDIC.[211] As of August 14, 2009, an additional 77 banks became insolvent.[212] This seven month tally surpasses
the 50 banks that were seized in all of 1993, but is still much smaller than the number of failed banking institutions
in 1992, 1991, and 1990.[213] The United States has lost over 6 million jobs since the recession began in December
2007.[214]
The FDIC deposit insurance fund, supported by fees on insured banks, fell to $13 billion in the first quarter of
2009.[215] That is the lowest total since September, 1993.[215]
According to some, the bailouts could be traced directly to Alan Greenspan's efforts to reflate the stock market and
the economy after the tech stock bust, and specifically to a February 23, 2004 speech Mr. Greenspan made to the
Mortgage Bankers Association where he suggested that the time had come to push average American borrowers into
more exotic loans with variable rates, or deferred interest.[216] This argument suggests that Mr. Greenspan sought to
enlist banks to expand lending and debt to stimulate asset prices and that the Federal Reserve and US Treasury
Department would back any losses that might result. As early as March 2007 some commentators predicted that a
bailout of the banks would exceed $1 trillion, at a time when Ben Bernanke, Alan Greenspan and Henry Paulson all
claimed that mortgage problems were "contained" to the subprime market and no bailout of the financial sector
would be necessary.[216]
Homeowner assistance
Both lenders and borrowers may benefit from avoiding foreclosure, which is a costly and lengthy process. Some
lenders have offered troubled borrowers more favorable mortgage terms (i.e., refinancing, loan modification or loss
mitigation). Borrowers have also been encouraged to contact their lenders to discuss alternatives.[217]
The Economist described the issue this way: "No part of the financial crisis has received so much attention, with so
little to show for it, as the tidal wave of home foreclosures sweeping over America. Government programmes have
been ineffectual, and private efforts not much better." Up to 9 million homes may enter foreclosure over the
2009-2011 period, versus one million in a typical year.[218] At roughly U.S. $50,000 per foreclosure according to a
2006 study by the Chicago Federal Reserve Bank, 9 million foreclosures represents $450 billion in losses.[219]
A variety of voluntary private and government-administered or supported programs were implemented during
2007-2009 to assist homeowners with case-by-case mortgage assistance, to mitigate the foreclosure crisis engulfing
the U.S. One example is the Hope Now Alliance, an ongoing collaborative effort between the US Government and
private industry to help certain subprime borrowers.[220] In February 2008, the Alliance reported that during the
second half of 2007, it had helped 545,000 subprime borrowers with shaky credit, or 7.7% of 7.1 million subprime
loans outstanding as of September 2007. A spokesperson for the Alliance acknowledged that much more must be
done.[221]
During late 2008, major banks and both Fannie Mae and Freddie Mac established moratoriums (delays) on
foreclosures, to give homeowners time to work towards refinancing.[222] [223] [224]
Critics have argued that the case-by-case loan modification method is ineffective, with too few homeowners assisted
relative to the number of foreclosures and with nearly 40% of those assisted homeowners again becoming delinquent
within 8 months.[225] [226] [227] In December 2008, the U.S. FDIC reported that more than half of mortgages
modified during the first half of 2008 were delinquent again, in many cases because payments were not reduced or
mortgage debt was not forgiven. This is further evidence that case-by-case loan modification is not effective as a
policy tool.[228]
In February 2009, economists Nouriel Roubini and Mark Zandi recommended an "across the board" (systemic)
reduction of mortgage principal balances by as much as 20-30%. Lowering the mortgage balance would help lower
monthly payments and also address an estimated 20 million homeowners that may have a financial incentive to enter
voluntary foreclosure because they are "underwater" (i.e., the mortgage balance is larger than the home value).[229]
[230]
A study by the Federal Reserve Bank of Boston indicated that banks were reluctant to modify loans. Only 3% of
seriously delinquent homeowners had their mortgage payments reduced during 2008. In addition, investors who hold
MBS and have a say in mortgage modifications have not been a significant impediment; the study found no
difference in the rate of assistance whether the loans were controlled by the bank or by investors. Commenting on
the study, economists Dean Baker and Paul Willen both advocated providing funds directly to homeowners instead
of banks.[231]
The L.A. Times reported the results of a study that found homeowners with high credit scores at the time of entering
the mortgage are 50% more likely to "strategically default" -- abruptly and intentionally pull the plug and abandon
the mortgage—compared with lower-scoring borrowers. Such strategic defaults were heavily concentrated in
markets with the highest price declines. An estimated 588,000 strategic defaults occurred nationwide during 2008,
more than double the total in 2007. They represented 18% of all serious delinquencies that extended for more than
60 days in the fourth quarter of 2008.[232]
Homeowners Affordability and Stability Plan

On 18 February 2009, U.S. President Barack Obama announced a $73 billion program to help up to nine million
homeowners avoid foreclosure, which was supplemented by $200 billion in additional funding for Fannie Mae and
Freddie Mac to purchase and more easily refinance mortgages. The plan is funded mostly from the EESA's $700
billion financial bailout fund. It uses cost sharing and incentives to encourage lenders to reduce homeowner's
monthly payments to 31 percent of their monthly income. Under the program, a lender would be responsible for
reducing monthly payments to no more than 38 percent of a borrower’s income, with government sharing the cost to
further cut the rate to 31 percent. The plan also involves forgiving a portion of the borrower’s mortgage balance.
Companies that service mortgages will get incentives to modify loans and to help the homeowner stay current.[233]
[234] [235]
Regulatory proposals and long-term solutions

President Barack Obama and key advisers introduced a series of regulatory proposals in June 2009. The proposals
address consumer protection, executive pay, bank financial cushions or capital requirements, expanded regulation of
the shadow banking system and derivatives, and enhanced authority for the Federal Reserve to safely wind-down
systemically important institutions, among others.[236] [237] [238]
A variety of regulatory changes have been proposed by economists, politicians, journalists, and business leaders to
minimize the impact of the current crisis and prevent recurrence. However, as of June 2009, many of the proposed
solutions have not yet been implemented. These include:
• Ben Bernanke: Establish resolution procedures for closing troubled financial institutions in the shadow banking
system, such as investment banks and hedge funds.[239]
• Joseph Stiglitz: Restrict the leverage that financial institutions can assume. Require executive compensation to be
more related to long-term performance.[12] Re-instate the separation of commercial (depository) and investment
banking established by the Glass-Steagall Act in 1933 and repealed in 1999 by the Gramm-Leach-Bliley Act.[117]
• Simon Johnson: Break-up institutions that are "too big to fail" to limit systemic risk.[240]
• Paul Krugman: Regulate institutions that "act like banks " similarly to banks.[163]
• Alan Greenspan: Banks should have a stronger capital cushion, with graduated regulatory capital requirements
(i.e., capital ratios that increase with bank size), to "discourage them from becoming too big and to offset their
competitive advantage."[241]
• Warren Buffett: Require minimum down payments for home mortgages of at least 10% and income
verification.[242]
• Eric Dinallo: Ensure any financial institution has the necessary capital to support its financial commitments.
Regulate credit derivatives and ensure they are traded on well-capitalized exchanges to limit counterparty
risk.[207]
• Raghuram Rajan: Require financial institutions to maintain sufficient "contingent capital" (i.e., pay insurance
premiums to the government during boom periods, in exchange for payments during a downturn.)[243]
• A. Michael Spence and Gordon Brown: Establish an early-warning system to help detect systemic risk.[244]
• Niall Ferguson and Jeffrey Sachs: Impose haircuts on bondholders and counterparties prior to using taxpayer
money in bailouts.[245] [246]
• Nouriel Roubini: Nationalize insolvent banks.[247] Reduce debt levels across the financial system through debt for
equity swaps. Reduce mortgage balances to assist homeowners, giving the lender a share in any future home
appreciation.[248]
• Paul McCulley advocated "counter-cyclical regulatory policy to help modulate human nature." He cited the work
of economist Hyman Minsky, who believed that human behavior is pro-cyclical, meaning it amplifies the extent
of booms and busts. In other words, humans are momentum investors rather than value investors.
Counter-cyclical policies would include increasing capital requirements during boom periods and reducing them
during busts.[249]
U.S. Treasury Secretary Timothy Geithner testified before Congress on October 29, 2009. His testimony included
five elements he stated as critical to effective reform: 1) Expand the FDIC bank resolution mechanism to include
non-bank financial institutions; 2) Ensure that a firm is allowed to fail in an orderly way and not be "rescued"; 3)
Ensure taxpayers are not on the hook for any losses, by applying losses to the firm's investors and creating a
monetary pool funded by the largest financial institutions; 4) Apply appropriate checks and balances to the FDIC and
Federal Reserve in this resolution process; 5) Require stronger capital and liquidity positions for financial firms and
related regulatory authority.[250]
The U.S. Senate passed a regulatory reform bill in May 2010, following the House which passed a bill in December
2009. These bills must now be reconciled. The New York Times has provided a comparative summary of the
features of the two bills, which address to varying extent the principles enumerated by Secretary Geithner.[251]
Law investigations, judicial and other responses

Significant law enforcement action and litigation is resulting from the crisis. The U.S. Federal Bureau of
Investigation was looking into the possibility of fraud by mortgage financing companies Fannie Mae and Freddie
Mac, Lehman Brothers, and insurer American International Group, among others.[252] New York Attorney General
Andrew Cuomo is suing Long Island based Amerimod, one of the nation's largest loan modification corporations for
fraud, and has issued 14 subpoenas to other similar companies.[253] The FBI also assigned more agents to
mortgage-related crimes and its caseload has dramatically increased.[254] [255] The FBI began a probe of
Countrywide in March 2008 for possible fraudulent lending practices and securities fraud.[256]
Over 300 civil lawsuits were filed in federal courts during 2007 related to the subprime crisis. The number of filings
in state courts was not quantified but is also believed to be significant.[257]
Implications
Estimates of impact have continued to climb. During April 2008, International Monetary Fund (IMF) estimated that
global losses for financial institutions would approach $1 trillion.[258] One year later, the IMF estimated cumulative
losses of banks and other financial institutions globally would exceed $4 trillion.[259] This is equal to U.S. $20,000
for each of 200,000,000 people.
Francis Fukuyama has argued that the crisis represents the end of Reaganism in the financial sector, which was
characterized by lighter regulation, pared-back government, and lower taxes. Significant financial sector regulatory
changes are expected as a result of the crisis.[260]
Fareed Zakaria believes that the crisis may force Americans and their government to live within their means. Further,
some of the best minds may be redeployed from financial engineering to more valuable business activities, or to
science and technology.[261]
Roger Altman wrote that "the crash of 2008 has inflicted profound damage on [the U.S.] financial system, its
economy, and its standing in the world; the crisis is an important geopolitical setback...the crisis has coincided with
historical forces that were already shifting the world's focus away from the United States. Over the medium term, the
United States will have to operate from a smaller global platform -- while others, especially China, will have a
chance to rise faster."[182]
GE CEO Jeffrey Immelt has argued that U.S. trade deficits and budget deficits are unsustainable. America must
regain its competitiveness through innovative products, training of production workers, and business leadership. He
advocates specific national goals related to energy security or independence, specific technologies, expansion of the
manufacturing job base, and net exporter status.[262] "The world has been reset. Now we must lead an aggressive
American renewal to win in the future." Of critical importance, he said, is the need to focus on technology and
manufacturing. “Many bought into the idea that America could go from a technology-based, export-oriented
powerhouse to a services-led, consumption-based economy — and somehow still expect to prosper,” Jeff said. “That
idea was flat wrong.”[263]
Economist Paul Krugman wrote in 2009: "The prosperity of a few years ago, such as it was—profits were terrific,
wages not so much—depended on a huge bubble in housing, which replaced an earlier huge bubble in stocks. And
since the housing bubble isn’t coming back, the spending that sustained the economy in the pre-crisis years isn’t
coming back either."[264] Niall Ferguson stated that excluding the effect of home equity extraction, the U.S. economy
grew at a 1% rate during the Bush years.[265] Microsoft CEO Steve Ballmer has argued that this is an economic reset
at a lower level, rather than a recession, meaning that no quick recovery to pre-recession levels can be expected.[266]
The U.S. Federal government's efforts to support the global financial system have resulted in significant new
financial commitments, totaling $7 trillion by November, 2008. These commitments can be characterized as
investments, loans, and loan guarantees, rather than direct expenditures. In many cases, the government purchased
financial assets such as commercial paper, mortgage-backed securities, or other types of asset-backed paper, to
enhance liquidity in frozen markets.[267] As the crisis has progressed, the Fed has expanded the collateral against
which it is willing to lend to include higher-risk assets.[268]
The Economist wrote in May 2009: "Having spent a fortune bailing out their banks, Western governments will have
to pay a price in terms of higher taxes to meet the interest on that debt. In the case of countries (like Britain and
America) that have trade as well as budget deficits, those higher taxes will be needed to meet the claims of foreign
creditors. Given the political implications of such austerity, the temptation will be to default by stealth, by letting
their currencies depreciate. Investors are increasingly alive to this danger..."[269]
Thomas Friedman wrote in May 2010 that technological and financial innovation have made us more globally
interdependent, but that ethics and values have not kept up. He supported the ideas of author Dov Seidman, that
"sustainable values" that reflect our interdependence should replace "situational values" that optimize outcomes for
one at the expense of many others.[270]
The crisis has cast doubt on the legacy of Alan Greenspan, the Chairman of the Federal Reserve System from 1986
to January 2006. Senator Chris Dodd claimed that Greenspan created the "perfect storm".[271] When asked to
comment on the crisis, Greenspan spoke as follows:[132]
The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely
liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home
equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for
residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the
crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally,
will be able to get back to business.
See also
• American Casino, documentary film on the crisis Other housing bubbles
• American International Group
• Bear Stearns subprime mortgage hedge fund crisis • Indian property bubble
• Collateralized debt obligation subprime mortgage crisis • Irish property bubble
• Community Reinvestment Act • Japanese asset price bubble
• Diamond-Dybvig model • Spanish property bubble
• Financial crisis of 2007–2010 • United Kingdom housing bubble
• Financial Crisis Inquiry Commission
• January 2008 stock market volatility
• Late 2000s recession
• List of entities involved in 2007–2008 financial crises
• Long-Term Capital Management
• Mortgage backed security
• Nationalisation of Northern Rock
• Real estate bubble
• Panic of 1837
• Panic of 1907
• Predatory lending
• Savings and loan crisis of the late 1980s.
• Securitization
• Shadow banking system
• Subprime mortgage crisis solutions debate
• Toxic security
• Troubled Assets Relief Program
• United States housing bubble
References
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[2] "Episode 06292007". Bill Moyers Journal. PBS. 2007-06-29. Transcript (http:/ / www. pbs. org/ moyers/ journal/ 06292007/ transcript5.
html).
[3] Justin Lahart (2007-12-24). "Egg Cracks Differ In Housing, Finance Shells" (http:/ / online. wsj. com/ article/ SB119845906460548071.
html?mod=googlenews_wsj). WSJ.com (Wall Street Journal). . Retrieved 2008-07-13.
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[265] Ferguson - Interview (http:/ / www. theglobeandmail. com/ servlet/ story/ RTGAM. 20090223. wferguson0223/ BNStory/
crashandrecovery/ home?pageRequested=all& print=true)
[266] Ballmer-Reset, Not Recession (http:/ / www. realclearmarkets. com/ video/ 2009/ 06/ 30/ ballmer_economy_has_reset. html)
[267] By David Goldman, CNNMoney.com staff writer (2008-11-26). "CNN-Bailout Summary" (http:/ / money. cnn. com/ 2008/ 11/ 26/ news/
economy/ where_bailout_stands/ index. htm?postversion=2008112813). Money.cnn.com. . Retrieved 2009-02-27.
[268] "Bloomberg Article" (http:/ / www. bloomberg. com/ apps/ news?pid=20601087& sid=akZVTnBs66uY& refer=home). .
[269] Economist-A New Global System is Coming Into Existence (http:/ / www. economist. com/ finance/ displayStory.
cfm?story_id=13653915& source=hptextfeature)
[270] NYT-Tom Friedman-A Letter from Lydia-May 2010 (http:/ / www. nytimes. com/ 2010/ 05/ 16/ opinion/ 16friedman. html?ref=opinion)
[271] "FT.com / Companies / US & Canada - Fed rapped over subprime loans" (http:/ / www. ft. com/ cms/ s/
66d98aea-d8e4-11db-a759-000b5df10621,Authorised=false. html?_i_location=http:/ / www. ft. com/ cms/ s/
66d98aea-d8e4-11db-a759-000b5df10621. html& _i_referer=http:/ / ftalphaville. ft. com/ blog/ 2007/ 03/ 23/ 3374/
fed-targeted-in-political-backlash-over-subprime-loans/ ). 2008. . Retrieved 2008-05-19.
Further reading
• Fengbo Zhang (2008): 1. Perspective on the United States Sub-prime Mortgage Crisis (http://sites.google.com/
site/fengbozhang/m), 2. Accurately Forecasting Trends of the Financial Crisis (http://sites.google.com/site/
forecastfinancialcrisis/), 3. Stop Arguing about Socialism versus Capitalism (https://sites.google.com/site/
usatoday2008/).
• Archaya and Richardson. Financial Stability: How to Repair a Failed System NYU Stern Project-Executive
Summaries of 18 Crisis-Related Papers (http://media.wiley.com/assets/1706/87/
NYU_Stern_Executive_Summaries.pdf)
• Committee for a Responsible Federal Budget " Stimulus Watch, (http://www.usbudgetwatch.org/stimulus)"
(Updated Regularly).
• Blackburn, Robin (2008) " The Subprime Mortgage Crisis, (http://www.newleftreview.org/?view=2715)" New
Left Review 50 (March–April).
• Pezzuto, Ivo (2008). Miraculous Financial Engineering or Toxic Finance? The Genesis of the U.S. Subprime
Mortgage Loans Crisis and its Consequences on the Global Financial Markets and Real Economy, ISSN
1662-761X. available on SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1332784
• Kolb, Robert (2010). “Lessons from the Financial Crisis: Causes, Consequences, and Our Economic Future”
(Robert W. Kolb Series), Publisher: Wiley ISBN-10: 0470561777, ISBN-13: 978-0470561775
• Demyanyk, Yuliya (FRB St. Louis), and Otto Van Hemert (NYU Stern School) (2008) " Understanding the
Subprime Mortgage Crisis, (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1020396)" Working paper
circulated by the Social Science Research Network.
• DiMartino, D., and Duca, J. V. (2007) " The Rise and Fall of Subprime Mortgages, (http://dallasfed.org/
research/eclett/2007/el0711.pdf)" Federal Reserve Bank of Dallas Economic Letter 2(11).
• Dominique Doise, Subprime: Price of infringements/Subprime : le prix des transgressions (http://www.
alerionavocats.com/fr/expertise/publications/subprime-le-prix-des-transgressions-price-of-infringements/),
Revue de droit des affaires internationales (RDAI) / International Business Law Journal (IBLJ), N° 4, 2008
• Ely, Bert (2009) “ Bad Rules Produce Bad Outcomes: Underlying Public-Policy Causes of the U.S. Financial
Crisis, (http://www.cato.org/pubs/journal/cj29n1/cj29n1-8.pdf)” Cato Journal 29(1).
• Gold, Gerry, and Feldman, Paul (2007) A House of Cards - From fantasy finance to global crash. London, Lupus
Books. ISBN 978-0-9523454-3-5
• Michael Lewis, " The End, (http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/
The-End-of-Wall-Streets-Boom)" Portfolio Magazine (November 11, 2008).
• Lewis, Michael (2010). The Big Short: Inside the Doomsday Machine. London: Allen Lane.
• Liebowitz, Stan (2009) " Anatomy of a Train Wreck: Causes of the Mortgage Meltdown (http://www.
independent.org/pdf/policy_reports/2008-10-03-trainwreck.pdf)" in Randall Holcombe and B. W. Powell, eds.,
Housing America: Building out of a Crisis (http://www.independent.org/store/book_detail.asp?bookID=76).
Oakland CA: The Independent Institute.
• Muolo, Paul, and Padilla, Matthew (2008). Chain of Blame: How Wall Street Caused the Mortgage and Credit
Crisis. Hoboken, NJ: John Wiley and Sons. ISBN 978-0-470-29277-8.
• Woods, Thomas E. (2009) Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy
Tanked, and Government Bailouts Will Make Things Worse / Washington DC: Regnery Publishing ISBN
1-59698-587-9
• Reinhart, Carmen M., and Kenneth Rogoff (2008) " Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An
International Historical Comparison, (http://www.economics.harvard.edu/faculty/rogoff/files/
Is_The_US_Subprime_Crisis_So_Different.pdf)" Harvard University working paper.
• Stewart, James B., "Eight Days: the battle to save the American financial system", The New Yorker magazine,
September 21, 2009.
External links
• Financial Crisis Inquiry Commission - Homepage (http://www.fcic.gov/)
• Reuters: Times of Crisis (http://widerimage.reuters.com/timesofcrisis) - multimedia interactive charting the
year of global change
• PBS Frontline - Inside the Meltdown (http://www.pbs.org/wgbh/pages/frontline/meltdown/)
• "Government warned of mortgage meltdown Regulators ignored warnings about risky mortgages, delayed
regulations on the industry" (http://money.cnn.com/2008/12/01/news/ignored_warnings.ap/index.htm).
CNN. December 1 2008. Retrieved 2010-05-24.
• "The US sub-prime crisis in graphics" (http://news.bbc.co.uk/2/hi/business/7073131.stm). BBC. 21
November 2007.
• CNN Scorecard of Bailout Funds at CNN Bailout Allocations & Payments (http://money.cnn.com/news/
specials/storysupplement/bailout_scorecard/index.html)
• Barth, Li, Lu, Phumiwasana and Yago. 2009. The Rise and Fall of the U.S. Mortgage and Credit Markets: A
Comprehensive Analysis of the Market Meltdown. Amazon (http://www.amazon.com/dp/0470477245)
• Financial Times - In depth: Subprime fall-out (http://www.ft.com/indepth/subprime)
• The Crisis of Credit Visualized - Infographic by Jonathan Jarvis (http://vimeo.com/3261363)
• The Economic Crisis: Its Origins and the Way Forward (http://www.bu.edu/phpbin/buniverse/videos/view/
?id=346) Video of lecture given by Marshall Carter, chairman of the New York Stock Exchange, at Boston
University, April 15, 2009
• The True American Dream (http://72.5.117.181/economica/stories/viewStory?storyid=3667) Home
Ownership, the Subprime Lending Crisis, and Financial Instability by Masum Momaya - International Museum of
Women
Financial crisis of 2007–2010

The financial crisis of 2007 to the present
is a crisis triggered by a liquidity shortfall in
the United States banking system.[1] It has
resulted in the collapse of large financial
institutions, the bailout of banks by national
governments, and downturns in stock
markets around the world. In many areas,
the housing market has also suffered,
resulting in numerous evictions,
World map showing GDP real growth rates for 2009
foreclosures and prolonged vacancies. It is
considered by many economists to be the
worst financial crisis since the Great Depression of the 1930s.[2] It contributed to the failure of key businesses,
declines in consumer wealth estimated in the hundreds of trillions of U.S. dollars, substantial financial commitments
incurred by governments, and a significant decline in economic activity.[3] Many causes have been suggested, with
varying weight assigned by experts.[4] Both market-based and regulatory solutions have been implemented or are
under consideration,[5] while significant risks remain for the world economy over the 2010–2011 periods.[6]
The collapse of the housing bubble, which peaked in the U.S. in 2006, caused the values of securities tied to real
estate pricing to plummet thereafter, damaging financial institutions globally.[7] Questions regarding bank solvency,
declines in credit availability, and damaged investor confidence had an impact on global stock markets, where
securities suffered large losses during late 2008 and early 2009. Economies worldwide slowed during this period as
credit tightened and international trade declined.[8] Critics argued that credit rating agencies and investors failed to
accurately price the risk involved with mortgage-related financial products, and that governments did not adjust their
regulatory practices to address 21st century financial markets.[9] Governments and central banks responded with
unprecedented fiscal stimulus, monetary policy expansion, and institutional bailouts.
Background
The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in
approximately 2005–2006.[10] [11] Already-rising default rates on "subprime" and adjustable rate mortgages (ARM)
began to increase quickly thereafter. An increase in loan packaging, marketing and incentives such as easy initial
terms, and a long-term trend of rising housing prices had encouraged borrowers to take on difficult mortgages in the
belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise
and housing prices started to drop moderately in 2006–2007 in many parts of the U.S., refinancing became more
difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to
go up as anticipated, and ARM interest rates reset higher.
Low interest rates and large inflows of
foreign funds created easy credit
conditions for a number of years prior
to the crisis, fueling a housing
construction boom and encouraging
debt-financed consumption.[13] The
combination of easy credit and money
inflow contributed to the United States
housing bubble. Loans of various types
(e.g., mortgage, credit card, and auto)
were easy to obtain and consumers
assumed an unprecedented debt
load.[14] [15] As part of the housing and
credit booms, the number of financial
agreements called mortgage-backed [12]
Share in GDP of U.S. financial sector since 1860
securities (MBS) and collateralized
debt obligations (CDO), which derived
their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled
institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major
global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses.
Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter
foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from
consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also
increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are
estimated in the trillions of U.S. dollars globally.[16]
While the housing and credit bubbles built, a series of factors caused the financial system to both expand and
become increasingly fragile, a process called financialization. Policymakers did not recognize the increasingly
important role played by financial institutions such as investment banks and hedge funds, also known as the shadow
banking system. Some experts believe these institutions had become as important as commercial (depository) banks
in providing credit to the U.S. economy, but they were not subject to the same regulations.[17] These institutions as
well as certain regulated banks had also assumed significant debt burdens while providing the loans described above
and did not have a financial cushion sufficient to absorb large loan defaults or MBS losses.[18] These losses impacted
the ability of financial institutions to lend, slowing economic activity. Concerns regarding the stability of key
financial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial
paper markets, which are integral to funding business operations. Governments also bailed out key financial
institutions and implemented economic stimulus programs, assuming significant additional financial commitments.
The crises culminated on Sept. 15, 2008 with Lehman Brothers filing for bankruptcy.
Growth of the housing bubble

Between 1997 and 2006, the price of
the typical American house increased
by 124%.[20] During the two decades
ending in 2001, the national median
home price ranged from 2.9 to 3.1
times median household income. This
ratio rose to 4.0 in 2004, and 4.6 in
2006.[21] This housing bubble resulted
in quite a few homeowners refinancing
their homes at lower interest rates, or
financing consumer spending by taking
A graph showing the median and average sales prices of new homes sold in the United
out second mortgages secured by the [19]
States between 1963 and 2008 (not adjusted for inflation)
price appreciation.
In a Peabody Award winning program, NPR correspondents argued that a "Giant Pool of Money" (represented by
$70 trillion in worldwide fixed income investments) sought higher yields than those offered by U.S. Treasury bonds
early in the decade. Further, this pool of money had roughly doubled in size from 2000 to 2007, yet the supply of
relatively safe, income generating investments had not grown as fast. Investment banks on Wall Street answered this
demand with the MBS and CDO, which were assigned safe ratings by the credit rating agencies. In effect, Wall
Street connected this pool of money to the mortgage market in the U.S., with enormous fees accruing to those
throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks that funded the
brokers, to the giant investment banks behind them. By approximately 2003, the supply of mortgages originated at
traditional lending standards had been exhausted. However, continued strong demand for MBS and CDO began to
drive down lending standards, as long as mortgages could still be sold along the supply chain. Eventually, this
speculative bubble proved unsustainable.[22]
The CDO in particular enabled financial institutions to obtain investor funds to finance subprime and other lending,
extending or increasing the housing bubble and generating large fees. A CDO essentially places cash payments from
multiple mortgages or other debt obligations into a single pool, from which the cash is allocated to specific securities
in a priority sequence. Those securities obtaining cash first received investment-grade ratings from rating agencies.
Lower priority securities received cash thereafter, with lower credit ratings but theoretically a higher rate of return on
the amount invested.[23] [24]
By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006 peak.[25] [26] As
prices declined, borrowers with adjustable-rate mortgages could not refinance to avoid the higher payments
associated with rising interest rates and began to default. During 2007, lenders began foreclosure proceedings on
nearly 1.3 million properties, a 79% increase over 2006.[27] This increased to 2.3 million in 2008, an 81% increase
vs. 2007.[28] By August 2008, 9.2% of all U.S. mortgages outstanding were either delinquent or in foreclosure.[29]
By September 2009, this had risen to 14.4%.[30]
Easy credit conditions

Lower interest rates encourage borrowing. From 2000 to 2003, the Federal Reserve lowered the federal funds rate
target from 6.5% to 1.0%.[31] This was done to soften the effects of the collapse of the dot-com bubble and of the
September 2001 terrorist attacks, and to combat the perceived risk of deflation.[32]
Additional downward pressure on
interest rates was created by the USA's
high and rising current account (trade)
deficit, which peaked along with the
housing bubble in 2006. Ben Bernanke
explained how trade deficits required
the U.S. to borrow money from abroad,
which bid up bond prices and lowered
interest rates.[33]
Bernanke explained that between 1996

and 2004, the USA current account
deficit increased by $650 billion, from
1.5% to 5.8% of GDP. Financing these
deficits required the USA to borrow
large sums from abroad, much of it
U.S. current account or trade deficit
from countries running trade surpluses,
mainly the emerging economies in
Asia and oil-exporting nations. The balance of payments identity requires that a country (such as the USA) running a
current account deficit also have a capital account (investment) surplus of the same amount. Hence large and
growing amounts of foreign funds (capital) flowed into the USA to finance its imports.
This created demand for various types of financial assets, raising the prices of those assets while lowering interest
rates. Foreign investors had these funds to lend, either because they had very high personal savings rates (as high as
40% in China), or because of high oil prices. Bernanke referred to this as a "saving glut."[34]
A "flood" of funds (capital or liquidity) reached the USA financial markets. Foreign governments supplied funds by
purchasing USA Treasury bonds and thus avoided much of the direct impact of the crisis. USA households, on the
other hand, used funds borrowed from foreigners to finance consumption or to bid up the prices of housing and
financial assets. Financial institutions invested foreign funds in mortgage-backed securities.
The Fed then raised the Fed funds rate significantly between July 2004 and July 2006.[35] This contributed to an
increase in 1-year and 5-year adjustable-rate mortgage (ARM) rates, making ARM interest rate resets more
expensive for homeowners.[36] This may have also contributed to the deflating of the housing bubble, as asset prices
generally move inversely to interest rates and it became riskier to speculate in housing.[37] [38] USA housing and
financial assets dramatically declined in value after the housing bubble burst.[39] [40]
Sub-prime lending
The term subprime refers to the credit
quality of particular borrowers, who
have weakened credit histories and a
greater risk of loan default than prime
borrowers.[41] The value of U.S.
subprime mortgages was estimated at
$1.3 trillion as of March 2007,[42] with
over 7.5 million first-lien subprime
mortgages outstanding.[43]
In addition to easy credit conditions,

there is evidence that both government
and competitive pressures contributed
to an increase in the amount of
subprime lending during the years
preceding the crisis. Major U.S.
U.S. subprime lending expanded dramatically 2004-2006
investment banks and government
sponsored enterprises like Fannie Mae
played an important role in the expansion of higher-risk lending.[44] [45]
Subprime mortgages remained below 10% of all mortgage originations until 2004, when they spiked to nearly 20%
and remained there through the 2005-2006 peak of the United States housing bubble.[46] A proximate event to this
increase was the April 2004 decision by the U.S. Securities and Exchange Commission (SEC) to relax the net capital
rule, which permitted the largest five investment banks to dramatically increase their financial leverage and
aggressively expand their issuance of mortgage-backed securities. This applied additional competitive pressure to
Fannie Mae and Freddie Mac, which further expanded their riskier lending.[47] Subprime mortgage payment
delinquency rates remained in the 10-15% range from 1998 to 2006,[48] then began to increase rapidly, rising to 25%
by early 2008.[49] [50]
Some, like American Enterprise Institute fellow Peter J. Wallison,[51] believe the roots of the crisis can be traced
directly to sub-prime lending by Fannie Mae and Freddie Mac, which are government sponsored entities. On
September 30, 1999, The New York Times reported that the Clinton Administration pushed for sub-prime lending:
Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the
Clinton Administration to expand mortgage loans among low and moderate income people... In moving, even
tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose
any difficulties during flush economic times. But the government-subsidized corporation may run into trouble
in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in
the 1980s.[52]
A 2000 United States Department of the Treasury study of lending trends for 305 cities from 1993 to 1998 showed
that $467 billion of mortgage credit poured out of Community Reinvestment Act (CRA)-covered lenders into low
and mid level income borrowers and neighborhoods.[53] Nevertheless, only 25% of all sub-prime lending occurred at
CRA-covered institutions, and a full 50% of sub-prime loans originated at institutions exempt from CRA.[54] While
the number of CRA sub-prime loans originated were less than non-CRA sub-prime loans originated, it is important
to note that the CRA sub-prime loans were the more "vulnerable during the downturn, to the detriment of both
borrowers and lenders. For example, lending done under Community Reinvestment Act criteria, according to a
quarterly report in October of 2008, constituted only 7% of the total mortgage lending by the Bank of America, but
constituted 29% of its losses on mortgages."[55]
Others have pointed out that there were not enough of these loans made to cause a crisis of this magnitude. In an
article in Portfolio Magazine, Michael Lewis spoke with one trader who noted that "There weren’t enough
Americans with [bad] credit taking out [bad loans] to satisfy investors’ appetite for the end product." Essentially,
investment banks and hedge funds used financial innovation to enable large wagers to be made, far beyond the actual
value of the underlying mortgage loans, using derivatives called credit default swaps and synthetic CDO. As long as
derivative buyers could be matched with sellers, the theoretical amount that could be wagered was infinite. "They
were creating [synthetic loans] out of whole cloth. One hundred times over! That’s why the losses are so much
greater than the loans."[56]
Economist Paul Krugman argued in January 2010 that the simultaneous growth of the residential and commercial
real estate pricing bubbles undermines the case made by those who argue that Fannie Mae, Freddie Mac, CRA or
predatory lending were primary causes of the crisis. In other words, bubbles in both markets developed even though
only the residential market was affected by these potential causes.[57]
Predatory lending
Predatory lending refers to the practice of unscrupulous lenders, to enter into "unsafe" or "unsound" secured loans
for inappropriate purposes.[58] A classic bait-and-switch method was used by Countrywide, advertising low interest
rates for home refinancing. Such loans were written into extensively detailed contracts, and swapped for more
expensive loan products on the day of closing. Whereas the advertisement might state that 1% or 1.5% interest
would be charged, the consumer would be put into an adjustable rate mortgage (ARM) in which the interest charged
would be greater than the amount of interest paid. This created negative amortization, which the credit consumer
might not notice until long after the loan transaction had been consummated.
Countrywide, sued by California Attorney General Jerry Brown for "Unfair Business Practices" and "False
Advertising" was making high cost mortgages "to homeowners with weak credit, adjustable rate mortgages (ARMs)
that allowed homeowners to make interest-only payments.".[59] When housing prices decreased, homeowners in
ARMs then had little incentive to pay their monthly payments, since their home equity had disappeared. This caused
Countrywide's financial condition to deteriorate, ultimately resulting in a decision by the Office of Thrift Supervision
to seize the lender.
Former employees from Ameriquest, which was United States's leading wholesale lender,[60] described a system in
which they were pushed to falsify mortgage documents and then sell the mortgages to Wall Street banks eager to
make fast profits.[60] There is growing evidence that such mortgage frauds may be a cause of the crisis.[60]
Deregulation
Critics have argued that the regulatory framework did not keep pace with financial innovation, such as the increasing
importance of the shadow banking system, derivatives and off-balance sheet financing. In other cases, laws were
changed or enforcement weakened in parts of the financial system. Key examples include:
• Jimmy Carter's Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) phased out a
number of restrictions on banks' financial practices, broadened their lending powers, and raised the deposit
insurance limit from $40,000 to $100,000 (raising the problem of moral hazard).[61] Banks rushed into real estate
lending, speculative lending, and other ventures just as the economy soured.
• In October 1982, U.S. President Ronald Reagan signed into Law the Garn–St. Germain Depository Institutions
Act, which provided for adjustable-rate mortgage loans, began the process of banking deregulation, and
contributed to the savings and loan crisis of the late 1980s/early 1990s.[62]
• In November 1999, U.S. President Bill Clinton signed into Law the Gramm-Leach-Bliley Act, which repealed
part of the Glass-Steagall Act of 1933. This repeal has been criticized for reducing the separation between
commercial banks (which traditionally had a conservative culture) and investment banks (which had a more
risk-taking culture).[63] [64]
• In 2004, the U.S. Securities and Exchange Commission relaxed the net capital rule, which enabled investment
banks to substantially increase the level of debt they were taking on, fueling the growth in mortgage-backed
securities supporting subprime mortgages. The SEC has conceded that self-regulation of investment banks
contributed to the crisis.[65] [66]
• Financial institutions in the shadow banking system are not subject to the same regulation as depository banks,
allowing them to assume additional debt obligations relative to their financial cushion or capital base.[67] This was
the case despite the Long-Term Capital Management debacle in 1998, where a highly-leveraged shadow
institution failed with systemic implications.
• Regulators and accounting standard-setters allowed depository banks such as Citigroup to move significant
amounts of assets and liabilities off-balance sheet into complex legal entities called structured investment
vehicles, masking the weakness of the capital base of the firm or degree of leverage or risk taken. One news
agency estimated that the top four U.S. banks will have to return between $500 billion and $1 trillion to their
balance sheets during 2009.[68] This increased uncertainty during the crisis regarding the financial position of the
major banks.[69] Off-balance sheet entities were also used by Enron as part of the scandal that brought down that
company in 2001.[70]
• As early as 1997, Federal Reserve Chairman Alan Greenspan fought to keep the derivatives market
unregulated.[71] With the advice of the President's Working Group on Financial Markets,[72] the U.S. Congress
and President allowed the self-regulation of the over-the-counter derivatives market when they enacted the
Commodity Futures Modernization Act of 2000. Derivatives such as credit default swaps (CDS) can be used to
hedge or speculate against particular credit risks. The volume of CDS outstanding increased 100-fold from 1998
to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to
$47 trillion. Total over-the-counter (OTC) derivative notional value rose to $683 trillion by June 2008.[73] Warren
Buffett famously referred to derivatives as "financial weapons of mass destruction" in early 2003.[74] [75]
Increased debt burden or over-leveraging

U.S. households and financial
institutions became increasingly
indebted or overleveraged during the
years preceding the crisis. This
increased their vulnerability to the
collapse of the housing bubble and
worsened the ensuing economic
downturn. Key statistics include:
• Free cash used by consumers from

home equity extraction doubled
from $627 billion in 2001 to
$1,428 billion in 2005 as the
housing bubble built, a total of
nearly $5 trillion dollars over the
period, contributing to economic
Leverage ratios of investment banks increased significantly 2003-2007
growth worldwide.[76] [77] [78] U.S.
home mortgage debt relative to
GDP increased from an average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion.[79]
• USA household debt as a percentage of annual disposable personal income was 127% at the end of 2007, versus
77% in 1990.[80]
• In 1981, U.S. private debt was 123% of GDP; by the third quarter of 2008, it was 290%.[81]
• From 2004-07, the top five U.S. investment banks each significantly increased their financial leverage (see
diagram), which increased their vulnerability to a financial shock. These five institutions reported over
$4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for 2007. Lehman Brothers was
liquidated, Bear Stearns and Merrill Lynch were sold at fire-sale prices, and Goldman Sachs and Morgan Stanley
became commercial banks, subjecting themselves to more stringent regulation. With the exception of Lehman,
these companies required or received government support.[82]
• Fannie Mae and Freddie Mac, two U.S. Government sponsored enterprises, owned or guaranteed nearly
$5 trillion in mortgage obligations at the time they were placed into conservatorship by the U.S. government in
September 2008.[83] [84]
These seven entities were highly leveraged and had $9 trillion in debt or guarantee obligations, an enormous
concentration of risk; yet they were not subject to the same regulation as depository banks.
Financial innovation and complexity

The term financial innovation refers to the ongoing development of financial products designed to achieve particular
client objectives, such as offsetting a particular risk exposure (such as the default of a borrower) or to assist with
obtaining financing. Examples pertinent to this crisis included: the adjustable-rate mortgage; the bundling of
subprime mortgages into mortgage-backed securities (MBS) or collateralized debt obligations (CDO) for sale to
investors, a type of securitization; and a form of credit insurance called credit default swaps (CDS). The usage of
these products expanded dramatically in the years leading up to the crisis. These products vary in complexity and the
ease with which they can be valued on the books of financial institutions.
As described in the section on subprime lending, the CDS and portfolio of CDS called synthetic CDO enabled a
theoretically infinite amount to be wagered on the finite value of housing loans outstanding, provided that buyers and
sellers of the derivatives could be found. For example, selling a CDS to insure a CDO ended up giving the seller the
same risk as if they owned the CDO, when those CDO's became worthless.
Certain financial innovation may also have the effect of circumventing regulations, such as off-balance sheet
financing that affects the leverage or capital cushion reported by major banks. For example, Martin Wolf wrote in
June 2009: "...an enormous part of what banks did in the early part of this decade – the off-balance-sheet vehicles,
the derivatives and the 'shadow banking system' itself – was to find a way round regulation."[85]
Incorrect pricing of risk

The pricing of risk refers to the incremental compensation required by
investors for taking on additional risk, which may be measured by
interest rates or fees. For a variety of reasons, market participants did
not accurately measure the risk inherent with financial innovation such
as MBS and CDO's or understand its impact on the overall stability of
the financial system.[9] For example, the pricing model for CDOs
clearly did not reflect the level of risk they introduced into the system.
Banks estimated that $450bn of CDO were sold between "late 2005 to
the middle of 2007"; among the $102bn of those that had been
A protester on Wall Street in the wake of the AIG
liquidated, JPMorgan estimated that the average recovery rate for "high
bonus payments controversy is interviewed by
quality" CDOs was approximately 32 cents on the dollar, while the news media.
recovery rate for mezzanine CDO was approximately five cents for
every dollar.[86]
Another example relates to AIG, which insured obligations of various financial institutions through the usage of
credit default swaps. The basic CDS transaction involved AIG receiving a premium in exchange for a promise to pay
money to party A in the event party B defaulted. However, AIG did not have the financial strength to support its
many CDS commitments as the crisis progressed and was taken over by the government in September 2008. U.S.
taxpayers provided over $180 billion in government support to AIG during 2008 and early 2009, through which the
money flowed to various counterparties to CDS transactions, including many large global financial institutions.[87]
[88]
The limitations of a widely-used financial model also were not properly understood.[89] [90] This formula assumed
that the price of CDS was correlated with and could predict the correct price of mortgage backed securities. Because
it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and
rating agencies.[90] According to one wired.com article:
Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways
that users of Li's formula hadn't expected. The cracks became full-fledged canyons in 2008—when ruptures in
the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking
system in serious peril... Li's Gaussian copula formula will go down in history as instrumental in causing the
unfathomable losses that brought the world financial system to its knees.[90]
As financial assets became more and more complex, and harder and harder to value, investors were reassured by the
fact that both the international bond rating agencies and bank regulators, who came to rely on them, accepted as valid
some complex mathematical models which theoretically showed the risks were much smaller than they actually
proved to be.[91] George Soros commented that "The super-boom got out of hand when the new products became so
complicated that the authorities could no longer calculate the risks and started relying on the risk management
methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators
of synthetic products. It was a shocking abdication of responsibility."[92]
Moreover, a conflict of interest between professional investment managers and their institutional clients, combined
with a global glut in investment capital, led to bad investments by asset managers in over-priced credit assets.
Professional investment managers generally are compensated based on the volume of client assets under
management. There is, therefore, an incentive for asset managers to expand their assets under management in order
to maximize their compensation. As the glut in global investment capital caused the yields on credit assets to decline,
asset managers were faced with the choice of either investing in assets where returns did not reflect true credit risk or
returning funds to clients. Many asset managers chose to continue to invest client funds in over-priced
(under-yielding) investments, to the detriment of their clients, in order to maintain their assets under management.
This choice was supported by a “plausible deniability” of the risks associated with subprime-based credit assets
because the loss experience with early “vintages” of subprime loans was so low.[93]
Despite the dominance of the above formula, there are documented attempts of the financial industry, occurring
before the crisis, to address the formula limitations, specifically the lack of dependence dynamics and the poor
representation of extreme events.[94] The volume "Credit Correlation: Life After Copulas", published in 2007 by
World Scientific, summarizes a 2006 conference held by Merrill Lynch in London where several practitioners
attempted to propose models rectifying some of the copula limitations. See also the article by Donnelly and
Embrechts [95] and the book by Brigo, Pallavicini and Torresetti, that reports relevant warnings and research on
CDOs appeared in 2006. [96]

In a June 2008 speech, President and
CEO of the New York Federal Reserve
Bank Timothy Geithner — who in
2009 became Secretary of the United
States Treasury — placed significant
to the same regulatory controls.
Further, these entities were vulnerable
because of maturity mismatch,
meaning that they borrowed short-term Securitization markets were impaired during the crisis
in liquid markets to purchase
long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid
deleveraging, selling their long-term assets at depressed prices. He described the significance of these entities:
In early 2007, asset-backed commercial paper conduits, in structured investment vehicles, in auction-rate
preferred securities, tender option bonds and variable rate demand notes, had a combined asset size of roughly
$2.2 trillion. Assets financed overnight in triparty repo grew to $2.5 trillion. Assets held in hedge funds grew
to roughly $1.8 trillion. The combined balance sheets of the then five major investment banks totaled
$4 trillion. In comparison, the total assets of the top five bank holding companies in the United States at that
point were just over $6 trillion, and total assets of the entire banking system were about $10 trillion. The
combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit
cycles.[17]
Paul Krugman, laureate of the Nobel Prize in Economics, described the run on the shadow banking system as the
"core of what happened" to cause the crisis. He referred to this lack of controls as "malign neglect" and argued that
regulation should have been imposed on all banking-like activity.[67]
The securitization markets supported by the shadow banking system started to close down in the spring of 2007 and
nearly shut-down in the fall of 2008. More than a third of the private credit markets thus became unavailable as a
source of funds.[97] According to the Brookings Institution, the traditional banking system does not have the capital
to close this gap as of June 2009: "It would take a number of years of strong profits to generate sufficient capital to
support that additional lending volume." The authors also indicate that some forms of securitization are "likely to
vanish forever, having been an artifact of excessively loose credit conditions."[98]
Economist Mark Zandi testified to the Financial Crisis Inquiry Commission in January 2010: "The securitization
markets also remain impaired, as investors anticipate more loan losses. Investors are also uncertain about coming
legal and accounting rule changes and regulatory reforms. Private bond issuance of residential and commercial
mortgage-backed securities, asset-backed securities, and CDOs peaked in 2006 at close to $2 trillion...In 2009,
private issuance was less than $150 billion, and almost all of it was asset-backed issuance supported by the Federal
Reserve's TALF program to aid credit card, auto and small-business lenders. Issuance of residential and commercial
mortgage-backed securities and CDOs remains dormant."[99]
Commodities boom
Rapid increases in a number of commodity prices followed the collapse in the housing bubble. The price of oil
nearly tripled from $50 to $147 from early 2007 to 2008, before plunging as the financial crisis began to take hold in
late 2008.[100] Experts debate the causes, with some attributing it to speculative flow of money from housing and
other investments into commodities, some to monetary policy,[101] and some to the increasing feeling of raw
materials scarcity in a fast growing world, leading to long positions taken on those markets, such as Chinese
increasing presence in Africa. An increase in oil prices tends to divert a larger share of consumer spending into
gasoline, which creates downward pressure on economic growth in oil importing countries, as wealth flows to
oil-producing states.[102]
In testimony before the Senate Committee on Commerce, Science, and Transportation on June 3, 2008, former
director of the CFTC Division of Trading & Markets (responsible for enforcement) Michael Greenberger specifically
named the Atlanta-based IntercontinentalExchange, founded by Goldman Sachs, Morgan Stanley and BP as playing
a key role in speculative run-up of oil futures prices traded off the regulated futures exchanges in London and New
York.[103]
It was also noticed that copper prices
increased at the same time as the oil
prices. Copper traded at about $2,500
per tonne from 1990 until 1999, when
it fell to about $1,600. The price slump
lasted until 2004 which saw a price
surge that had copper reaching $7,040
per tonne in 2008.[104]
Nickel prices boomed in the late

1990s, then the price of nickel
imploded from around $51,000
/£36,700 per metric ton in May 2007 to
about $11,550/£8,300 per metric ton in Global copper prices
January 2009. Prices were only just

starting to recover as of January 2010, but most of Australia's nickel mines had gone bankrupt by then.[105] As the
price for high grade nickel sulphate ore recovered in 2010, so did the Australian nickel mining industry.[106]
Coincidentally with these price fluctuations, long-only commodity index funds became popular – by one estimate
investment increased from $90 billion in 2006 to $200 billion at the end of 2007, while commodity prices increased
71% – which raised concern as to whether these index funds caused the commodity bubble.[107] The empirical
research has been mixed.[107]
Systemic crisis
Another analysis, different from the mainstream explanation, is that the financial crisis is merely a symptom of
another, deeper crisis, which is a systemic crisis of capitalism itself. According to Samir Amin, an Egyptian Marxist
economist, the constant decrease in GDP growth rates in Western countries since the early 1970s created a growing
surplus of capital which did not have sufficient profitable investment outlets in the real economy. The alternative
was to place this surplus into the financial market, which became more profitable than capital investment, especially
with subsequent deregulation.[108] According to Samir Amin, this phenomenon has led to recurrent financial bubbles
(such as the internet bubble) and is the deep cause of the financial crisis of 2007-2010.[109]
John Bellamy Foster, a political economy analyst and editor of the Monthly Review, believes that the decrease in
GDP growth rates since the early 1970s is due to increasing market saturation.[110]
John C. Bogle wrote during 2005 that a series of unresolved challenges face capitalism that have contributed to past
financial crises and have not been sufficiently addressed:
Corporate America went astray largely because the power of managers went virtually unchecked by our
gatekeepers for far too long...They failed to 'keep an eye on these geniuses' to whom they had entrusted the
responsibility of the management of America's great corporations.
He cites particular issues, including:[111] [112]
• "Manager's capitalism" which he argues has replaced "owner's capitalism," meaning management runs the firm
for its benefit rather than for the shareholders, a variation on the principal-agent problem;
• Burgeoning executive compensation;
• Managed earnings, mainly a focus on share price rather than the creation of genuine value; and
• The failure of gatekeepers, including auditors, boards of directors, Wall Street analysts, and career politicians.
Robert Reich has attributed the current economic downturn to the stagnation of wages in the United States,
particularly those of the hourly workers who comprise 80% of the workforce. His claim is that this stagnation forced
the population to borrow in order to meet the cost of living.[113]
Role of economic forecasting

The financial crisis was not widely predicted by mainstream economists, who instead spoke of The Great
Moderation. A number of heterodox economists predicted the crisis, with varying arguments. Dirk Bezemer in his
research[114] credits (with supporting argument and estimates of timing) 12 economists with predicting the crisis:
Dean Baker (US), Wynne Godley (UK), Fred Harrison (UK), Michael Hudson (US), Eric Janszen (US), Steve Keen
(Australia), Jakob Brøchner Madsen & Jens Kjaer Sørensen (Denmark), Kurt Richebächer (US), Nouriel Roubini
(US), Peter Schiff (US), and Robert Shiller (US). Examples of other experts who gave indications of a financial
crisis have also been given.[115] [116] [117]
A cover story in BusinessWeek magazine claims that economists mostly failed to predict the worst international
economic crisis since the Great Depression of 1930s.[118] The Wharton School of the University of Pennsylvania's
online business journal examines why economists failed to predict a major global financial crisis.[119] Popular
articles published in the mass media have led the general public to believe that the majority of economists have
failed in their obligation to predict the financial crisis. For example, an article in the New York Times informs that
economist Nouriel Roubini warned of such crisis as early as September 2006, and the article goes on to state that the
profession of economics is bad at predicting recessions.[120] According to The Guardian, Roubini was ridiculed for
predicting a collapse of the housing market and worldwide recession, while The New York Times labelled him "Dr.
Doom".[121]
Within mainstream financial economics, most believe that financial crises are simply unpredictable,[122] following
Eugene Fama's efficient-market hypothesis and the related random-walk hypothesis, which state respectively that
markets contain all information about possible future movements, and that the movement of financial prices are
random and unpredictable.
Trader and financial risk engineer Nassim Nicholas Taleb author of The Black Swan spent years warning against the
breakdown of the banking system in particular and the economy in general owing to their use of bad risk models and
reliance on forecasting, and their reliance on bad models, and framed the problem as part of "robustness and
fragility".[123] [124] He also reacted against the cold of the establishment by making a big financial bet on banking
stocks and making a fortune from the crisis ("They didn't listen, so I took their money") .[125] According to David
Brooks from the New York Times, "Taleb not only has an explanation for what’s happening, he saw it coming." .[126]
Financial markets impacts
Impacts on financial institutions

The International Monetary Fund estimated that large U.S. and
European banks lost more than $1 trillion on toxic assets and from bad
loans from January 2007 to September 2009. These losses are expected
to top $2.8 trillion from 2007-10. U.S. banks losses were forecast to hit
$1 trillion and European bank losses will reach $1.6 trillion. The IMF
estimated that U.S. banks were about 60% through their losses, but
British and eurozone banks only 40%.[127]
One of the first victims was Northern Rock, a medium-sized British

bank.[128] The highly leveraged nature of its business led the bank to 2007 bank run on Northern Rock, a UK bank
request security from the Bank of England. This in turn led to investor
panic and a bank run in mid-September 2007. Calls by Liberal Democrat Shadow Chancellor Vince Cable to
nationalise the institution were initially ignored; in February 2008, however, the British government (having failed to
find a private sector buyer) relented, and the bank was taken into public hands. Northern Rock's problems proved to
be an early indication of the troubles that would soon befall other banks and financial institutions.
Initially the companies affected were those directly involved in home construction and mortgage lending such as
Northern Rock and Countrywide Financial, as they could no longer obtain financing through the credit markets.
Over 100 mortgage lenders went bankrupt during 2007 and 2008. Concerns that investment bank Bear Stearns would
collapse in March 2008 resulted in its fire-sale to JP Morgan Chase. The financial institution crisis hit its peak in
September and October 2008. Several major institutions either failed, were acquired under duress, or were subject to
government takeover. These included Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington
Mutual, Wachovia, and AIG.[129]
Credit markets and the shadow banking system

During September 2008, the crisis hit
its most critical stage. There was the
equivalent of a bank run on the money
market mutual funds, which frequently
invest in commercial paper issued by
corporations to fund their operations
and payrolls. Withdrawal from money
markets were $144.5 billion during one
week, versus $7.1 billion the week
prior. This interrupted the ability of
corporations to rollover (replace) their
short-term debt. The U.S. government
responded by extending insurance for
money market accounts analogous to
bank deposit insurance via a temporary
guarantee[130] and with Federal TED spread and components during 2008
Reserve programs to purchase
commercial paper. The TED spread, an indicator of perceived credit risk in the general economy, spiked up in July
2007, remained volatile for a year, then spiked even higher in September 2008,[131] reaching a record 4.65% on
October 10, 2008.
In a dramatic meeting on September 18, 2008, Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke
met with key legislators to propose a $700 billion emergency bailout. Bernanke reportedly told them: "If we don't do
this, we may not have an economy on Monday."[132] The Emergency Economic Stabilization Act, which
implemented the Troubled Asset Relief Program (TARP), was signed into law on October 3, 2008.[133]
Economist Paul Krugman and U.S. Treasury Secretary Timothy Geithner explain the credit crisis via the implosion
of the shadow banking system, which had grown to nearly equal the importance of the traditional commercial
banking sector as described above. Without the ability to obtain investor funds in exchange for most types of
mortgage-backed securities or asset-backed commercial paper, investment banks and other entities in the shadow
banking system could not provide funds to mortgage firms and other corporations.[17] [67]
This meant that nearly one-third of the U.S. lending mechanism was frozen and continued to be frozen into June
2009.[134] According to the Brookings Institution, the traditional banking system does not have the capital to close
this gap as of June 2009: "It would take a number of years of strong profits to generate sufficient capital to support
that additional lending volume." The authors also indicate that some forms of securitization are "likely to vanish
forever, having been an artifact of excessively loose credit conditions." While traditional banks have raised their
lending standards, it was the collapse of the shadow banking system that is the primary cause of the reduction in
funds available for borrowing.[135]
Wealth effects
There is a direct relationship between declines in wealth, and declines in
consumption and business investment, which along with government spending
represent the economic engine. Between June 2007 and November 2008,
Americans lost an estimated average of more than a quarter of their collective net
worth. By early November 2008, a broad U.S. stock index the S&P 500, was
down 45% from its 2007 high. Housing prices had dropped 20% from their 2006
peak, with futures markets signaling a 30-35% potential drop. Total home equity
in the United States, which was valued at $13 trillion at its peak in 2006, had
dropped to $8.8 trillion by mid-2008 and was still falling in late 2008. Total
retirement assets, Americans' second-largest household asset, dropped by 22%,
from $10.3 trillion in 2006 to $8 trillion in mid-2008. During the same period,
savings and investment assets (apart from retirement savings) lost $1.2 trillion The New York City headquarters of
and pension assets lost $1.3 trillion. Taken together, these losses total a Lehman Brothers
staggering $8.3 trillion.[136] Since peaking in the second quarter of 2007,
household wealth is down $14 trillion.[137]
Further, U.S. homeowners had extracted significant equity in their homes in the years leading up to the crisis, which
they could no longer do once housing prices collapsed. Free cash used by consumers from home equity extraction
doubled from $627 billion in 2001 to $1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion
over the period.[76] [77] [78] U.S. home mortgage debt relative to GDP increased from an average of 46% during the
1990s to 73% during 2008, reaching $10.5 trillion.[79]
To offset this decline in consumption and lending capacity, the U.S. government and U.S. Federal Reserve have
committed $13.9 trillion, of which $6.8 trillion has been invested or spent, as of June 2009.[138] In effect, the Fed has
gone from being the "lender of last resort" to the "lender of only resort" for a significant portion of the economy. In
some cases the Fed can now be considered the "buyer of last resort." Economist Dean Baker explained the reduction
in the availability of credit this way:
Yes, consumers and businesses can't get credit as easily as they could a year ago. There is a really good reason
for tighter credit. Tens of millions of homeowners who had substantial equity in their homes two years ago
have little or nothing today. Businesses are facing the worst downturn since the Great Depression. This matters
for credit decisions. A homeowner with equity in her home is very unlikely to default on a car loan or credit
card debt. They will draw on this equity rather than lose their car and/or have a default placed on their credit
record. On the other hand, a homeowner who has no equity is a serious default risk. In the case of businesses,
their creditworthiness depends on their future profits. Profit prospects look much worse in November 2008
than they did in November 2007 (of course, to clear-eyed analysts, they didn't look too good a year ago either).
While many banks are obviously at the brink, consumers and businesses would be facing a much harder time
getting credit right now even if the financial system were rock solid. The problem with the economy is the loss
of close to $6 trillion in housing wealth and an even larger amount of stock wealth. Economists, economic
policy makers and economic reporters virtually all missed the housing bubble on the way up. If they still can't
notice its impact as the collapse of the bubble throws into the worst recession in the post-war era, then they are
in the wrong profession.[139]
At the heart of the portfolios of many of these institutions were investments whose assets had been derived from
bundled home mortgages. Exposure to these mortgage-backed securities, or to the credit derivatives used to insure
them against failure, caused the collapse or takeover of several key firms such as Lehman Brothers, AIG, Merrill
Lynch, and HBOS.[140] [141] [142]
European contagion
The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank
failures, declines in various stock indexes, and large reductions in the market value of equities[143] and
commodities.[144]
Both MBS and CDO were purchased by corporate and institutional investors globally. Derivatives such as credit
default swaps also increased the linkage between large financial institutions. Moreover, the de-leveraging of
financial institutions, as assets were sold to pay back obligations that could not be refinanced in frozen credit
markets, further accelerated the solvency crisis and caused a decrease in international trade.
World political leaders, national ministers of finance and central bank directors coordinated their efforts[145] to
reduce fears, but the crisis continued. At the end of October 2008 a currency crisis developed, with investors
transferring vast capital resources into stronger currencies such as the yen, the dollar and the Swiss franc, leading
many emergent economies to seek aid from the International Monetary Fund.[146] [147]
Effects on the global economy
Global effects
A number of commentators have suggested that if the liquidity crisis continues, there could be an extended recession
or worse.[148] The continuing development of the crisis has prompted in some quarters fears of a global economic
collapse although there are now many cautiously optimistic forecasters in addition to some prominent sources who
remain negative.[149] The financial crisis is likely to yield the biggest banking shakeout since the savings-and-loan
meltdown.[150] Investment bank UBS stated on October 6 that 2008 would see a clear global recession, with
recovery unlikely for at least two years.[151] Three days later UBS economists announced that the "beginning of the
end" of the crisis had begun, with the world starting to make the necessary actions to fix the crisis: capital injection
by governments; injection made systemically; interest rate cuts to help borrowers. The United Kingdom had started
systemic injection, and the world's central banks were now cutting interest rates. UBS emphasized the United States
needed to implement systemic injection. UBS further emphasized that this fixes only the financial crisis, but that in
economic terms "the worst is still to come".[152] UBS quantified their expected recession durations on October 16:
the Eurozone's would last two quarters, the United States' would last three quarters, and the United Kingdom's would
last four quarters.[153] The economic crisis in Iceland involved all three of the country's major banks. Relative to the
size of its economy, Iceland’s banking collapse is the largest suffered by any country in economic history.[154]
At the end of October UBS revised its outlook downwards: the forthcoming recession would be the worst since the
early 1980s recession with negative 2009 growth for the U.S., Eurozone, UK; very limited recovery in 2010; but not
as bad as the Great Depression.[155]
The Brookings Institution reported in June 2009 that U.S. consumption accounted for more than a third of the growth
in global consumption between 2000 and 2007. "The US economy has been spending too much and borrowing too
much for years and the rest of the world depended on the U.S. consumer as a source of global demand." With a
recession in the U.S. and the increased savings rate of U.S. consumers, declines in growth elsewhere have been
dramatic. For the first quarter of 2009, the annualized rate of decline in GDP was 14.4% in Germany, 15.2% in
Japan, 7.4% in the UK, 18% in Latvia,[156] 9.8% in the Euro area and 21.5% for Mexico.[157]
Some developing countries that had seen strong economic growth saw significant slowdowns. For example, growth
forecasts in Cambodia show a fall from more than 10% in 2007 to close to zero in 2009, and Kenya may achieve
only 3-4% growth in 2009, down from 7% in 2007. According to the research by the Overseas Development
Institute, reductions in growth can be attributed to falls in trade, commodity prices, investment and remittances sent
from migrant workers (which reached a record $251 billion in 2007, but have fallen in many countries since).[158]
This has stark implications and has led to a dramatic rise in the number of households living below the poverty line,
be it 300,000 in Bangladesh or 230,000 in Ghana.[158]
By March 2009, the Arab world had lost $3 trillion due to the crisis.[159] In April 2009, unemployment in the Arab
world is said to be a 'time bomb'.[160] In May 2009, the United Nations reported a drop in foreign investment in
Middle-Eastern economies due to a slower rise in demand for oil.[161] In June 2009, the World Bank predicted a
tough year for Arab states.[162] In September 2009, Arab banks reported losses of nearly $4 billion since the onset of
the global financial crisis.[163]
U.S. economic effects

Real gross domestic product — the output of goods and services produced by labor and property located in the
United States—decreased at an annual rate of approximately 6% in the fourth quarter of 2008 and first quarter of
2009, versus activity in the year-ago periods.[164] The U.S. unemployment rate increased to 10.1% by October 2009,
the highest rate since 1983 and roughly twice the pre-crisis rate. The average hours per work week declined to 33,
the lowest level since the government began collecting the data in 1964.[165] [166]
Official economic projections

On November 3, 2008, the European Commission at Brussels predicted for 2009 an extremely weak growth of GDP,
by 0.1%, for the countries of the Eurozone (France, Germany, Italy, etc.) and even negative number for the UK
(-1.0%), Ireland and Spain. On November 6, the IMF at Washington, D.C., launched numbers predicting a
worldwide recession by -0.3% for 2009, averaged over the developed economies. On the same day, the Bank of
England and the European Central Bank, respectively, reduced their interest rates from 4.5% down to 3%, and from
3.75% down to 3.25%. As a consequence, starting from November 2008, several countries launched large "help
packages" for their economies.
The U.S. Federal Reserve Open Market Committee release in June 2009 stated:
...the pace of economic contraction is slowing. Conditions in financial markets have generally improved in
recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing
job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing
but appear to be making progress in bringing inventory stocks into better alignment with sales. Although
economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions
to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute
to a gradual resumption of sustainable economic growth in a context of price stability.[167] Economic
projections from the Federal Reserve and Reserve Bank Presidents include a return to typical growth levels
(GDP) of 2-3% in 2010; an unemployment plateau in 2009 and 2010 around 10% with moderation in 2011;
and inflation that remains at typical levels around 1-2%.[168]
2010 European sovereign debt crisis

One of the long-term worldwide consequences of the economic breakdown is the 2010 European sovereign debt
crisis. This crisis primarily impacted five countries: Greece, Ireland, Portugal, Italy, and Spain. The governments of
these nations habitually run large government budget deficits. Other Eurozone countries include: France, Belgium,
The Netherlands, Luxembourg, Germany, Finland, Austria, and Italy. Greece, which at the time of the crisis also
suffered from bad governing with widespread corruption and tax evasion, was hit the hardest and was thus targeted
by credit rating agencies as the weak link of the Eurozone. Fear that Greece's debt problems would cause lenders to
stop lending to it, with the result that Greece would default on its sovereign debt, sparked speculation that such a
default would cause lenders to stop loaning money to the other PIGS (Portugal, Ireland/Italy, Greece and Spain) as
well, with the result that they would also eventually default on their sovereign debt. A sovereign default by Spain,
Portugal, Italy and Greece would result in bank losses so large that almost every bank in Europe would become
insolvent due to the now uncollectible outstanding loans to those four countries.
On Friday, May 7, 2010 a long-desired financial aid package for Greece was constructed; however, it was obvious
that other states, because of their extremely large debts, would have - or already had - financial difficulties.
Therefore, the following Sunday a large group of ministers of Eurozone gathered in Brussels, decided on a mutual
financial aid package of €750 billion; and the European Central Bank announced that in the future it would support
by explicit monetary help, if necessary, government bonds of the Eurozone countries (which was not allowed before,
because of fears of inflation).
Already on May 21, 2010 the German parliament, only with a slight majority, was the first one to accept the new
rules.
While this aid package has so far averted a financial panic, the PIGS continue to have difficulties.[169]
Responses to financial crisis
Emergency and short-term responses

The U.S. Federal Reserve and central banks around the world have taken steps to expand money supplies to avoid
the risk of a deflationary spiral, in which lower wages and higher unemployment lead to a self-reinforcing decline in
global consumption. In addition, governments have enacted large fiscal stimulus packages, by borrowing and
spending to offset the reduction in private sector demand caused by the crisis. The U.S. executed two stimulus
packages, totaling nearly $1 trillion during 2008 and 2009.[170]
This credit freeze brought the global financial system to the brink of collapse. The response of the U.S. Federal
Reserve, the European Central Bank, and other central banks was immediate and dramatic. During the last quarter of
2008, these central banks purchased US$2.5 trillion of government debt and troubled private assets from banks. This
was the largest liquidity injection into the credit market, and the largest monetary policy action, in world history. The
governments of European nations and the USA also raised the capital of their national banking systems by
$1.5 trillion, by purchasing newly issued preferred stock in their major banks.[129]
Governments have also bailed out a variety of firms as discussed above, incurring large financial obligations. To
date, various U.S. government agencies have committed or spent trillions of dollars in loans, asset purchases,
guarantees, and direct spending. For a summary of U.S. government financial commitments and investments related
to the crisis, see CNN - Bailout Scorecard [186]. Significant controversy has accompanied the bailout, leading to the
development of a variety of "decision making frameworks", to help balance competing policy interests during times
of financial crisis. [171]
Regulatory proposals and long-term responses

United States President Barack Obama and key advisers introduced a series of regulatory proposals in June 2009.
The proposals address consumer protection, executive pay, bank financial cushions or capital requirements,
expanded regulation of the shadow banking system and derivatives, and enhanced authority for the Federal Reserve
to safely wind-down systemically important institutions, among others.[172] [173] [174] In January 2010, Obama
proposed additional regulations limiting the ability of banks to engage in proprietary trading. The proposals were
dubbed "The Volcker Rule", in recognition of Paul Volcker, who has publicly argued for the proposed changes.[175]
[176]
The U.S. Senate passed a regulatory reform bill in May 2010, following the House which passed a bill in December
2009. These bills must now be reconciled. The New York Times provided a comparative summary of the features of
the two bills, which address to varying extent the principles enumerated by the Obama administration.[177] For
instance, the Volcker Rule against proprietary trading is not part of the legislation, though in the Senate bill
regulators have the discretion but not the obligation to prohibit these trades.
A variety of other regulatory changes have been proposed by economists, politicians, journalists, and business
leaders to minimize the impact of the current crisis and prevent recurrence. None of the proposed solutions have yet
been implemented. These include:
• Ben Bernanke: Establish resolution procedures for closing troubled financial institutions in the shadow banking
system, such as investment banks and hedge funds.[178]
• Nassim Nicholas Taleb: "Black Swan Robustness" i.e. Robustness against High Impact Rare Events("Fat Tails").
• Joseph Stiglitz: Restrict the leverage that financial institutions can assume. Require executive compensation to be
more related to long-term performance.[179] Re-instate the separation of commercial (depository) and investment
banking established by the Glass-Steagall Act in 1933 and repealed in 1999 by the Gramm-Leach-Bliley Act.[180]
• Simon Johnson: Break-up institutions that are "too big to fail" to limit systemic risk.[181]
• Paul Krugman: Regulate institutions that "act like banks" similarly to banks.[67]
• Alan Greenspan: Banks should have a stronger capital cushion, with graduated regulatory capital requirements
(i.e., capital ratios that increase with bank size), to "discourage them from becoming too big and to offset their
competitive advantage."[182]
• Warren Buffett: Require minimum down payments for home mortgages of at least 10% and income
verification.[183]
• Eric Dinallo: Ensure any financial institution has the necessary capital to support its financial commitments.
Regulate credit derivatives and ensure they are traded on well-capitalized exchanges to limit counterparty
risk.[184]
• Raghuram Rajan: Require financial institutions to maintain sufficient "contingent capital" (i.e., pay insurance
premiums to the government during boom periods, in exchange for payments during a downturn.).[185]
• HM Treasury: Contingent capital or capital insurance held by the private sector could supplement common equity
in times of crisis. There are a variety of proposals (e.g. Raviv 2004, Flannery 2009) under which banks would
issue fixed income debt that would convert into capital according to a predetermined mechanism, either
bank-specific (related to levels of regulatory capital) or a more general measure of crisis. Alternatively, under
capital insurance, an insurer would receive a premium for agreeing to provide an amount of capital to the bank in
case of systemic crisis. Following Raviv (2004) proposal, on November 3 Lloyds Banking Group (LBG), Britain’s
biggest retail bank, said it would convert existing debt into about £7.5 billion ($12.3 billion) of “contingent core
Tier-1 capital” (dubbed CoCos). This is a kind of debt that will automatically convert into shares if the bank’s
cushion of equity capital falls below 5%.[186] [187]
• A. Michael Spence and Gordon Brown: Establish an early-warning system to help detect systemic risk.[188]
• Niall Ferguson and Jeffrey Sachs: Impose haircuts on bondholders and counterparties prior to using taxpayer
money in bailouts. In other words, bondholders with a claim of $100 would have their claim reduced to $80,
creating $20 in equity. This is also called a debt for equity swap. This is frequently done in bankruptcies, where
the current shareholders are wiped out and the bondholders become the new stockholders, agreeing to reduce the
company's debt burden in the process. This is being done with General Motors, for example.[189] [190]
• Nouriel Roubini: Nationalize insolvent banks.[191] Reduce mortgage balances to assist homeowners, giving the
lender a share in any future home appreciation.[192]
• Adair Turner: In August 2009 in a roundtable interview in Prospect Adair Turner supported the idea of new
global taxes on financial transactions, warning that a “swollen” financial sector paying excessive salaries has
grown too big for society.[193] Lord Turner’s suggestion that a “Tobin tax” – named after the economist James
Tobin – should be considered for financial transactions reverberated around the world.[194] [195]
• Let Wall Street Pay for the Restoration of Main Street Bill - in the US only (not international) - Proposed
legislation introduced December 3, 2009 - Contained in the US House of Representatives bill entitled "H.R. 4191:
Let Wall Street Pay for the Restoration of Main Street Act of 2009"[196] [197] It is a proposed piece of legislation
that was introduced into the United States House of Representatives to assess a minuscule tax on US Financial
market ("Wall Street") securities transactions. If passed, the money it generates will be used to rebuild "Main
Street." On the day it was introduced, it had the support of 22 representatives.[198]
• Volcker Rule - (in US) - Endorsed by President Barack Obama on January 21, 2010. At its heart, it is a proposal
by US economist Paul Volcker to restrict banks from making speculative investments that do not benefit their
customers.[176] Volcker has argued that such speculative activity played a key role in the financial crisis of
2007–2010.
• On April 16, 2010, the IMF proposed two types of global taxes on banks: The "Financial Activities Tax" comes in
two varieties. The simple version is a straight tax on a bank's gross profits—before deducting compensation. A
"financial stability contribution", would initially be at a flat rate, this would eventually be refined so that riskier
businesses paid more.[199] The second, more complex tax aims directly at excess bank profit and pay.[200] [201]
(See also Bank tax)
• Maximum wage is an idea which has been enacted in early 2009 in the United States, where they capped
executive pay at $500,000 per year for companies receiving extraordinary financial assistance from the US
Taxpayers. The argument is to place a cap on the amount that any person may legally make, in the same way as
there is a floor of a minimum wage so that people can not earn too little.[202]
United States Congress response

• On December 11, 2009 - House cleared bill H.R.4173 - Wall Street Reform and Consumer Protection Act of
2009[203]
• On April 15, 2010 - Senate introduced bill S.3217 - Restoring American Financial Stability Act of 2010[204]
• On July 21, 2010.[205] - the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted.[206]
Books, Blogs, and Films on the Crisis

The financial crises have provoked an outpouring of articles and books outside of the scholarly and financial press.
Most notable have been articles and books by author William Greider, economist Michael Hudson, author and
former bond salesman Michael Lewis, Congressman Ron Paul, author Kevin Phillips, and Rolling Stone national
correspondent Matt Taibbi.
In October 2010, a new documentary film about the crisis, Inside Job directed by Charles Ferguson, will be released
by Sony Pictures Classics.
In addition, a number of blogs experienced phenomenal growth, including The Baseline Scenario by James Kwak
and Simon Johnson, Calculated Risk by Bill McBride, and Zero Hedge by "Tyler Durden".
See also
• 1929 stock market crash
• 2009 G-20 London summit protests
• 2008 Greek riots
• 2009 Icelandic financial crisis protests
• 2009 May Day protests
• 2009 Moldova civil unrest
• 2009 Riga riot
• 2008–2010 bank failures in the United States
• Crisis (Marxian)
• Dot-com bubble
• Europeans for Financial Reform
• Keynesian resurgence of 2008
• List of acquired or bankrupt banks in the late 2000s financial crisis
• List of acquired or bankrupt United States banks in the late 2000s financial crisis
• List of economic crises
• List of entities involved in 2007–2008 financial crises
• List of largest U.S. bank failures
• Low-Income Countries Under Stress (LICUS) (World Bank program)
• Mark-to-market accounting
• Private equity in the 2000s
• Subprime crisis impact timeline
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The initial articles and some subsequent material were adapted from the Wikinfo article Financial crisis of
2007-2008 (http:/ / www. wikinfo. org/ index. php?title=Financial_crisis_of_2007-2008) released under the GNU
Free Documentation License Version 1.2
External links and further reading

• Times of Crisis (http://widerimage.reuters.com/timesofcrisis) - Reuters: Multimedia interactive charting the
year of global change
• PBS Frontline - Inside the Meltdown (http://www.pbs.org/wgbh/pages/frontline/meltdown/)
• Economic Crisis and Stimulus (http://ucblibraries.colorado.edu/govpubs/us/stimulus.html) from UCB
Libraries GovPubs
• Credit Crisis—The Essentials (http://topics.nytimes.com/topics/reference/timestopics/subjects/c/
credit_crisis/) topic page from The New York Times
• NYU Stern on Finance (http://pages.stern.nyu.edu/~sternfin/crisis/) - Understanding the Financial Crisis
• How nations around the world are responding to the global financial crisis (http://www.pbs.org/wnet/
wideangle/uncategorized/how-global-is-the-crisis/3543/) from PBS
• In depth: Global financial crisis (http://www.ft.com/indepth/global-financial-crisis) from the Financial Times
• Timeline: Global credit crunch (http://news.bbc.co.uk/2/hi/business/7521250.stm) Published in BBC News
on October 6, 2008.
• ILO Job Crisis Observatory (http://www.ilo.org/public/english/support/lib/financialcrisis/index.htm)
• Financial Crisis-IMF (http://www.imf.org/external/np/exr/key/finstab.htm)

• Financial Crisis-World Bank Group (http://www.worldbank.org/html/extdr/financialcrisis/)
• Global Financial Crisis-Asian Development Bank (http://www.adb.org/Financial-Crisis/)
Causes of the financial crisis of 2007–2010

Many factors directly and indirectly caused the ongoing Financial crisis of 2007-2010 (which started with the US
subprime mortgage crisis), with experts placing different weights upon particular causes. The complexity and
interdependence of many of the causes, as well as competing political, economic and organizational interests, have
resulted in a variety of narratives describing the crisis. One category of causes created a vulnerable or fragile
financial system, including complex financial securities, a dependence on short-term funding markets, and
international trade imbalances. Other causes increased the stress on this fragile system, such as high corporate and
consumer debt levels. Still others represent shocks to that system, such as the ongoing foreclosure crisis and the
failures of key financial institutions. Regulatory and market-based controls did not effectively protect this system or
measure the buildup of risk. Some causes relate to particular markets, such as the stock market or housing market,
while others relate to the global economy more broadly.[1] In July 2009, the U.S. announced the members of the
Financial Crisis Inquiry Commission to investigate the causes of the crisis. Its report is expected at the end of
2010.[2]
Housing market
The U.S. housing bubble and foreclosures

Between 1997 and 2006, the price of the typical American house
increased by 124%.[3] During the two decades ending in 2001, the
national median home price ranged from 2.9 to 3.1 times median
household income. This ratio rose to 4.0 in 2004, and 4.6 in 2006.[4]
This housing bubble resulted in quite a few homeowners refinancing
their homes at lower interest rates, or financing consumer spending by
taking out second mortgages secured by the price appreciation.
By September 2008, average U.S. housing prices had declined by over

20% from their mid-2006 peak.[5] [6] Easy credit, and a belief that Number of U.S. residential properties subject to
house prices would continue to appreciate, had encouraged many foreclosure actions by quarter (2007-2009).
subprime borrowers to obtain adjustable-rate mortgages. These
mortgages enticed borrowers with a below market interest rate for some predetermined period, followed by market
interest rates for the remainder of the mortgage's term. Borrowers who could not make the higher payments once the
initial grace period ended would try to refinance their mortgages. Refinancing became more difficult, once house
prices began to decline in many parts of the USA. Borrowers who found themselves unable to escape higher monthly
payments by refinancing began to default. During 2007, lenders had begun foreclosure proceedings on nearly 1.3
million properties, a 79% increase over 2006.[7] This increased to 2.3 million in 2008, an 81% increase vs. 2007.[8]
As of August 2008, 9.2% of all mortgages outstanding were either delinquent or in foreclosure.[9]
The Economist described the issue this way: "No part of the financial crisis has received so much attention, with so
little to show for it, as the tidal wave of home foreclosures sweeping over America. Government programmes have
been ineffectual, and private efforts not much better." Up to 9 million homes may enter foreclosure over the
2009-2011 period, versus one million in a typical year.[10] At roughly U.S. $50,000 per foreclosure according to a
2006 study by the Chicago Federal Reserve Bank, 9 million foreclosures represents $450 billion in losses.[11]
Sub-prime lending
In addition to easy credit conditions, there is evidence that both
government and competitive pressures contributed to an increase in the
amount of subprime lending during the years preceding the crisis.
Major U.S. investment banks and government sponsored enterprises
like Fannie Mae played an important role in the expansion of
higher-risk lending.[12] [13] [14]
The term subprime refers to the credit quality of particular borrowers,

who have weakened credit histories and a greater risk of loan default
than prime borrowers.[15] The value of U.S. subprime mortgages was U.S. Subprime lending expanded dramatically
estimated at $1.3 trillion as of March 2007,[16] with over 7.5 million 2004-2006
first-lien subprime mortgages outstanding.[17]
Subprime mortgages remained below 10% of all mortgage originations until 2004, when they spiked to nearly 20%
and remained there through the 2005-2006 peak of the United States housing bubble.[18] A proximate event to this
increase was the April 2004 decision by the U.S. Securities and Exchange Commission (SEC) to relax the net capital
rule, which encouraged the largest five investment banks to dramatically increase their financial leverage and
aggressively expand their issuance of mortgage-backed securities.[19] Subprime mortgage payment delinquency rates
remained in the 10-15% range from 1998 to 2006,[20] then began to increase rapidly, rising to 25% by early 2008.[21]
[22]
Mortgage underwriting
In addition to considering higher-risk borrowers, lenders offered increasingly risky loan options and borrowing
incentives. Mortgage underwriting standards declined gradually during the boom period. The use of automated loan
approvals allowed loans to be made without appropriate review and documentation.[23] In 2007, 40% of all subprime
loans resulted from automated underwriting.[24] [25] The chairman of the Mortgage Bankers Association claimed that
mortgage brokers, while profiting from the home loan boom, did not do enough to examine whether borrowers could
repay.[26] Mortgage fraud by lenders and borrowers increased enormously.[27]
A study by analysts at the Federal Reserve Bank of Cleveland found that the average difference between subprime
and prime mortgage interest rates (the "subprime markup") declined significantly between 2001 and 2007. The
quality of loans originated also worsened gradually during that period. The combination of declining risk premia and
credit standards is common to boom and bust credit cycles. The authors also concluded that the decline in
underwriting standards did not directly trigger the crisis, because the gradual changes in standards did not
statistically account for the large difference in default rates for subprime mortgages issued between 2001-2005
(which had a 10% default rate within one year of origination) and 2006-2007 (which had a 20% rate). In other
words, standards gradually declined but defaults suddenly jumped. Further, the authors argued that the trend in
worsening loan quality was harder to detect with rising housing prices, as more refinancing options were available,
keeping the default rate lower.[28] [29]
Mortgage fraud
In 2004, the Federal Bureau of Investigation warned of an "epidemic" in mortgage fraud, an important credit risk of
nonprime mortgage lending, which, they said, could lead to "a problem that could have as much impact as the S&L
crisis".[30] [31] [32] [33]
Down payments and negative equity

A down payment refers to the cash paid to the lender for the home and represents the initial homeowners equity or
financial interest in the home. A low down payment means that a home represents a highly leveraged investment for
the homeowner, with little equity relative to debt. In such circumstances, only small declines in the value of the
home result in negative equity, a situation in which the value of the home is less than the mortgage amount owed. In
2005, the median down payment for first-time home buyers was 2%, with 43% of those buyers making no down
payment whatsoever.[34] By comparison, China has down payment requirements that exceed 20%, with higher
amounts for non-primary residences.[35]
Economist Nouriel Roubini wrote in Forbes in July 2009: "Home prices have already fallen from their peak by about
30%. Based on my analysis, they are going to fall by at least 40% from their peak, and more likely 45%, before they
bottom out. They are still falling at an annualized rate of over 18%. That fall of at least 40%-45% percent of home
prices from their peak is going to imply that about half of all households that have a mortgage—about 25 million of
the 51 million that have mortgages—are going to be underwater with negative equity and will have a significant
incentive to walk away from their homes."[36]
Economist Stan Leibowitz argued in the Wall Street Journal that the extent of equity in the home was the key factor
in foreclosure, rather than the type of loan, credit worthiness of the borrower, or ability to pay. Although only 12%
of homes had negative equity (meaning the property was worth less than the mortgage obligation), they comprised
47% of foreclosures during the second half of 2008. Homeowners with negative equity have less financial incentive
to stay in the home.[37]
The L.A. Times reported the results of a study that found homeowners with high credit scores at the time of entering
the mortgage are 50% more likely to "strategically default" -- abruptly and intentionally pull the plug and abandon
the mortgage—compared with lower-scoring borrowers. Such strategic defaults were heavily concentrated in
markets with the highest price declines. An estimated 588,000 strategic defaults occurred nationwide during 2008,
more than double the total in 2007. They represented 18% of all serious delinquencies that extended for more than
60 days in the fourth quarter of 2008.[38]
Predatory lending
Predatory lending refers to the practice of unscrupulous lenders, to enter into "unsafe" or "unsound" secured loans
for inappropriate purposes.[39] A classic bait-and-switch method was used by Countrywide, advertising low interest
rates for home refinancing. Such loans were written into mind-numbingly detailed contracts, and swapped for more
expensive loan products on the day of closing. Whereas the advertisement might state that 1% or 1.5% interest
would be charged, the consumer would be put into an adjustable rate mortgage (ARM) in which the interest charged
would be greater than the amount of interest paid. This created negative amortization, which the credit consumer
might not notice until long after the loan transaction had been consummated.
Countrywide, sued by California Attorney General Jerry Brown for "Unfair Business Practices" and "False
Advertising" was making high cost mortgages "to homeowners with weak credit, adjustable rate mortgages (ARMs)
that allowed homeowners to make interest-only payments.".[40] When housing prices decreased, homeowners in
ARMs then had little incentive to pay their monthly payments, since their home equity had disappeared. This caused
Countrywide's financial condition to deteriorate, ultimately resulting in a decision by the Office of Thrift Supervision
to seize the lender.
Countrywide, according to Republican Lawmakers, had involved itself in making low-cost loans to politicians, for
purposes of gaining political favors.[41]
Former employees from Ameriquest, which was United States's leading wholesale lender,[42] described a system in
which they were pushed to falsify mortgage documents and then sell the mortgages to Wall Street banks eager to
make fast profits.[42] There is growing evidence that such mortgage frauds may be a cause of the crisis.[42]
Risk-taking behavior
In a June 2009 speech, U.S. President Barack Obama argued that a "culture of irresponsibility"[43] was an important
cause of the crisis. He criticized executive compensation that "rewarded recklessness rather than responsibility" and
Americans who bought homes "without accepting the responsibilities." He continued that there "was far too much
debt and not nearly enough capital in the system. And a growing economy bred complacency."[44]
A key theme of the crisis is that many large financial institutions did not have a sufficient financial cushion to absorb
the losses they sustained or to support the commitments made to others. Using technical terms, these firms were
highly leveraged (i.e., they maintained a high ratio of debt to equity) or had insufficient capital to post as collateral
for their borrowing. A key to a stable financial system is that firms have the financial capacity to support their
commitments.[45] Michael Lewis and David Einhorn argued: "The most critical role for regulation is to make sure
that the sellers of risk have the capital to support their bets."[46]
Consumer and household borrowing

U.S. households and financial institutions became increasingly indebted or overleveraged during the years preceding
the crisis. This increased their vulnerability to the collapse of the housing bubble and worsened the ensuing
economic downturn.
• USA household debt as a percentage of annual disposable personal income was 127% at the end of 2007, versus
77% in 1990.[47]
• U.S. home mortgage debt relative to gross domestic product (GDP) increased from an average of 46% during the
1990s to 73% during 2008, reaching $10.5 trillion.[48]
• In 1981, U.S. private debt was 123% of GDP; by the third quarter of 2008, it was 290%.[49]
Home equity extraction

This refers to homeowners borrowing and spending against the value of their homes, typically via a home equity
loan or when selling the home. Free cash used by consumers from home equity extraction doubled from $627 billion
in 2001 to $1,428 billion in 2005 as the housing bubble built, a total of nearly $5 trillion dollars over the period,
contributing to economic growth worldwide.[50] [51] [52] U.S. home mortgage debt relative to GDP increased from an
average of 46% during the 1990s to 73% during 2008, reaching $10.5 trillion.[48]
Housing speculation
Speculative borrowing in residential real estate has been cited as a contributing factor to the subprime mortgage
crisis.[53] During 2006, 22% of homes purchased (1.65 million units) were for investment purposes, with an
additional 14% (1.07 million units) purchased as vacation homes. During 2005, these figures were 28% and 12%,
respectively. In other words, a record level of nearly 40% of homes purchases were not intended as primary
residences. David Lereah, NAR's chief economist at the time, stated that the 2006 decline in investment buying was
expected: "Speculators left the market in 2006, which caused investment sales to fall much faster than the primary
market."[54]
Housing prices nearly doubled between 2000 and 2006, a vastly different trend from the historical appreciation at
roughly the rate of inflation. While homes had not traditionally been treated as investments subject to speculation,
this behavior changed during the housing boom. Media widely reported condominiums being purchased while under
construction, then being "flipped" (sold) for a profit without the seller ever having lived in them.[55] Some mortgage
companies identified risks inherent in this activity as early as 2005, after identifying investors assuming highly
leveraged positions in multiple properties.[56]
Nicole Gelinas of the Manhattan Institute described the negative consequences of not adjusting tax and mortgage
policies to the shifting treatment of a home from conservative inflation hedge to speculative investment.[57]
Economist Robert Shiller argued that speculative bubbles are fueled by "contagious optimism, seemingly impervious
to facts, that often takes hold when prices are rising. Bubbles are primarily social phenomena; until we understand
and address the psychology that fuels them, they're going to keep forming."[58]
Pro-cyclical human nature

Keynesian economist Hyman Minsky described how speculative borrowing contributed to rising debt and an
eventual collapse of asset values.[59] Economist Paul McCulley described how Minsky's hypothesis translates to the
current crisis, using Minsky's words: "...from time to time, capitalist economies exhibit inflations and debt deflations
which seem to have the potential to spin out of control. In such processes, the economic system's reactions to a
movement of the economy amplify the movement--inflation feeds upon inflation and debt-deflation feeds upon debt
deflation." In other words, people are momentum investors by nature, not value investors. People naturally take
actions that expand the apex and nadir of cycles. One implication for policymakers and regulators is the
implementation of counter-cyclical policies, such as contingent capital requirements for banks that increase during
boom periods and are reduced during busts.[60]
Corporate risk-taking and leverage

The former CEO of Citigroup Charles O. Prince said in November
2007: "As long as the music is playing, you've got to get up and
dance." This metaphor summarized how financial institutions took
advantage of easy credit conditions, by borrowing and investing large
sums of money, a practice called leveraged lending.[61] Debt taken on
by financial institutions increased from 63.8% of U.S. gross domestic
product in 1997 to 113.8% in 2007.[62]
A 2004 SEC decision related to the net capital rule allowed USA
investment banks to issue substantially more debt, which was then used Leverage Ratios of Investment Banks Increased
to help fund the housing bubble through purchases of mortgage-backed Significantly 2003-2007
securities.[63] From 2004-07, the top five U.S. investment banks each
significantly increased their financial leverage (see diagram), which increased their vulnerability to a financial shock.
These five institutions reported over $4.1 trillion in debt for fiscal year 2007, about 30% of USA nominal GDP for
2007. Lehman Brothers was liquidated, Bear Stearns and Merrill Lynch were sold at fire-sale prices, and Goldman
Sachs and Morgan Stanley became commercial banks, subjecting themselves to more stringent regulation. With the
exception of Lehman, these companies required or received government support.[63]
Fannie Mae and Freddie Mac, two U.S. Government sponsored enterprises, owned or guaranteed nearly $5 trillion in
mortgage obligations at the time they were placed into conservatorship by the U.S. government in September
2008.[64] [65]
These seven entities were highly leveraged and had $9 trillion in debt or guarantee obligations, an enormous
concentration of risk, yet were not subject to the same regulation as depository banks.
In a May 2008 speech, Ben Bernanke quoted Walter Bagehot: "A good banker will have accumulated in ordinary
times the reserve he is to make use of in extraordinary times."[66] However, this advice was not heeded by these
institutions, which had used the boom times to increase their leverage ratio instead.
Financial market factors

In its "Declaration of the Summit on Financial Markets and the World Economy," dated 15 November 2008, leaders
of the Group of 20 cited the following causes related to features of the modern financial markets:
During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade,
market participants sought higher yields without an adequate appreciation of the risks and failed to exercise
proper due diligence. At the same time, weak underwriting standards, unsound risk management practices,
increasingly complex and opaque financial products, and consequent excessive leverage combined to create
vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not
adequately appreciate and address the risks building up in financial markets, keep pace with financial
innovation, or take into account the systemic ramifications of domestic regulatory actions.[67]
Financial product innovation

The term financial innovation refers to the ongoing development of
financial products designed to achieve particular client objectives, such
as offsetting a particular risk exposure (such as the default of a
borrower) or to assist with obtaining financing. Examples pertinent to
this crisis included: the adjustable-rate mortgage; the bundling of
subprime mortgages into mortgage-backed securities (MBS) or
collateralized debt obligations (CDO) for sale to investors, a type of
securitization; and a form of credit insurance called credit default
swaps(CDS). The usage of these products expanded dramatically in the
A protester on Wall Street in the wake of the AIG
years leading up to the crisis. These products vary in complexity and
bonus payments controversy is interviewed by
the ease with which they can be valued on the books of financial news media.
institutions.
The CDO in particular enabled financial institutions to obtain investor funds to finance subprime and other lending,
extending or increasing the housing bubble and generating large fees. Approximately $1.6 trillion in CDO's were
originated between 2003-2007.[68] A CDO essentially places cash payments from multiple mortgages or other debt
obligations into a single pool, from which the cash is allocated to specific securities in a priority sequence. Those
securities obtaining cash first received investment-grade ratings from rating agencies. Lower priority securities
received cash thereafter, with lower credit ratings but theoretically a higher rate of return on the amount invested.[69]
[70]
For a variety of reasons, market participants did not accurately measure the risk inherent with this innovation or
understand its impact on the overall stability of the financial system.[67] For example, the pricing model for CDOs
clearly did not reflect the level of risk they introduced into the system. The average recovery rate for "high quality"
CDOs has been approximately 32 cents on the dollar, while the recovery rate for mezzanine CDO's has been
approximately five cents for every dollar. These massive, practically unthinkable, losses have dramatically impacted
the balance sheets of banks across the globe, leaving them with very little capital to continue operations.[71]
Others have pointed out that there were not enough of these loans made to cause a crisis of this magnitude. In an
article in Portfolio Magazine, Michael Lewis spoke with one trader who noted that "There weren’t enough
Americans with [bad] credit taking out [bad loans] to satisfy investors’ appetite for the end product." Essentially,
investment banks and hedge funds used financial innovation to synthesize more loans using derivatives. "They were
creating [loans] out of whole cloth. One hundred times over! That’s why the losses are so much greater than the
loans."[72]
Princeton professor Harold James wrote that one of the byproducts of this innovation was that MBS and other
financial assets were "repackaged so thoroughly and resold so often that it became impossible to clearly connect the
thing being traded to its underlying value." He called this a "...profound flaw at the core of the U.S. financial
system..."[73]
Another example relates to AIG, which insured obligations of various financial institutions through the usage of
credit default swaps. The basic CDS transaction involved AIG receiving a premium in exchange for a promise to pay
money to party A in the event party B defaulted. However, AIG did not have the financial strength to support its
many CDS commitments as the crisis progressed and was taken over by the government in September 2008. U.S.
taxpayers provided over $180 billion in government support to AIG during 2008 and early 2009, through which the
money flowed to various counterparties to CDS transactions, including many large global financial institutions.[74]
[75]
Author Michael Lewis wrote that CDS enabled speculators to stack bets on the same mortgage bonds and CDO's.
This is analogous to allowing many persons to buy insurance on the same house. Speculators that bought CDS
insurance were betting that significant defaults would occur, while the sellers (such as AIG) bet they would not.[76]
In addition, Chicago Public Radio and the Huffington Post reported in April 2010 that market participants, including
a hedge fund called Magnetar Capital, encouraged the creation of CDO's containing low quality mortgages, so they
could bet against them using CDS. NPR reported that Magnetar encouraged investors to purchase CDO's while
simultaneously betting against them, without disclosing the latter bet.[77] [78]
Inaccurate credit ratings

Credit rating agencies are now under scrutiny for having given
investment-grade ratings to MBSs based on risky subprime mortgage
loans. These high ratings enabled these MBS to be sold to investors,
thereby financing the housing boom. These ratings were believed
justified because of risk reducing practices, such as credit default
insurance and equity investors willing to bear the first losses. However,
there are also indications that some involved in rating subprime-related
securities knew at the time that the rating process was faulty.[79]
An estimated $3.2 trillion in loans were made to homeowners with bad MBS credit rating downgrades, by quarter.
credit and undocumented incomes (e.g., subprime or Alt-A mortgages)
between 2002 and 2007. Economist Joseph Stiglitz stated: "I view the rating agencies as one of the key
culprits...They were the party that performed the alchemy that converted the securities from F-rated to A-rated. The
banks could not have done what they did without the complicity of the rating agencies." Without the AAA ratings,
demand for these securities would have been considerably less. Bank writedowns and losses on these investments
totaled $523 billion as of September 2008.[80] [81]
The ratings of these securities was a lucrative business for the rating agencies, accounting for just under half of
Moody's total ratings revenue in 2007. Through 2007, ratings companies enjoyed record revenue, profits and share
prices. The rating companies earned as much as three times more for grading these complex products than corporate
bonds, their traditional business. Rating agencies also competed with each other to rate particular MBS and CDO
securities issued by investment banks, which critics argued contributed to lower rating standards. Interviews with
rating agency senior managers indicate the competitive pressure to rate the CDO's favorably was strong within the
firms. This rating business was their "golden goose" (which laid the proverbial golden egg or wealth) in the words of
one manager.[81] Author Upton Sinclair (1878-1968) famously stated: "It is difficult to get a man to understand
something when his job depends on not understanding it."[82]
Critics allege that the rating agencies suffered from conflicts of interest, as they were paid by investment banks and
other firms that organize and sell structured securities to investors.[83] On 11 June 2008, the SEC proposed rules
designed to mitigate perceived conflicts of interest between rating agencies and issuers of structured securities.[84]
On 3 December 2008, the SEC approved measures to strengthen oversight of credit rating agencies, following a
ten-month investigation that found "significant weaknesses in ratings practices," including conflicts of interest.[85]
Between Q3 2007 and Q2 2008, rating agencies lowered the credit ratings on $1.9 trillion in mortgage backed
securities. Financial institutions felt they had to lower the value of their MBS and acquire additional capital so as to
maintain capital ratios. If this involved the sale of new shares of stock, the value of the existing shares was reduced.
Thus ratings downgrades lowered the stock prices of many financial firms.[86]
Financial modeling
The limitations of a widely-used financial model also were not properly understood.[87] [88] This formula assumed
that the price of CDS was correlated with and could predict the correct price of mortgage backed securities. Because
it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and
rating agencies.[88] According to one wired.com article:[88] "Then the model fell apart. Cracks started appearing early
on, when financial markets began behaving in ways that users of Li's formula hadn't expected. The cracks became
full-fledged canyons in 2008—when ruptures in the financial system's foundation swallowed up trillions of dollars
and put the survival of the global banking system in serious peril... Li's Gaussian copula formula will go down in
history as instrumental in causing the unfathomable losses that brought the world financial system to its knees."
As financial assets became more and more complex, and harder and harder to value, investors were reassured by the
fact that both the international bond rating agencies and bank regulators, who came to rely on them, accepted as valid
some complex mathematical models which theoretically showed the risks were much smaller than they actually
proved to be in practice.[89] George Soros commented that "The super-boom got out of hand when the new products
became so complicated that the authorities could no longer calculate the risks and started relying on the risk
management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by
the originators of synthetic products. It was a shocking abdication of responsibility." [90]
Off-balance sheet financing

Complex financing structures called structured investment vehicles (SIV) or conduits enabled banks to move
significant amounts of assets and liabilities, including unsold CDO's, off their books. This had the effect of helping
the banks maintain regulatory minimum capital ratios. They were then able to led anew, earning additional fees.
Author Robin Blackburn explained how they worked:[62]
Institutional investors could be persuaded to buy the SIV's supposedly high-quality, short-term commercial
paper, allowing the vehicles to acquire longer-term, lower quality assets, and generating a profit on the spread
between the two. The latter included larger amounts of mortgages, credit-card debt, student loans and other
receivables...For about five years those dealing in SIV's and conduits did very well by exploiting the
spread...but this disappeared in August 2007, and the banks were left holding a very distressed baby.
Banks had established automatic lines of credit to these SIV and conduits. When the cash flow into the SIV's began
to decline as subprime defaults mounted, banks were contractually obligated to provide cash to these structures and
their investors. This "conduit-related balance sheet pressure" placed strain on the banks' ability to lend, both raising
interbank lending rates and reducing the availability of funds.[91]
In the years leading up to the crisis, the top four U.S. depository banks moved an estimated $5.2 trillion in assets and
liabilities off-balance sheet into these SIV's and conduits. This enabled them to essentially bypass existing
regulations regarding minimum capital ratios, thereby increasing leverage and profits during the boom but increasing
losses during the crisis. Accounting guidance was changed in 2009 that will require them to put some of these assets
back onto their books, which will significantly reduce their capital ratios. One news agency estimated this amount to
be between $500 billion and $1 trillion. This effect was considered as part of the stress tests performed by the
government during 2009.[92]
During March 2010, the bankruptcy court examiner released a report on Lehman Brothers, which had failed
spectacularly in September 2008. The report indicated that up to $50 billion was moved off-balance sheet in a
questionable manner by management during 2008, with the effect of making its debt level (leverage ratio) appear
smaller.[93] Analysis by the Federal Reserve Bank of New York indicated big banks mask their risk levels just prior
to reporting data quarterly to the public.[94]
Regulatory avoidance
Certain financial innovation may also have the effect of circumventing regulations, such as off-balance sheet
financing that affects the leverage or capital cushion reported by major banks. For example, Martin Wolf wrote in
June 2009: "...an enormous part of what banks did in the early part of this decade – the off-balance-sheet vehicles,
the derivatives and the 'shadow banking system' itself – was to find a way round regulation."[95]
Financial sector concentration

Niall Ferguson wrote that the financial sector became increasingly concentrated in the years leading up to the crisis,
which made the stability of the financial system more reliant on just a few firms, which were also highly
leveraged:[96]
Between 1990 and 2008, according to Wall Street veteran Henry Kaufman, the share of financial assets held
by the 10 largest U.S. financial institutions rose from 10 percent to 50 percent, even as the number of banks
fell from more than 15,000 to about 8,000. By the end of 2007, 15 institutions with combined shareholder
equity of $857 billion had total assets of $13.6 trillion and off-balance-sheet commitments of $5.8 trillion—a
total leverage ratio of 23 to 1. They also had underwritten derivatives with a gross notional value of $216
trillion. These firms had once been Wall Street's "bulge bracket," the companies that led underwriting
syndicates. Now they did more than bulge. These institutions had become so big that the failure of just one of
them would pose a systemic risk.
Macroeconomic conditions
Two important factors that contributed to the United states housing bubble were low U.S. interest rates and a large
U.S. trade deficit. Low interest rates made bank lending more profitable, while trade deficits resulted in large capital
inflows to the U.S. Both made funds for borrowing plentiful and relatively inexpensive.
Interest rates
From 2000 to 2003, the Federal Reserve lowered the federal funds rate
target from 6.5% to 1.0%.[97] This was done to soften the effects of the
collapse of the dot-com bubble and of the September 2001 terrorist
attacks, and to combat the perceived risk of deflation.[98] The Fed then
raised the Fed funds rate significantly between July 2004 and July
2006.[99] This contributed to an increase in 1-year and 5-year
adjustable-rate mortgage (ARM) rates, making ARM interest rate
resets more expensive for homeowners.[100] This may have also
contributed to the deflating of the housing bubble, as asset prices
Federal Funds Rate and Various Mortgage Rates
generally move inversely to interest rates and it became riskier to
speculate in housing.[101] [102]
Trade deficits
In 2005, Ben Bernanke addressed the implications of the USA's high
and rising current account (trade) deficit, resulting from USA imports
exceeding its exports.[103] Between 1996 and 2004, the USA current
account deficit increased by $650 billion, from 1.5% to 5.8% of GDP.
Financing these deficits required the USA to borrow large sums from
abroad, much of it from countries running trade surpluses, mainly the
emerging economies in Asia and oil-exporting nations. The balance of
payments identity requires that a country (such as the USA) running a
current account deficit also have a capital account (investment) surplus
U.S. Current Account or Trade Deficit
of the same amount. Hence large and growing amounts of foreign
funds (capital) flowed into the USA to finance its imports. This created
demand for various types of financial assets, raising the prices of those assets while lowering interest rates. Foreign
investors had these funds to lend, either because they had very high personal savings rates (as high as 40% in China),
or because of high oil prices. Bernanke referred to this as a "saving glut."[104] A "flood" of funds (capital or liquidity)
reached the USA financial markets. Foreign governments supplied funds by purchasing USA Treasury bonds and
thus avoided much of the direct impact of the crisis. USA households, on the other hand, used funds borrowed from
foreigners to finance consumption or to bid up the prices of housing and financial assets. Financial institutions
invested foreign funds in mortgage-backed securities. USA housing and financial assets dramatically declined in
value after the housing bubble burst.[105] [106]
Chinese mercantilism
Martin Wolf has argued that "inordinately mercantilist currency policies" were a significant cause of the U.S. trade
deficit, indirectly driving a flood of money into the U.S. as described above. In his view, China maintained an
artificially weak currency to make Chinese goods relatively cheaper for foreign countries to purchase, thereby
keeping its vast workforce occupied and encouraging exports to the U.S. One byproduct was a large accumulation of
U.S. dollars by the Chinese government, which were then invested in U.S. government securities and those of Fannie
Mae and Freddie Mac, providing additional funds for lending that contributed to the housing bubble.[107] [108]
Economist Paul Krugman also wrote similar comments during October 2009, further arguing that China's currency
should have appreciated relative to the U.S. dollar beginning around 2001.[109] Various U.S. officials have also
indicated concerns with Chinese exchange rate policies, which have not allowed its currency to appreciate
significantly relative to the dollar despite large trade surpluses. In January 2009, Timothy Geithner wrote: "Obama --
backed by the conclusions of a broad range of economists -- believes that China is manipulating its currency...the
question is how and when to broach the subject in order to do more good than harm."[110]
Capital market pressures
Private capital and the search for yield

In a Peabody Award winning program, NPR correspondents argued that a "Giant Pool of Money" (represented by
$70 trillion in worldwide fixed income investments) sought higher yields than those offered by U.S. Treasury bonds
early in the decade, which were low due to low interest rates and trade deficits discussed above. Further, this pool of
money had roughly doubled in size from 2000 to 2007, yet the supply of relatively safe, income generating
investments had not grown as fast. Investment banks on Wall Street answered this demand with the mortgage-backed
security (MBS) and collateralized debt obligation (CDO), which were assigned safe ratings by the credit rating
agencies. In effect, Wall Street connected this pool of money to the mortgage market in the U.S., with enormous fees
accruing to those throughout the mortgage supply chain, from the mortgage broker selling the loans, to small banks
that funded the brokers, to the giant investment banks behind them. By approximately 2003, the supply of mortgages
originated at traditional lending standards had been exhausted. However, continued strong demand for MBS and
CDO began to drive down lending standards, as long as mortgages could still be sold along the supply chain.
Eventually, this speculative bubble proved unsustainable.[111]
Significance of the parallel banking system

In a June 2008 speech, U.S. Treasury
Secretary Timothy Geithner, then
President and CEO of the NY Federal
Reserve Bank, placed significant
to the same regulatory controls.
Further, these entities were vulnerable
because they borrowed short-term in
liquid markets to purchase long-term,
illiquid and risky assets. This meant Securitization markets were impaired during the crisis
that disruptions in credit markets
would make them subject to rapid deleveraging, selling their long-term assets at depressed prices. He described the
significance of these entities: "In early 2007, asset-backed commercial paper conduits, in structured investment
vehicles, in auction-rate preferred securities, tender option bonds and variable rate demand notes, had a combined
asset size of roughly $2.2 trillion. Assets financed overnight in triparty repo grew to $2.5 trillion. Assets held in
hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the then five major investment banks
totaled $4 trillion. In comparison, the total assets of the top five bank holding companies in the United States at that
point were just over $6 trillion, and total assets of the entire banking system were about $10 trillion." He stated that
the "combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit
cycles."[112]
Run on the shadow banking system

like a bank." He referred to this lack of controls as "malign neglect."[113]
For example, investment bank Bear Stearns was required to replenish much of its funding in overnight markets,
making the firm vulnerable to credit market disruptions. When concerns arose regarding its financial strength, its
ability to secure funds in these short-term markets was compromised, leading to the equivalent of a bank run. Over
four days, its available cash declined from $18 billion to $3 billion as investors pulled funding from the firm. It
collapsed and was sold at a fire-sale price to bank JP Morgan Chase March 16, 2008.[114] [115] [116]
American homeowners, consumers, and corporations owed roughly $25 trillion during 2008. American banks
retained about $8 trillion of that total directly as traditional mortgage loans. Bondholders and other traditional
lenders provided another $7 trillion. The remaining $10 trillion came from the securitization markets, meaning the
parallel banking system. The securitization markets started to close down in the spring of 2007 and nearly shut-down
in the fall of 2008. More than a third of the private credit markets thus became unavailable as a source of funds.[117]
[118]
In February 2009, Ben Bernanke stated that securitization markets remained effectively shut, with the exception
of conforming mortgages, which could be sold to Fannie Mae and Freddie Mac.[119]
The Economist reported in March 2010: "Bear Stearns and Lehman Brothers were non-banks that were crippled by a
silent run among panicky overnight "repo" lenders, many of them money market funds uncertain about the quality of
securitized collateral they were holding. Mass redemptions from these funds after Lehman's failure froze short-term
funding for big firms."[120]
Mortgage compensation model, executive pay and bonuses

During the boom period, enormous fees were paid to those throughout the mortgage supply chain, from the mortgage
broker selling the loans, to small banks that funded the brokers, to the giant investment banks behind them. Those
originating loans were paid fees for selling them, regardless of how the loans performed. Default or credit risk was
passed from mortgage originators to investors using various types of financial innovation.[111] This became known
as the "originate to distribute" model, as opposed to the traditional model where the bank originating the mortgage
retained the credit risk. In effect, the mortgage originators were left with nothing which was at risk, giving rise to
moral hazard in which behavior and consequence were separated.
The New York State Comptroller's Office has said that in 2006, Wall Street executives took home bonuses totaling
$23.9 billion. "Wall Street traders were thinking of the bonus at the end of the year, not the long-term health of their
firm. The whole system—from mortgage brokers to Wall Street risk managers—seemed tilted toward taking
short-term risks while ignoring long-term obligations. The most damning evidence is that most of the people at the
top of the banks didn't really understand how those [investments] worked."[4] [121]
Investment banker incentive compensation was focused on fees generated from assembling financial products, rather
than the performance of those products and profits generated over time. Their bonuses were heavily skewed towards
cash rather than stock and not subject to "claw-back" (recovery of the bonus from the employee by the firm) in the
event the MBS or CDO created did not perform. In addition, the increased risk (in the form of financial leverage)
taken by the major investment banks was not adequately factored into the compensation of senior executives.[122]
Bank CEO Jamie Dimon argued: "Rewards have to track real, sustained, risk-adjusted performance. Golden
parachutes, special contracts, and unreasonable perks must disappear. There must be a relentless focus on risk
management that starts at the top of the organization and permeates down to the entire firm. This should be
business-as-usual, but at too many places, it wasn't."[123]
Regulation and Deregulation

Critics have argued that the regulatory framework did not keep pace with financial innovation, such as the increasing
importance of the shadow banking system, derivatives and off-balance sheet financing. In other cases, laws were
changed or enforcement weakened in parts of the financial system. Several critics have argued that the most critical
role for regulation is to make sure that financial institutions have the ability or capital to deliver on their
commitments.[46] [124]
Key examples of regulatory failures include:
• In 1999, the U.S. Congress passed the Gramm-Leach-Bliley Act, which repealed part of the Glass-Steagall Act of
1933. This repeal has been criticized for reducing the separation between commercial banks (which traditionally
had a conservative culture) and investment banks (which had a more risk-taking culture).[125] [126]
• In 2004, the Securities and Exchange Commission relaxed the net capital rule, which enabled investment banks to
substantially increase the level of debt they were taking on, fueling the growth in mortgage-backed securities
supporting subprime mortgages. The SEC has conceded that self-regulation of investment banks contributed to
the crisis.[127] [128]
• Financial institutions in the shadow banking system are not subject to the same regulation as depository banks,
allowing them to assume additional debt obligations relative to their financial cushion or capital base.[113] This
was the case despite the Long-Term Capital Management debacle in 1998, where a highly-leveraged shadow
institution failed with systemic implications.
• Regulators and accounting standard-setters allowed depository banks such as Citigroup to move significant
amounts of assets and liabilities off-balance sheet into complex legal entities called structured investment
vehicles, masking the weakness of the capital base of the firm or degree of leverage or risk taken. One news
agency estimated that the top four U.S. banks will have to return between $500 billion and $1 trillion to their
balance sheets during 2009.[129] This increased uncertainty during the crisis regarding the financial position of the
major banks.[130] Off-balance sheet entities were also used by Enron as part of the scandal that brought down that
company in 2001.[131]
• The U.S. Congress allowed the self-regulation of the derivatives market when it passed the Commodity Futures
Modernization Act of 2000. Derivatives such as credit default swaps (CDS) can be used to hedge or speculate
against particular credit risks. The volume of CDS outstanding increased 100-fold from 1998 to 2008, with
estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to $47 trillion. Total
over-the-counter (OTC) derivative notional value rose to $683 trillion by June 2008.[132] Warren Buffett famously
referred to derivatives as "financial weapons of mass destruction" in early 2003.[133] [134]
Author Roger Lowenstein summarized some of the regulatory problems that caused the crisis in November 2009: "1)
Mortgage regulation was too lax and in some cases nonexistent; 2) Capital requirements for banks were too low; 3)
Trading in derivatives such as credit default swaps posed giant, unseen risks; 4) Credit ratings on structured
securities such as collateralized-debt obligations were deeply flawed; 5) Bankers were moved to take on risk by
excessive pay packages; 6) The government’s response to the crash also created, or exacerbated, moral hazard.
Markets now expect that big banks won’t be allowed to fail, weakening the incentives of investors to discipline big
banks and keep them from piling up too many risky assets again."[135]
Conflicts of interest and lobbying

A variety of conflicts of interest have been argued as contributing to this crisis:
• Credit rating agencies are compensated for rating debt securities by those issuing the securities, who have an
interest in seeing the most positive ratings applied. Further, changing the debt rating on a company that insures
multiple debt securities such as AIG or MBIA, requires the re-rating of many other securities, creating significant
costs. Despite taking on significantly more risk, AIG and MBIA retained the highest credit ratings until well into
the crisis.[136]
• There is a "revolving door" between major financial institutions, the Treasury Department, and Treasury bailout
programs. For example, the former CEO of Goldman Sachs was Henry Paulson, who became President George
W. Bush's Treasury Secretary. Although three of Goldman's key competitors either failed or were allowed to fail,
it received $10 billion in Troubled Asset Relief Program (TARP) funds (which it has since paid back) and $12.9
billion in payments via AIG, while remaining highly profitable and paying enormous bonuses. The first two
officials in charge of the TARP bailout program were also from Goldman.[137]
• There is a "revolving door" between major financial institutions and the Securities and Exchange Commission
(SEC), which is supposed to monitor them. For example, as of January 2009, the SEC's two most recent Directors
of Enforcement had taken positions at powerful banks directly after leaving the role. The route into lucrative
positions with banks places a financial incentive on regulators to maintain good relationships with those they
monitor. This is sometimes referred to as regulatory capture.[136]
Banks in the U.S. lobby politicians extensively. A November 2009 report from economists of the International
Monetary Fund (IMF) writing independently of that organization indicated that:
• Firms that lobby aggressively are more likely to engage in risky securitization of their loan books, have
faster-growing mortgage loan portfolios as well as poorer share performance and larger loan defaults;
• Thirty-three legislative proposals that would have increased regulatory scrutiny over banks were the targets of
intense and successful lobbying;
• US business spends $4.2 billion over the four-year election cycle on "targeted political activity", with finance,
insurance and real estate ("FIRE") firms accounting for 15% of that total ($479,500 per firm) in 2006; and
• The "lobbying intensity" of the FIRE sector also "increased at a much faster pace relative to the average lobbying
intensity over 1999-2006."
The study concluded that: "the prevention of future crises might require weakening political influence of the
financial industry or closer monitoring of lobbying activities to understand better the incentives behind it."[138] [139]
The Boston Globe reported during that during January-June 2009, the largest four U.S. banks spent these amounts ($
millions) on lobbying, despite receiving taxpayer bailouts: Citigroup $3.1; JP Morgan Chase $3.1; Bank of America
$1.5; and Wells Fargo $1.4.[140]
The New York Times reported in April 2010: "An analysis by Public Citizen found that at least 70 former members
of Congress were lobbying for Wall Street and the financial services sector last year, including two former Senate
majority leaders (Trent Lott and Bob Dole), two former House majority leaders (Richard A. Gephardt and Dick
Armey) and a former House speaker (J. Dennis Hastert). In addition to the lawmakers, data from the Center for
Responsive Politics counted 56 former Congressional aides on the Senate or House banking committees who went
on to use their expertise to lobby for the financial sector."[141]
Other factors
Commodity price volatility

A commodity price bubble was created following the collapse in the housing bubble. The price of oil nearly tripled
from $50 to $140 from early 2007 to 2008, before plunging as the financial crisis began to take hold in late 2008.[142]
Experts debate the causes, which include the flow of money from housing and other investments into commodities to
speculation and monetary policy.[143] An increase in oil prices tends to divert a larger share of consumer spending
into gasoline, which creates downward pressure on economic growth in oil importing countries, as wealth flows to
oil-producing states.[144]
Inaccurate economic forecasting

A cover story in BusinessWeek magazine claims that economists mostly failed to predict the worst international
economic crisis since the Great Depression of 1930s.[145] The Wharton School of the University of Pennsylvania
online business journal examines why economists failed to predict a major global financial crisis.[146] An article in
the New York Times informs that economist Nouriel Roubini warned of such crisis as early as September 2006, and
the article goes on to state that the profession of economics is bad at predicting recessions.[147] According to The
Guardian, Roubini was ridiculed for predicting a collapse of the housing market and worldwide recession, while The
New York Times labelled him "Dr. Doom".[148] However, there are examples of other experts who gave indications
of a financial crisis.[149] [150] [151]
Monetary expansion and uncertainty

An empirical study by John B. Taylor concluded that the crisis was: (1) caused by excess monetary expansion; (2)
prolonged by an inability to evaluate counter-party risk due to opaque financial statements; and (3) worsened by the
unpredictable nature of government's response to the crisis.[152] [153]
Mark-to-Market Accounting
The appropriate valuation of complex and illiquid securities such as MBS and CDO held as assets on the books of
financial institutions has been an ongoing debate during the crisis. The debate arises because accounting rules require
companies to adjust the value of such securities to market value, as opposed to the original price paid. Many large
financial institutions recognized significant losses during 2007 and 2008, as a result of marking-down MBS asset
prices to market value. For some institutions, this also triggered a margin call, where lenders that had provided the
funds using the MBS as collateral had contractual rights to get their money back.[154] The combination of losses and
margin calls resulted in further forced sales of MBS and emergency efforts to obtain cash (liquidity). Markdowns
may also reduce the value of bank regulatory capital, requiring additional capital raising and creating uncertainty
regarding the health of the bank. In other words, writing down the assets presented both liquidity and solvency
challenges. Advocates argued that the rule enabled the most accurate estimate of the financial health of the
banks.[155] [156]
Systemic crisis
Another analysis, different from the mainstream explanation, is that the financial crisis is merely a symptom of
another, deeper crisis, which is a systemic crisis of capitalism itself. According to Samir Amin, an Egyptian
economist, the constant decrease in GDP growth rates in Western countries since the early 1970s created a growing
surplus of capital which did not have sufficient profitable investment outlets in the real economy. The alternative
was to place this surplus into the financial market, which became more profitable than productive capital investment,
especially with subsequent deregulation.[157] According to Samir Amin, this phenomenon has led to recurrent
financial bubbles (such as the internet bubble) and is the deep cause of the financial crisis of 2007-2009.[158]
John Bellamy Foster, a political economy analyst and editor of the Monthly Review, believes that the decrease in
GDP growth rates since the early 1970s is due to increasing market saturation.[159]
John C. Bogle wrote during 2005 that a series of unresolved challenges face capitalism that have contributed to past
financial crises and have not been sufficiently addressed: "Corporate America went astray largely because the power
of managers went virtually unchecked by our gatekeepers for far too long...They failed to 'keep an eye on these
geniuses' to whom they had entrusted the responsibility of the management of America's great corporations." He
cites particular issues, including:[160] [161]
• "Manager's capitalism" which he argues has replaced "owner's capitalism," meaning management runs the firm
for its benefit rather than for the shareholders, a variation on the principal-agent problem;
• Burgeoning executive compensation;
• Managed earnings, mainly a focus on share price rather than the creation of genuine value; and
• The failure of gatekeepers, including auditors, boards of directors, Wall Street analysts, and career politicians.
Interaction of the housing and financial markets

One of the unique features of this crisis is the linkage of global
investors and financial institutions to the price of U.S. housing, through
financial innovations such as MBS, CDO, and CDS described above.
As borrowers stop paying their mortgages (due to the inability to
refinance, negative equity, or loss of employment), foreclosures and
the supply of homes for sale increases. This places downward pressure
on housing prices, which further lowers homeowners' equity. The
decline in mortgage payments also reduces the value of
mortgage-backed securities, which erodes the net worth and financial
Vicious Cycles in the Housing & Financial
health of banks. This reduces the amount of lending that banks can
Markets
support, which slows down business investment. When consumers do
not spend, business earnings are impacted, which increases
unemployment. This vicious cycle or self-reinforcing loop is at the heart of the crisis.[162]
Thomas Friedman summarized some of this interaction in November 2008:[163]

When these reckless mortgages eventually blew up, it led to a credit crisis. Banks stopped lending. That soon
morphed into an equity crisis, as worried investors liquidated stock portfolios. The equity crisis made people
feel poor and metastasized into a consumption crisis, which is why purchases of cars, appliances, electronics,
homes and clothing have just fallen off a cliff. This, in turn, has sparked more company defaults, exacerbated
the credit crisis and metastasized into an unemployment crisis, as companies rush to shed workers.
Questionable assumptions underlying the financial system

Various experts have summarized the causes as a series of questionable assumptions underlying the U.S. financial
and economic system.
• Housing prices would not fall dramatically. Warren Buffett testified to the Financial Crisis Inquiry Commission:
"There was the greatest bubble I've ever seen in my life...The entire American public eventually was caught up in
a belief that housing prices could not fall dramatically."[164] Housing prices declined on average by approximately
20% from their 2006 peak to 2009 bottom, with much larger declines in certain markets.[165]
Former Fed Chair Paul Volcker summarized several other assumptions:
• Free and open financial markets supported by sophisticated financial engineering would most effectively support
market efficiency and stability, directing funds to the most profitable and productive uses. He questioned whether
the capture of 35-40% of U.S. corporate profits by financial firms at the peak of the bubble was beneficial to
society.
• Concepts embedded in mathematics and physics could be directly adapted to markets, in the form of various
financial models used to evaluate credit risk. While repetitive patterns and normal distribution curves are part of
the physical sciences, financial markets are heavily influenced by herd behavior, emotional swings, political
intervention and uncertainty.
• Economic imbalances, such as large trade deficits and budget deficits indicative of over-consumption, were
sustainable. Private debt relative to GDP tripled over 30 years. Trade deficits increased the flow of capital into the
U.S. and put downward pressure on interest rates, making the housing bubble worse.
• Regulation of the shadow banking industry was not needed. Investment banks, hedge funds, and other
components of the shadow banking system were not subject to the regulations of traditional depository banks and
were allowed to become "too big to fail," creating a significant moral hazard. Further, derivatives such as credit
default swaps (a $60 trillion market far larger than the underlying credits) were not regulated.[166]
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• Financial Crisis Inquiry Commission Homepage (http://www.fcic.gov/)
• CNBC-David Faber-The House of Cards-Video (http://www.cnbc.com/id/15840232?video=1145392808&
play=1)
• PBS Frontline -Inside the Meltdown-Video (http://www.pbs.org/wgbh/pages/frontline/meltdown/)
• New Left Review-The Subprime Mortgage Crisis-Robin Blackburn (http://www.newleftreview.org/
?view=2715)
• Leveraged Losses Paper-Greenlaw Hatzius Kashyap Shin (http://www.chicagobooth.edu/usmpf/docs/
usmpf2008confdraft.pdf)
• Reinhart and Rogoff - Is the U.S. 2007 Subprime Financial Crisis So Different? Feb 2008 Paper (http://www.
economics.harvard.edu/files/faculty/51_Is_The_US_Subprime_Crisis_So_Different.pdf)
• Testimony of Ben Bernanke on the Causes of the Recent Financial and Economic Crisis (http://www.
federalreserve.gov/newsevents/testimony/bernanke20100902a.htm)
2000s energy crisis

From the mid-1980s to September 2003, the
inflation-adjusted price of a barrel of crude
oil on NYMEX was generally under
$25/barrel. During 2003, the price rose
above $30, reached $60 by August 11, 2005,
and peaked at $147.30 in July 2008.[1]
Commentators attributed these price
increases to many factors, including reports
from the United States Department of
Energy and others showing a decline in
petroleum reserves,[2] worries over peak
oil,[3] Middle East tension, and oil price
speculation.[4]
For a time, geo-political events and natural

Medium term crude oil prices Jan. 2003 - Nov. 2008, (not adjusted for inflation)
disasters indirectly related to the global oil
market had strong short-term effects on oil
prices, such as North Korean missile tests,[5] the 2006 conflict between Israel and Lebanon,[6] worries over Iranian
nuclear plans in 2006,[7] Hurricane Katrina,[8] [9] and various other factors.[10] By 2008, such pressures appeared to
have a insignificant impact on oil prices given the onset of the global recession.[11] The recession caused demand for
energy to shrink in late 2008, with oil prices falling from the July 2008 high of $147 to a December 2008 low of
$32.[12] Oil prices stabilized by October 2009 and established a trading range between $60 and $80.[12]
New inflation-adjusted records

The price of crude oil in 2003 traded in a range between $20–$30/bbl.[13] Between 2003 and July 2008, prices
steadily rose, reaching $100/bbl in late 2007, tying the previous all time inflation-adjusted record set in 1980.[14] A
steep rise in the price of oil in 2008 - also mirrored by other commodities - culminated in an all time high of $147.27
during trading on July 11, 2008, more than a third above the previous inflation-adjusted high.[15]
High oil prices and economic weakness contributed to a demand contraction in 2007-2008. In the United States,
gasoline consumption declined by 0.4% in 2007[16] , then fell by 0.5% in the first two months of 2008 alone.[17]
Record-setting oil prices in the first half of 2008 and economic weakness in the second half of the year prompted a
1.2 million bbl/day contraction in US consumption of petroleum products, representing 5.5% of total US
consumption, the largest decline since 1980 at the climax of the 1979 energy crisis.[18]
Possible causes
Oil price trend, 1861–2007, both nominal and adjusted to inflation.

Detailed analysis of changes in oil price from 1970–2007. The graph is based on the nominal, not real, price of oil.
Demand
World crude oil demand grew an average of 1.76% per year from 1994 to 2006, with a high of 3.4% in 2003-2004.
World demand for oil is projected to increase 37% over 2006 levels by 2030, according to the 2007 U.S. Energy
Information Administration's (EIA) annual report.[19] In 2007, the EIA expected demand to reach an ultimate high of
118 million barrels per day (18.8×106 m3/d), from 2006's 86 million barrels (13.7×106 m3), driven in large part by
the transportation sector.[20] [21] A 2008 report from the International Energy Agency (IEA) predicted that although
drops in petroleum demand due to high prices have been observed in developed countries and are expected to
continue, a 3.7 percent rise in demand by 2013 is predicted in developing countries. This is projected to cause a net
rise in global petroleum demand during that period.[22]
Transportation consumes the largest proportion of energy, and has seen the largest growth in demand in recent
decades. This growth has largely come from new demand for personal-use vehicles powered by internal combustion
engines.[23] This sector also has the highest consumption rates, accounting for approximately 68.9% of the oil used
in the United States in 2006,[24] and 55% of oil use worldwide as documented in the Hirsch report. Cars and trucks
are predicted to cause almost 75% of the increase in oil consumption by India and China between 2001 and 2025.[25]
In 2008, auto sales in China have been expected to grow by as much as 15-20 percent, resulting in part from
economic growth rates of over 10 percent for 5 years in a row.[26]
Demand growth is highest in the developing world,[27] but the United States is the world's largest consumer of
petroleum. Between 1995 and 2005, US consumption grew from 17.7 million barrels a day to 20.7 million barrels a
day, a 3 million barrel a day increase. China, by comparison, increased consumption from 3.4 million barrels a day
to 7 million barrels a day, an increase of 3.6 million barrels a day, in the same time frame.[28] Per capita, annual
consumption by people in the US is 24.85 barrels[29] , 1.79 barrels in China[30] , and .79 barrels in India.[31]
As countries develop, industry, rapid urbanization and higher living standards drive up energy use, most often of oil.
Thriving economies such as China and India are quickly becoming large oil consumers.[32] China has seen oil
consumption grow by 8% yearly since 2002, doubling from 1996-2006.[27]
Although swift continued growth in China is often predicted, others predict that China's export dominated economy
will not continue such growth trends due to wage and price inflation and reduced demand from the US.[33] India's oil
imports are expected to more than triple from 2005 levels by 2020, rising to 5 million barrels per day
(790×103 m3/d).[34]
Another large factor on petroleum demand has been human population growth. Because world population grew
faster than oil production, production per capita peaked in 1979 (preceded by a plateau during the period of
1973-1979).[35] The world’s population in 2030 is expected to be double that of 1980.[36]
The role of fuel subsidies

State fuel subsidies have shielded consumers in many nations from the price rises, but many of these subsidies are
being reduced or removed as the cost to governments of subsidization increases.
In June 2008, AFP reported that:
“ China became the latest Asian nation to curb energy subsidies last week after hiking retail petrol and diesel prices as much as 18 percent...
Elsewhere in Asia, Malaysia has hiked fuel prices by 41 percent and Indonesia by around 29 percent, while Taiwan and India have also raised
their energy costs.
[37]
”
In the same month, Reuters reported that:
“ Countries like China and India, along with Gulf nations whose retail oil prices are kept below global prices, contributed 61 percent of the
increase in global consumption of crude oil from 2000 to 2006, according to JPMorgan.
Other than Japan, Hong Kong, Singapore and South Korea, most Asian nations subsidize domestic fuel prices. The more countries subsidize
them, the less likely high oil prices will have any affect [sic] in reducing overall demand, forcing governments in weaker financial situations
to surrender first and stop their subsidies.
That is what happened over the past two weeks. Indonesia, Taiwan, Sri Lanka, Bangladesh, India, and Malaysia have either raised regulated
fuel prices or pledged that they will.
[38]
”
The Economist reported: "Half of the world's population enjoys fuel subsidies. This estimate, from Morgan Stanley,
implies that almost a quarter of the world's petrol is sold at less than the market price."[39] U.S. Secretary of Energy
Samuel Bodman stated that around 30 million barrels per day (4800000 m3/d) of oil consumption (over a third of the
global total) is subsidized.[37] But energy analyst Jeff Vail warned that cutting subsidies would do little to reduce
global prices.[40]
Supply
An important contributor to price increases has been the slow down in oil supply growth, which has continued since
oil production surpassed new discoveries in 1980. The fact that global oil production will decline at some point,
leading to lower supply is the main long-term fundamental cause of rising prices.[41] Although there is contention
about the exact time at which global production will peak, there are now very few parties who do not acknowledge
that the concept of a production peak is valid. However, before the record oil prices of 2008, some commentators
argued that global warming awareness and new energy sources would limit demand before the effects of supply
could, suggesting that reserve depletion would be a non-issue.[42]
A large factor in the lower supply growth of petroleum has been that oil's historically high ratio of Energy Returned
on Energy Invested is in significant decline. Petroleum is a limited resource, and the remaining accessible reserves
are consumed more rapidly each year. Remaining reserves are increasingly more technically difficult to extract and
therefore more expensive. Eventually, reserves will only be economically feasible to extract at extremely high prices.
Even if total oil supply does not decline, increasing numbers of experts believe the easily accessible sources of light
sweet crude are almost exhausted and in the future the world will depend on more expensive unconventional oil
reserves and heavy oil, as well as renewable energy sources. It is thought by many, including energy economists
such as Matthew Simmons, that prices could continue to rise indefinitely until a new market equilibrium is reached
at which point supply satisfies worldwide demand.
A prominent example of investment in non-conventional sources is seen in the Canadian tar sands. They are a far
less cost-efficient source of heavy, low-grade oil than conventional crude, but when oil trades above $60/bbl, the tar
sands become attractive to exploration and production companies. While Canada's tar sands region is estimated to
contain as much "heavy" oil as all the world's reserves of "conventional" oil, efforts to economically exploit these
resources lag behind the increasing demand of recent years.[43]
Until 2008, CERA (a consulting company wholly owned by energy consultants IHS Energy[44] ) did not believe this
would be such an immediate problem. However, in an interview with The Wall Street Journal, Daniel Yergin,
previously known for his quotes that the price of oil would soon return down to "normal", amended the company's
position on May 7, 2008 to predict that oil would reach $150 during 2008, due to tightness of supply[45] This reversal
of opinion was significant, as CERA, among other consultancies, provided price projections that were used by many
official bodies to plan long term strategy in respect of energy mix and price.
Other major energy organisations, such as the International Energy Agency (IEA), had already been much less
optimistic in their assessments for some time.[46] In 2008, the IEA drastically reduced its prediction of production
decline from 3.7% a year to 6.7% a year, based largely on better accounting methods, including actual research of
individual oil field production through out the world.[47]
Terrorist and insurgent groups have increasingly targeted oil and gas installations. . Sometimes, such attacks are
perpetrated by militias in regions where oil wealth has produced few tangible benefits for the local citizenry, as is the
case in the Niger Delta.
Many factors have resulted in possible and/or actual concerns about reduced supply of oil. The post-9/11 war on
terror, Labor strikes, hurricane threats to oil platforms, fires and terrorist threats at refineries, and other short-lived
problems are not solely responsible for the higher prices. Such problems do push prices higher temporarily, but have
not historically been fundamental to long-term price increases.
Investment demand
Investment demand for oil occurs when investors purchase futures contracts to buy a commodity at a set price for
future delivery. "Speculators are not buying any actual crude. ... When [the] contracts mature, they either settle them
with a cash payment or sell them on to genuine consumers."[48]
Several claims have been made implicating financial speculation as a major cause of the price increases. In May
2008 the transport chief for Germany's Social Democrats estimated that 25 percent of the rise to $135 a barrel had
nothing to do with underlying supply and demand.[49] Testimony was given to a U.S. Senate committee in May
indicating that "demand shock" from "Institutional Investors" had increased by 848 million barrels (134800000 m3)
over the last five years, similar to increases in demand from China (920 million barrels).[50] The influence of
Institutional Investors, such as sovereign-wealth funds, was also discussed in June 2008, when Lehman Brothers
suggested that price increases were related to increases in exposure to commodities by such investors. It claimed that
"for every $100 million in new inflows, the price of West Texas Intermediate, the U.S. benchmark, increased by
1.6%."[51] Also in May 2008, an article in The Economist pointed out that oil futures transactions on the New York
Mercantile Exchange (NYMEX), nearly mirrored the price of oil increases for a several year period, however the
article conceded that the increased investment might be following rising prices, rather than causing them, and that
the nickel commodity market had halved in value between May 2007 and May 2008 despite significant speculative
interest.[48] It also reminds readers "Investment can flood into the oil market without driving up prices because
speculators are not buying any actual crude... no oil is hoarded or somehow kept off the market," and that prices of
some commodities which are not openly traded have actually risen faster than oil prices.[48] In June 2008, OPEC's
Secretary General Abdullah al-Badri stated that current world consumption of oil at 87 million bpd was far exceeded
by the "paper market" for oil, which equals about 1.36 billion bpd, or more than 15 times the actual market
demand.[52]
In response to the possibility that financial speculators artificially inflated the oil market, the U.S. Congress began
hearings in June 2008 to discover if actions to "tighten restrictions on pension funds, investment banks and other
investors that they say are driving up fuel prices" were necessary.[53]
An interagency task force on commodities markets was formed in the U.S. government to investigate the claims of
speculators influence on the petroleum market concluded in July 2008 that "market fundamentals" such as supply
and demand provide the best explanations for oil price increases, and that increased speculation was not statistically
correlated with the increases. The report also noted that increased prices with an elastic supply would cause increases
in petroleum inventories. As inventories have actually declined, the task force concluded market pressures are most
likely to blame. Similarly, other commodities which are not subject to market speculation (such as coal, steel, and
onions) have seen similar price increases over the same time period.[54]
In June 2008 U.S. energy secretary Samuel Bodman had said that insufficient oil production, not financial
speculation, was driving rising crude prices. He said that oil production has not kept pace with growing demand. "In
the absence of any additional crude supply, for every 1% of crude demand, we will expect a 20% increase in price in
order to balance the market," Bodman said.[55] [56] This contradicts earlier statements by Iranian OPEC governor
Mohammad-Ali Khatibi indicating that the oil market is saturated and that an increase in production announced by
Saudi Arabia was "wrong". OPEC itself had also previously stated that the oil market was well supplied and that
high prices were a result of speculation and a weak U.S. dollar.[57]
In September 2008, a study of the oil market by Masters Capital Management was released which claimed that
speculation did significantly impact the market. The study stated that over $60 billion was invested in oil during the
first 6 months of 2008, helping drive the price per barrel from $95 to $147 per barrel, and that by the beginning of
September, $39 billion had been withdrawn by speculators, causing prices to fall.[58]
Monetary inflation and the value of the US Dollar

The Austrian School of economics holds that price inflation derives from monetary inflation, and its advocates, such
as the Ludwig von Mises Institute and congressman Ron Paul, argue that loose monetary policy from the Federal
Reserve and other central banks is a major contributor to the increase in oil prices, and the cause of both commodity
speculation and dollar devaluation.[59] [60]
Oil is quoted and traded in US Dollars. Therefore by definition the price or value of oil fluctuates based on investors'
assessment of the value of oil and US Dollars. This has led to concern among some economists that the principal
earned from the sale of oil may lose value in the long run if the U.S. dollar loses real value. Some analysts believe
that as much as $25 of the June 2008 prices around $140 were due to dollar devaluation.[61]
The US Dollar price of oil demonstrated a strong positive correlation with the EUR/USD exchange rate from 2006 to
2010. [62]
Effects
There is debate over what the effects of the 2000s energy crisis will be over the long term. Some speculate that an
oil-price spike could create a recession comparable to those that followed the 1973 and 1979 energy crises or a
potentially worse situation such as a global oil crash. Increased petroleum prices are however reflected in a vast
number of products derived from petroleum, as well as those transported using petroleum fuels.[63]
Political scientist George Friedman has postulated that if high prices for oil and food persist, they will define the
fourth distinct geopolitical regime since the end of World War II, the previous three being the Cold War, the
1989-2001 period in which economic globalization was primary, and the post-9/11 "war on terror".[64]
In addition to high oil prices, from year 2000 volatility in the price of oil has increased notably and this volatility has
been suggested to be a factor in the ongoing financial crisis which began in 2008.[65]
Forecasted prices and trends

According to informed observers, OPEC, meeting in early December, 2007, seemed to desire a high but stable price
that would deliver substantial needed income to the oil producing states, but avoid prices so high that they would
negatively impact the economies of the oil consuming nations. A range of 70–80 dollars a barrel was suggested by
some analysts to be OPEC's goal.[66]
Some analysts point out that major oil exporting countries are rapidly developing; and because they are using more
oil domestically, less oil may be available on the international market. This effect, outlined in the export land
economic model, could significantly reduce the oil available for trade and cause prices to continue to rise.
Particularly significant are Indonesia (which is now a net importer of oil), Mexico and Iran (where demand is
projected to exceed production in about 5 years), and Russia (whose domestic petroleum demand is growing
rapidly).[67]
In May 2008, T. Boone Pickens, an influential oil investor who believes the world’s oil output is about to peak,
predicted oil prices would hit $150 a barrel by the end of the year. “Eighty-five million barrels of oil a day is all the
world can produce, and the demand is 87 m,” Mr Pickens said in an interview with CNBC. “It’s just that simple.”[68]
In June 2008, Alexei Miller, head of Russian energy giant Gazprom, warned that the price of oil is likely to hit $250
a barrel sometime in 2009. Miller said that while speculation had played a role in oil prices, "this influence was not
decisive."[69] Bloomberg reported that, as of mid-June, "At least 3,008 options contracts have been purchased giving
holders the right to buy oil at $250 a barrel in December".[70]
Also in June 2008, Shukri Ghanem, head of Libya's National Oil Corporation, said: "I think it [the oil price] will go
higher. That is a trend that will continue for some time. The easy, cheap oil is over, peak oil is looming."[71]
On June 26, 2008, OPEC President Chakib Khelil said in an interview: "I forecast prices probably between $150-170
during this summer. That will perhaps ease towards the end of the year."[72] Iran's OPEC governor Mohammad-Ali
Khatibi predicts that the price of oil would reach $150 a barrel by the end of this summer.[73]
Near-term peak oil proponent Matthew Simmons predicts a rise to $300 a barrel or higher by 2013 as sweet crude
petroleum becomes more scarce and major producers begin failing to meet demand.[74]
In November, as prices fell below $60 a barrel, the IEA warned that falling prices may create both a lack of
investment in new sources of oil and a fall in production of more expensive unconventional reserves such as the tar
sands of Canada. The IEA's chief economist warned, "Oil supplies in the future will come more and more from
smaller and more difficult fields," meaning that future production requires more investment every year. A lack of
new investment in such projects, which had already been observed, could eventually cause new and more severe
supply issues than had been experienced in the early 2000s according to the IEA. Because the sharpest production
declines had been seen in developed countries, the IEA warned that the greatest growth in production was expected
to come from smaller projects in OPEC states, raising their world production share from 44% in 2008 to a projected
51% in 2030. The IEA also pointed out that demand from the developed world may have also peaked, so that future
demand growth was likely to come from developing nations such as China, contributing 43%, and India and the
Middle East, each about 20%).[75]
Timothy Kailing argued against the IEA's earlier predictions in a 2008 Journal of Energy Security article. He pointed
out the difficulty of increasing production even with vastly increased investment in exploration and production in
mature petroleum regions. By looking at the historical response of production to variation in drilling effort, this
analysis claimed that very little increase of production could be attributed to increased drilling. This was due to a
tight the quantitative relationship of diminishing returns with increasing drilling effort: as drilling effort increased,
the energy obtained per active drill rig was reduced according to a severely diminishing power law. This fact means
that even an enormous increase of drilling effort is unlikely to lead to significantly increased oil and gas production
in a mature petroleum region like the United States.[76]
In its 2008 World Energy Outlook, the International Energy Agency (IEA) predicted a rate of decline in output from
the world's existing oilfields of 6.7% a year.[47]
The end of the crisis

By the beginning of September 2008, prices had fallen to $110. OPEC secretary Abdalla El-Badri said that it
intended to cut output by about 500,000 barrels a day, which he saw as correcting a "huge oversupply" due to
declining economies and a stronger U.S. dollar.[77] On September 10, the International Energy Agency (IEA)
lowered its 2009 demand forecast by 140,000 barrels to 87.6 million barrels a day.[77]
As many countries throughout the world entered economic recession in the third quarter of 2008, prices continued to
slide. In November and December, global demand growth fell, and U.S. demand fell 10% overall from early October
to early November 2008 (accompanying a significant drop in auto sales).[78]
In their December meeting, OPEC planned to reduce their production by 2.2 million barrels per day, though they
admitted their resolution to reduce production in October had only an 85% compliance rate.[79]
Petroleum prices had fallen to below $35 in February 2009, but on May 6, 2009 had risen back to mid-November
2008 levels at about $56. The global economic downturn left oil storage facilities with more oil than in any year
since 1990, when Iraq's invasion of Kuwait upset the market.[80]
Possible mitigations
Attempts to mitigate the impacts of oil price increases include:
• Increasing the supply of petroleum
• Finding substitutes for petroleum
• Decreasing the demand for petroleum
• Attempting to reduce the impact of rising prices on petroleum consumers
In mainstream economic theory, a free market rations an increasingly scarce commodity by increasing its price. A
higher price should stimulate producers to produce more, and consumers to consume less, while possibly shifting to
substitutes. The first three mitigation strategies in the above list are, therefore, in keeping with mainstream economic
theory, as government policies can affect the supply and demand for petroleum as well as the availability of
substitutes. In contrast, the last type of strategy in the list (attempting to shield consumers from rising prices) would
seem to work against classical economic theory, by encouraging consumers to overconsume the scarce quantity, thus
making it even scarcer. To avoid creating outright shortages, attempts at price control may require some sort of
rationing scheme.
Alternative propulsion
Alternative fuels
Economists say that the substitution effect will spur demand for alternate fossil fuels, such as coal or liquefied
natural gas and for renewable energies, such as solar power, wind power, and advanced biofuels.
For example, China and India are currently heavily investing in natural gas and coal liquefaction facilities. Nigeria is
working on burning natural gas to produce electricity instead of simply flaring the gas, where all non-emergency gas
flaring will be forbidden after 2008.[81] [82] Outside the U.S., more than 50% of oil is consumed for stationary,
non-transportation purposes such as electricity production where it is relatively easy to substitute natural gas for
oil.[83]
Ironically, oil companies including the supermajors have begun to fund research into alternative fuel. BP has
invested half a billion dollars for research over the next several years. The motivations behind such moves are to
acquire the patent rights as well as understanding the technology so vertical integration of the future industry could
be achieved.
Bioplastics and bioasphalt

Another major factor in petroleum demand is the widespread use of petroleum products such as plastic. These could
be partially replaced by bioplastics, which are derived from renewable plant feedstocks such as vegetable oil,
cornstarch, pea starch,[84] or microbiota.[85] They are used either as a direct replacement for traditional plastics or as
blends with traditional plastics. The most common end use market is for packaging materials. Japan has also been a
pioneer in bioplastics, incorporating them into electronics and automobiles.
Also bioasphalt can be used as a replacement of petroleum asphalt.
United States Strategic Fuel Reserve

The United States Strategic Petroleum Reserve could, on its own, supply current U.S. demand for about a month in
the event of an emergency, unless it were also destroyed or inaccessible in the emergency. This could potentially be
the case if a major storm were to hit the Gulf of Mexico, where the reserve is located. While total consumption has
increased,[86] the western economies are less reliant on oil than they were twenty-five years ago, due both to
substantial growth in productivity and the growth of sectors of the economy with little oil dependence such as
finance and banking, retail, etc. The decline of heavy industry and manufacturing in most developed countries has
reduced the amount of oil per unit GDP; however, since these items are imported anyway, there is less change in the
oil dependence of industrialized countries than the direct consumption statistics indicate.
Fuel taxes
One recourse used and discussed in the past to avoid the negative impacts of oil shocks in the many developed
countries which have high fuel taxes has been to temporarily or permanently suspend these taxes as fuel costs rise.
France, Italy, and the Netherlands lowered taxes in 2000 in response to protests over high prices, but other European
nations resisted this option because public service financiation is partly based on energy taxes.[87] The issue came up
again in 2004, when oil reached $40 a barrel causing a meeting of 25 EU finance ministers to lower economic
growth forecasts for that year. Because of budget deficits in several countries, they decided to pressure OPEC to
lower prices instead of lowering taxes.[88] In 2007, European truckers, farmers, and fishermen again raised concerns
over record oil prices cutting into their earnings, hoping to have taxes lowered. In the United Kingdom, where fuel
taxes were raised in October and are scheduled to rise again in April 2008, there was talk of protests and roadblocks
if the tax issue was not addressed.[89] On April 1, 2008, a 25 yen per liter fuel tax in Japan was allowed to lapse
temporarily.[90]
This method of softening price shocks is even less viable to countries with much lower gas taxes, such as the United
States.
Demand management
Transportation demand management has the potential to be an effective policy response to fuel shortages[91] or price
increases and has a greater probability of long term benefits than other mitigation options.[92]
There are major differences in energy consumption for private transport between cities; an average U.S. urban
dweller uses 24 times more energy annually for private transport as a Chinese urban resident. These differences
cannot be explained by wealth alone but are closely linked to the rates of walking, cycling, and public transport use
and to enduring features of the city including urban density and urban design.[93]
For individuals, telecommuting provides alternatives to daily commuting and long-distance air travel for business.
Technologies for telecommuting, such as videoconferencing, e-mail, and corporate wikis, continue to improve, in
keeping with the overall improvement in information technologies ascribed to Moore's law. As the cost of moving
information by moving human workers continues to rise, while the cost of moving information electronically
continues to fall, presumably market forces should cause more people to substitute virtual travel for physical travel.
Matthew Simmons explicitly calls for "liberating the workforce" by changing the corporate mindset from paying
people to show up physically to work every day, to paying them instead for the work they do, from any location.[94]
This would allow many more information workers to work from home either part-time or full-time, or from satellite
offices or Internet cafes near to where they live, freeing them from long daily commutes to central offices. However,
even full adoption of telecommuting by all eligible workers might only decrease energy consumption by about 1%
(with present energy savings estimated at 0.01-0.04%). By comparison, a 20% increase in automobile fuel economy
would save 5.4%.[95]
High energy prices and a slowed economy caused petroleum consumption to reach a three year low in crude oil
imports to the United States in December 2008.[96]
Political action against market speculation

The price rises of mid-2008 led to a variety of proposals to change the rules governing energy markets and energy
futures markets, in order to prevent rises due to market speculation.
On July 26, 2008, the United States House of Representatives passed the Energy Markets Emergency Act of 2008
(H.R. 6377)[97] , which directs the Commodity Futures Trading Commission (CFTC) "to utilize all its authority,
including its emergency powers, to curb immediately the role of excessive speculation in any contract market within
the jurisdiction and control of the Commodity Futures Trading Commission, on or through which energy futures or
swaps are traded, and to eliminate excessive speculation, price distortion, sudden or unreasonable fluctuations or
unwarranted changes in prices, or other unlawful activity causing major market disturbances that prevent the market
from accurately reflecting the forces of supply and demand for energy commodities.
See also
• Hirsch report
• Oil consumption
• 2003 to 2008 world oil market chronology
• World food price crisis
• 2000s commodities boom
Notes
[1] http:/ / tfc-charts. com/ chart/ QM/ W
[2] "Record oil price sets the scene for $200 next year" (http:/ / www. ameinfo. com/ 90848. html). AME. July 6, 2006. . Retrieved 2007-11-29.
[3] "Peak Oil News Clearinghouse" (http:/ / www. energybulletin. net/ ). EnergyBulletin.net. .
[4] "The Hike in Oil Prices: Speculation -- But Not Manipulation" (http:/ / www. spiegel. de/ international/ business/ 0,1518,556519,00. html). .
[5] "Missile tension sends oil surging" (http:/ / edition. cnn. com/ 2006/ BUSINESS/ 07/ 05/ oil. price/ index. html). CNN. . Retrieved
2010-04-21.
[6] "Oil hits $100 barrel" (http:/ / news. bbc. co. uk/ 2/ hi/ business/ 7083015. stm). BBC News. 2008-01-02. . Retrieved 2009-12-31.
[7] "Iran nuclear fears fuel oil price" (http:/ / news. bbc. co. uk/ 2/ hi/ business/ 4684844. stm). BBC News. 2006-02-06. . Retrieved 2009-12-31.
[8] The Macroeconomic Effects of Hurricane Katrina, CRS Report for Congress (http:/ / fpc. state. gov/ documents/ organization/ 53572. pdf)
[9] Hurricane Katrina whips oil price to a record high - The Times Online, August 30, 2005 (http:/ / business. timesonline. co. uk/ tol/ business/
economics/ article560389. ece)
[10] Gross, Daniel (2008-01-05). "Gas Bubble: Oil is at $100 per barrel. Get used to it." (http:/ / www. slate. com/ id/ 2181282/ ). Slate. .
[11] "Oil Prices Fall As Gustav Hits" (http:/ / news. sky. com/ skynews/ Home/ Business/
Oil-Prices-Fall-To-Four-month-Lows-Despite-Production-In-Gulf-of-Mexico-Shut-Due-To-Hurricane-Gustav/ Article/
200809115091229?lpos=Business_3& lid=ARTICLE_15091229_Oil+ Prices+ Fall+ To+ Four-month+ Lows+ Despite+ Production+ In+
Gulf+ of+ Mexico+ Shut+ Due+ To+ Hurricane+ Gustav). Sky News. September 2, 2008. . Retrieved May 5, 2009.
[12] "Oil Ministers See Demand Rising, Price May Exceed $85" (http:/ / www. bloomberg. com/ apps/ news?pid=20601072&
sid=aqjfU59OuXbA). Bloomberg. 2010-05-10. .
[13] "Weekly United States Spot Price FOB Weighted by Estimated Import Volume" (http:/ / www. webcitation. org/ 5glwaY35V). U.S. Energy
Information Administration. February 2009. Archived from the original (http:/ / tonto. eia. doe. gov/ dnav/ pet/ hist/ wtotusaw. htm) on
2009-05-14. . Retrieved February 13, 2009.
[14] "What is driving oil prices so high?" (http:/ / news. bbc. co. uk/ 1/ hi/ business/ 7048600. stm). BBC. November 5, 2007. . Retrieved
2009-12-31.
[15] "Oil sets new trading record above $147 a barrel" (http:/ / www. usatoday. com/ money/ economy/ 2008-07-11-3815204975_x. htm). USA
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[16] Marianne Lavelle (March 4, 2008). "Oil Demand Is Dropping, but Prices Aren't" (http:/ / www. usnews. com/ blogs/ beyond-the-barrel/
2008/ 3/ 4/ oil-demand-is-dropping-but-prices-arent. html). U.S. News & World Report. .
[17] Frank Langfitt (March 5, 2008). "Americans Using Less Gasoline" (http:/ / www. webcitation. org/ 5glwayk4a). NPR. Archived from the
original (http:/ / www. npr. org/ templates/ story/ story. php?storyId=87924270) on 2009-05-14. . Retrieved 2009-05-07.
[18] AC2 (February 10, 2009). "Short-Term Energy Outlook" (http:/ / www. webcitation. org/ 5glwbnFwg). U.S. Energy Information
Administration. Archived from the original (http:/ / www. eia. doe. gov/ emeu/ steo/ pub/ feb09. pdf) on 2009-05-14. . Retrieved February 13,
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[19] "Global Oil Consumption" (http:/ / www. eia. doe. gov/ pub/ oil_gas/ petroleum/ analysis_publications/ oil_market_basics/ demand_text.
htm#Global Oil Consumption). U.S. Energy Information Administration. . Retrieved 2008-07-27.
[20] "World oil demand 'to rise by 37%'" (http:/ / news. bbc. co. uk/ 2/ hi/ business/ 5099400. stm). BBC News. 2006-06-20. . Retrieved
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[21] "2007 International Energy Outlook: Petroleum and other liquid fuels" (http:/ / www. eia. doe. gov/ oiaf/ ieo/ oil. html). U.S. Energy
Information Administration. May 2007. .
[22] Clifford Krauss (July 2, 2008). "Oil Demand Will Grow, Despite Prices, Report Says" (http:/ / www. nytimes. com/ 2008/ 07/ 02/ business/
02oil. html?ei=5124& en=d92ebb45abddef25& ex=1372651200& adxnnl=1& partner=digg& exprod=digg&
adxnnlx=1215090471-nCZUb0Eg4s/ EwFnWc0QBBg). The New York Times. . Retrieved 2008-07-03.
[23] Wood John H, Long Gary R, Morehouse David F (2004-08-18). "Long-Term World Oil Supply Scenarios: The Future Is Neither as Bleak or
Rosy as Some Assert" (http:/ / www. eia. doe. gov/ pub/ oil_gas/ petroleum/ feature_articles/ 2004/ worldoilsupply/ oilsupply04. html).
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[24] "Domestic Demand for Refined Petroleum Products by Sector" (http:/ / www. bts. gov/ publications/ national_transportation_statistics/ html/
table_04_03. html). U.S. Bureau of Transportation Statistics. . Retrieved 2007-12-20.
[25] "Asia's Thirst for Oil" (http:/ / www. iags. org/ wsj050504. htm). Wall Street Journal. 2004-05-05. .
[26] Joe Mcdonald (April 21, 2008). "Gas guzzlers a hit in China, where car sales are booming" (http:/ / biz. yahoo. com/ ap/ 080421/
china_auto_show_big_cars. html). Associated Press. .
[27] "International Petroleum (Oil) Consumption Data" (http:/ / www. eia. doe. gov/ emeu/ international/ oilconsumption. html). U.S. Energy
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[28] "BP Statistical Review of Energy - 2008" (http:/ / www. bp. com/ productlanding. do?categoryId=6929& contentId=7044622). Beyond
Petroleum. 2008. . Retrieved 2008-07-27.
[29] 20.7 Mbpd divided by the population of 304 million times 365 days/year
[30] 6.5 Mbpd divided by the population of 1,325 million people times 365 days/year(figures from the CIA Factbook (https:/ / www. cia. gov/
library/ publications/ the-world-factbook/ print/ ch. html))
[31] 2.45 Mbpd divided by the population of 1,136 million people times 365 days/year(figures from the CIA Factbook (https:/ / www. cia. gov/
library/ publications/ the-world-factbook/ print/ in. html))
[32] Oil price 'may hit $200 a barrel' (http:/ / news. bbc. co. uk/ 2/ hi/ business/ 7387203. stm), BBC News
[33] Kevin O'Brien (2008-07-02). "China's Negative Economic Outlook" (http:/ / seekingalpha. com/ article/
83459-china-s-negative-economic-outlook). Seeking Alpha. . Retrieved 2008-07-27.
[34] "China and India: A Rage for Oil" (http:/ / www. businessweek. com/ bwdaily/ dnflash/ aug2005/ nf20050825_4692_db016. htm?chan=gb).
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[35] Duncan Richard C (November 2001). "The Peak of World Oil Production and the Road to the Olduvai Gorge" (http:/ / dieoff. org/ page224.
htm). Population & Environment 22 (5): 503–522. doi:10.1023/A:1010793021451. ISSN 0199-0039 (Print) 1573-7810 (Online). .
[36] "Total Midyear Population for the World: 1950-2050" (http:/ / www. census. gov/ ipc/ www/ idb/ worldpop. html). U.S. Census Bureau. .
[37] "Chinese cut fuel subsidies but demand fears remain" (http:/ / afp. google. com/ article/ ALeqM5habiTClO6-7n56i9zrbBMxdYvWBA).
AFP. . Retrieved 2008-07-10.
[38] "The hidden costs of fuel subsidies" (http:/ / www. iht. com/ articles/ 2008/ 06/ 04/ business/ rtrcol05. php). Reuters. . Retrieved 2008-07-10.
[39] "Crude measures" (http:/ / www. economist. com/ finance/ displaystory. cfm?story_id=11453151). The Economist. . Retrieved 2008-07-10.
[40] "Eliminating Subsidies Won't Solve the Oil Demand Problem" (http:/ / www. jeffvail. net/ 2008/ 06/ eliminating-subsidies-wont-solve-oil.
html). Jeff Vail. . Retrieved 2008-07-10.
[41] Peak oil primer and links | EnergyBulletin.net | Peak Oil News Clearinghouse (http:/ / www. energybulletin. net/ primer. php)
[42] Peter Davies, Economist for BP (14 June 2007). "____". The Independent. ""We don't believe there is an absolute resource constraint. When
peak oil comes, it is just as likely to come from consumption peaking, perhaps because of climate change policies as from production
peaking.""
[43] "Canada: Pinning hopes on the tar sand" (http:/ / www. energybulletin. net/ 1191. html). EnergyBulletin.net. .
[44] "IHS Energy Acquires Cambridge Energy Research Associates (CERA)" (http:/ / www. ihs. com/ News/ Press-Releases/ 2004/ 04cera. htm).
September 1, 2004. . Retrieved 2007-11-30.
[45] Neil King Jr, Spencer Swartz (May 7, 2008). "Some See Oil At $150 a Barrel This Year" (http:/ / online. wsj. com/ article/
SB121010625118671575. html). Wall Street Journal. .
[46] "Transcript: Interview with IEA chief economist" (http:/ / www. ft. com/ cms/ s/ 0/ 3c8940ca-8d46-11dc-a398-0000779fd2ac.
html?nclick_check=1). Financial Times. . Interview with Fatih Birol.
[47] George Monbiot asks Fatih Birol, chief economist of IEA, when will the oil run out? (http:/ / www. guardian. co. uk/ business/ 2008/ dec/
15/ oil-peak-energy-iea), The Guardian,
[48] "Double, double, oil and trouble" (http:/ / www. economist. com/ research/ articlesBySubject/ displaystory. cfm?subjectid=381586&
story_id=11453090). The Economist. 2008-05-29. . Retrieved 2008-06-17.
[49] Evans-Pritchard, Ambrose (26 May 2008). "Germany in call for ban on oil speculation" (http:/ / www. telegraph. co. uk/ money/ main.
jhtml?xml=/ money/ 2008/ 05/ 26/ cnoil126. xml). The Daily Telegraph (London: The Telegraph). . Retrieved 2008-06-07.
[50] Masters, Michael. "Written Testimony" (http:/ / hsgac. senate. gov/ public/ _files/ 052008Masters. pdf) (PDF). United States Senate
Committee on Homeland Security and Governmental Affairs. . Retrieved 2008-05-28.
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[52] "OPEC chief appeals for calm over oil" (http:/ / www. reuters. com/ article/ newsOne/ idUSWLA462520080610?pageNumber=1&
virtualBrandChannel=0). Reuters. 2008-06-10. . Retrieved 2008-06-10.
[53] Associated Press (June 24, 2008). "Congress Plans to Tighten Rules on Energy Speculation" (http:/ / www. nytimes. com/ 2008/ 06/ 24/
business/ 24speculate. html). The New York Times. .
[54] Interagency Task Force on Commodity Markets (July 2008). "Interim Report on Crude Oil" (http:/ / www. cftc. gov/ stellent/ groups/ public/
@newsroom/ documents/ file/ itfinterimreportoncrudeoil0708. pdf) (PDF). Washington DC. .
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External links
• U.S. DOE EIA energy chronology and analysis (http://www.eia.doe.gov/emeu/cabs/MEC_Past/index.html)
• Oil Price History and Analysis (http://www.wtrg.com/prices.htm)
Automotive industry crisis of 2008–2010

The automotive industry crisis of 2008–2010 was a part of a global financial downturn. The crisis affected
European and Asian automobile manufacturers, but it was primarily felt in the American automobile manufacturing
industry. The downturn also affected Canada by virtue of the Automotive Products Trade Agreement.[1]
The automotive industry was weakened by a substantial increase in the prices of automotive fuels[2] linked to the
2003-2008 energy crisis which discouraged purchases of sport utility vehicles (SUVs) and pickup trucks which have
low fuel economy.[3] The popularity and relatively high profit margins of these vehicles had encouraged the
American "Big Three" automakers, General Motors, Ford, and Chrysler to make them their primary focus. With
fewer fuel-efficient models to offer to consumers, sales began to slide. By 2008, the situation had turned critical as
the credit crunch [4] placed pressure on the prices of raw materials.
Car companies from Asia, Europe, North America, and elsewhere have implemented creative marketing strategies to
entice reluctant consumers as most experienced double-digit percentage declines in sales. Major manufacturers,
including the Big Three and Toyota offered substantial discounts across their lineups. The Big Three faced criticism
for their lineups, which were seen to be irresponsible in light of rising fuel prices. North American consumers turned
to higher-quality and more fuel-efficient product of Japanese and European automakers. However, many of the
vehicles perceived to be foreign were actually "transplants," foreign cars manufactured or assembled in the United
States, at lower cost than true imports.[5]
Asia
China
In 2008 the Chinese government reduced automotive taxes in order to spur flagging sales. In January 2009, Chinese
auto-manufacturer Chery reported unprecedented monthly sales.[6] (See also Automobile industry in China.
India
Citing falling production numbers, the State Bank of India reduced interest rates on automotive loans in February
2009.[7]
For the first few months of 2009, Tata Motors conducted a widespread marketing campaign heralding the debut of
the Tata Nano. Billed as "the people's car," the manufacturer hopes the low cost will encourage customers to
purchase the vehicle despite the ongoing credit crisis.[8]
Japan
With high gas prices and a weak US economy in the summer
of 2008, Toyota reported a double-digit decline in sales for the
month of June, similar to figures reported by the Detroit Big
Three. For Toyota, these were attributed mainly to slow sales
of its Tundra pickup, as well as shortages of its fuel-efficient
vehicles such as the Prius, Corolla and Yaris. In response, the
company has announced plans to idle its truck plants, while
shifting production at other facilities to manufacture
in-demand vehicles.[9] [10] [11] [12] On December 22, 2008,
Toyota declared that it expected the first time loss in 70 years The Toyota Prius is one of Toyota's Hybrid Fuel efficient
vehicles which have moved in and out of short supply
in its core vehicle-making business. Loss of $1.7 billion, in its group operating revenue, would be its first operating
loss since 1938 (Company was founded in 1937). Toyota saw its sales drop 33.9 percent and Honda Motor by 31.6
percent.[13]
On 5 December 2008 Honda Motor Company announced that it would be exiting Formula One race with immediate
effect due to the 2008 economic crisis and are looking to sell the team.[14] Honda has predicted that there may be
reductions among part-time and contract staff. Upper management bonuses would also be reassessed and directors in
the company will take a 10 percent pay cut effective January 2009.[15]
Nissan, another leading Japanese car manufacturer, announced that it also would be slashing production and will
reduce its output by 80,000 vehicles in the first few months of 2009.[16]
In December 2008, Suzuki, Japan's fourth biggest car manufacturer, announced that it will cut production in Japan
by about 30,000 units due to falling demand. The company is expected to face its first profit drop in eight years for
financial year ending in March 2009.[17]
On 16 December 2008, Fuji Heavy Industries, Japan's largest transport equipment manufacturer and the maker of
Subaru brand cars, announced that it would exiting World Rally Championship at the end of the 2008 championship,
"this sudden decision was in response to the widespread economic downturn that is affecting the entire automotive
industry", and came one day after competitor Suzuki exited the sport.[18] [19]
Reported in Bloomberg on Dec 23, 2008, that Mitsubishi Motors is to widen production cuts on falling demand. The
Japanese maker of Outlander sport-utility vehicles, will scrap the night shifts at two domestic factories as the
deepening global recession saps auto demand. The carmaker will halt the night shift at its Mizushima plant,
excluding the minicar line. Nighttime work at the Okazaki factory will stop from Feb. 2. The cuts are part of
Mitsubishi's move to reduce planned output by 110,000 vehicles in the year ending March because of tumbling sales
in Japan, the U.S. and Europe. Japan's vehicle sales may fall to the lowest in 31 years in 2009, according to the
country's automobile manufacturers association. Mitsubishi will also halt production of passenger cars on every
Friday next month at the Mizushima factory in western Japan. The Okazaki plant in central Japan will close every
Saturday in January and for another five days.
Toyota on Dec 22, 2008 slashed profit forecasts amid a sales slump. The Japanese automaker, often held up with
Honda as a success story for the rest of the auto industry to follow, said it expected a slim profit margin of US$555
million for the year ending in March 2009. Toyota had originally been projecting a massive profit of $13.9 billion for
that period. Their sales in the United States were down 34 per cent and were down 34 per cent in Europe as well.
They expected a loss which would be the equivalent of about $2 billion (CDN)." Toyota President Katsuaki
Watanabe said the impact on the company from the struggling global economy has been "faster, wider and deeper
than expected." "The change that has hit the world economy is of a critical scale that comes once in a hundred
years," Watanabe said, speaking in Nagoya.[20] Facing its first loss in nearly sixty years, Toyota sought loans from
the Japanese government.[21]
On November 4, 2009, Toyota announced its immediate withdrawal from Formula One, ending the team's
involvement in the sport after eight seasons. See also 2009–2010 Toyota vehicle recalls.
South Korea
South Korean automakers have been generally much more
profitable than their US and Japanese counterparts, recording
strong growth even in depressed markets such as the United
States.[22] Despite a global economic slowdown, Hyundai-Kia
successfully managed to overtake Honda Motor in 2008 as the
world's 5th largest automaker, climbing eight rankings in less
than a decade.[23] Hyundai-Kia continued its rapid success in
2009, when only a year after overtaking Honda, it surpassed
Ford Motor as the world's 4th largest automaker.[24]
Hyundai-Kia's continued success was unusual at a time when

most automakers saw their sales falling sharply, with leading The Hyundai Genesis named the 2009 North American Car
automaker GM even filing for bankruptcy. Hyundai-Kia took of the Year.
significant advantage of the prolonged automotive crisis by

producing affordable yet high quality and well designed vehicles. Rapid globalization has seen state of the art
factories being built in several countries including Slovakia, the United States and China. The manufacturing
facilities have been geared-up to build products that are designed and engineered for local markets. The Kia cee'd is
a leading example, being designed, developed and engineered in Germany and built in Slovakia.[25]
Unlike others, this crisis turned into an opportunity for many South Korean automakers. Korean automaker Hyundai
offered customers who have lost their jobs to return a new-car purchase for a refund.[26] The continued growth and
success is attributable to the country's fuel-efficient and well-equipped, yet affordable cars with generous warranties,
such as the Kia Picanto, Kia cee'd and Hyundai i30, which attracted global consumers at a time of severe economic
recession, rapidly rising oil prices and increasing environmental concerns. South Korean automakers therefore had a
competitive advantage against expensive luxury vehicles and SUVs from US, Japanese and German automakers.
During the fourth quarter of 2008 to the first quarter of 2009, which was the height of this automotive crisis, the
extremely weak South Korean won, especially against the US dollar and Japanese yen, significantly boosted the
price competitiveness of South Korean exports in key markets. Another factor that helped maintain this momentum
was an increasingly improving brand awareness, attributable to the introduction of the country's own luxury vehicles
such as the Hyundai Genesis and Hyundai Genesis Coupe, which received highly positive awards in the press and
reviews. Hyundai's brand grew by 9% in 2008, surpassing Porsche and Ferrari, while it used the Super Bowl football
broadcast, the world's most expensive commercial air time, to promote the Hyundai brand in the United States.[27]
Nonetheless, South Korean automakers were not completely immune to this automotive crisis and in December 2008
Hyundai Motor Company had begun reducing production at plants in the U.S., China, Slovakia, India and Turkey
because of sluggish demand. The company missed an earlier projection of 4.8 million units for 2008 and announced
a freeze of wages for administrative workers and shortened factory operations as demand weakens amid a global
financial crisis.[28]
South Korea's fourth largest automaker, SsangYong Motor, owned by the Chinese automobile manufacturer SAIC
(Shanghai Automotive Industry Corporation), is the worst affected company in this crisis as it manufactures mainly
heavy petroleum consuming SUVs. The carmaker recorded its fourth straight quarterly losses by the end of 2008
with red ink of $20.8 million in the third quarter. Also during the July to September period, sales dropped 63 percent
to 3,835 vehicles. Its production lines have been idle since Dec. 17 as part of efforts to reduce its inventory. The
automaker has halted production twice previously this year. In December 2008, SAIC gave an ultimatum to the
SsangYong union to accept its restructuring plan or face the parent company's withdrawal, which, if implemented,
would mean certain bankruptcy.[29]
However, the South Korean Ministry of Knowledge Economy said that there will be no liquidity provision at the
government level for five automakers - Hyundai, Kia, GM Daewoo, Samsung Renault and Ssangyong."We have no
plans to inject liquidity into the carmakers, a ministry official said. "It has been repeatedly made clear.[29]
Europe
In Europe where car sales had also drastically decreased, consideration was being given to financial support for the
automotive industry, particularly in France, Germany and Italy. German Foreign Minister Frank-Walter Steinmeier
and Jean-Claude Juncker, Luxembourg's Prime Minister and head of the Eurogroup of single currency nations,
discussed the possibility of a common rescue package to be agreed by all the EU member states.[30]
France
On November 20, 2008, French automobile manufacturer PSA Peugeot Citroen predicted sales volumes would fall
by at least 10% in 2009, following a 17% drop in the current quarter. As a result, it planned to cut 2,700 jobs.[31] On
the 11 February 2009, PSA announced it would cut 11,000 jobs world wide, however none of these are expected to
be in France.[32]
Renault announced a net profit for 2008 of 599 million euros for the 2008 financial year. This was a 78% drop in
profits from the 2007 financial year. European sales fell 4% and world wide sales 7%, forcing Renault to abandon
their 2009 growth targets.[33] This however made Renault one of the few car makers to return a profit. Renault
consistently struggled to return profits in the 1990s.
France/Germany
On November 24, 2008, French President Nicolas Sarkozy and German Chancellor Angela Merkel agreed to support
the crisis-stricken automobile industry in France and Germany.[34] Detailed plans would be announced shortly.[35]
Italy
On December 16, 2008 Fiat in Italy announced that it will
extend its temporary plant closures in Italy by a month; the
Pomigliano d'Arco, the main plant for its Alfa Romeo cars
will be shut for four weeks.[36] However, on February 20,
2009, reacting to actions by the Italian government to
stimulate the automotive sector, Fiat said its plant closures
would be curtailed.[37] The company also forecast that sales in
Europe will drop by 14 percent in 2009.[36]
On January 20, 2009 the company announced that it had Fiat and Chrysler hope smaller models like the Fiat Grande
entered into an agreement, subject to regulatory approvals, to Punto could be successful in the US market
acquire 35% of Chrysler. Fiat's 35% stake in Chrysler would

not involve a conventional sale of shares, but would be achieved in return for allowing Chrysler to utilise some of
Fiat's fuel efficient technologies (Chrysler's February submission to the US government included a commitment to
produce nine Fiat-derived vehicles over a four-year period starting in 2010, including four hybrid-electric and
battery-electric models).[38] Chrysler would be accorded access to Fiat's sales outlets in Europe, while in
reciprocation Fiat will also gain access to Chrysler's dealership network in the US, where it is predicted smaller
models such as the Fiat Grande Punto may be successful.[39] In the past, Fiat has had trouble gaining a foothold in
the American markets, whilst Chrysler has never held a strong market share in Europe since it sold its UK based
Rootes Group and France based Simca to PSA Peugeot Citroen in the 1980s.
On January 22, 2009, Fiat announced a 19% drop in revenues in the last three months of 2008. Italian Prime Minister
Silvio Berlusconi said the government would meet to discuss the issue.[40]
Spain
Spanish automobile manufacturer SEAT (a subsidiary of the Volkswagen Group) cut production at its Martorell
plant by 5% on the 7 October 2008, due to a fall in general sales. This affected 750 employees. This continued until
July 2009.[41] SEAT is still continuing to install solar panels in its Martorell plant near Barcelona.[42]
Sweden
On December 11, 2008, the Swedish government provided its troubled auto makers, Volvo and Saab, with support
amounting to SEK 28 billion ($3.5 billion). The two companies had requested assistance, faced with the financial
difficulties of their U.S. owners Ford and General Motors. The plan consists of a maximum of SEK 20 billion in
credit guarantees, and up to SEK 5 billion in rescue loans.[43] On the 18 February, 2009 General Motors warned
Saab may fail within ten days, should the Swedish government not intervene.[44] On 20 February, an administrator
was appointed to restructure Saab and assist in it becoming independent of its troubled parent General Motors.
General Motors have confirmed their intention to sell their Swedish subsidiary, Saab.[45] Of Sweden's 9 million
population, 140,000 work in the car industry and they account for 15% of exports.[44]
Russia
In December 2008, protectionist tariffs of 30% were announced on cars imported into Russia, described by prime
minister Vladimir Putin as vital to save jobs in the domestic auto industry.[46] The tariffs provoked protests across
Russia. Riot police broke up protests in the city of Vladivostok, which is the main port of entry for second-hand
Japanese cars.[47]
United Kingdom
In the U.K., Jaguar Land Rover, now owned by Tata Motors,
was seeking a $1.5 billion loan from the government to cope
with the credit crisis.[48]
On December 22, 2008, Tata motors declared that it would
inject "tens of millions" of pounds for Jaguar Land Rover
company it had acquired from Ford Motor Corporation in
early 2008. British Prime Minister Gordon Brown also stated
the intention to help out car industry in U.K.[49]
On the 8 January 2009, Nissan UK announced it was to shed
Nissan UK in Washington, Tyne and Wear is to shed 1200
1200 jobs from its Washington, Tyne and Wear factory in
jobs
North East England due to the automotive industry crisis of
2008.[50] This announcement was made, despite the plant
recently being hailed as the most efficient in Europe.[51] [52]
General Motors UK subsidiary Vauxhall Motors, whose brand is the second most popular in the UK has two bases in
the UK, a factory in Ellesmere Port, Cheshire and their headquarters and design and development centre in Luton,
Bedfordshire. It is as yet unknown whether these plants will be affected by the GM cutbacks. The group along with
their sister subsidiary, Opel of Germany was supposed to be sold in their majority to Magna International, a
Austro-Canadian company who supply many parts to large car companies, but General Motors cancelled the
transaction.
UK bus manufacturer Optare received an order from Arriva in November 2008 for the manufacture of 53 buses in a
contract worth over £6million, securing 500 jobs at the company's Assembly factory in Cross Gates, Leeds, West
Yorkshire and the parts centre in Cumbernauld, North Lanarkshire.[53]
UK Van and commercial vehicle manufacturer LDV asked the UK government for a £30 million bridging loan to
facilitate a management buyout of the group. On the same day this was refused.[54] LDV has since said it has a viable
future and intends to become the first volume producer of electric vans should the management buyout take place.
Production at LDV's factory in Birmingham, West Midlands (where it employs 850 staff) has been suspended since
December 2008 due to falling demand.[55] Eventually, no buyout materialised and the LDV was declared defunct on
15 October 2009
North America
Canada
The Canadian auto industry is closely linked to the U.S., due to the Automotive Products Trade Agreement and later
the North American Free Trade Agreement (NAFTA), and is in similar trouble.
United States
The crisis in the United States is mainly defined by the government bailouts of both General Motors and Chrysler,
while Ford secured a line of credit in case they require a bridging loan in the near future. Car sales declined in the
United States, affecting both US based and foreign car manufacturers. The bridging loans lead to greater scrutiny of
the US automotive industry in addition to criticism of their product range, product quality, high labour wages, job
bank programs, and healthcare and retirement benefits.
While the "Big Three" U.S. market share declined from 70% in 1998 to 53% in 2008, global volume increased
particularly in Asia and Europe.[56] The U.S. auto industry was profitable in every year since 1955, except those
years following U.S. recessions and involvement in wars. U.S. auto industry profits suffered from 1971-73 during
the Vietnam War, during the recession in the late 1970s which impacted auto industry profits from 1981–83, during
and after the Gulf War when industry profits declined from 1991–93, and during the Iraq War from 2001–03 and
2006-09. During these periods the companies incurred much legacy debt.[57]
Facing financial losses, the Big Three have idled many factories and drastically reduced employment levels. GM
spun off many of its employees in certain divisions into independent companies, including American Axle in 1994
and Delphi in 1999. Ford spun off Visteon in 2000. The spin-offs and other parts makers have shared Detroit's
downturns, as have the U.S.-owned plants in Canada. Altogether the parts makers employ 416,000 people in the U.S.
and Canada. General Motors alone is estimated to have lost $51 billion in the three years before the 2008 financial
crisis began. GM is set to reacquire factories from its Delphi subsidiary during its Chapter 11 restructing.[58]
The 2005 Harbour Report estimated that Toyota's lead in benefits cost advantage amounted to $350 US to $500 US
per vehicle over North American manufacturers. The United Auto Workers agreed to a two-tier wage in recent 2007
negotiations, something which the Canadian Auto Workers has so far refused.[59] Jared Bernstein, the chief
economist of Vice President Joe Biden, noted in an interview with WWJ-AM in Detroit that most of the 2007
contract concessions apply only to new hires, while older workers "still benefit from contracts that were signed a
long time ago."[60] However, only 30% of parts used by the Big Three employ union labor, with 70% sourced from
non-union labor.
Delphi, which was spun off from GM in 1999, filed for Chapter 11 bankruptcy after the UAW refused to cut their
wages and GM is expected to be liable for a $7 billion shortfall.[61] [62] [63]
In order to improve profits, the Detroit automakers made agreements with unions to reduce wages while making
pension and health care commitments. GM, for instance, at one time picked up the entire cost of funding health
insurance premiums of its employees, their survivors and GM retirees, as the US did not have a universal health care
system.[64] With most of these plans chronically underfunded in the late 1990s, the companies have tried to provide
retirement packages to older workers, and made agreements with the UAW to transfer pension obligations to an
independent trust.[65] Nonetheless, non-unionized Japanese automakers, with their younger American workforces
(and far fewer American retirees) will continue to enjoy a cost advantage.[66] [67] [68]
Despite the history of their marques, many long running cars
have been discontinued or relegated to fleet sales,[69] [70] [71]
as GM, Ford and DaimlerChrysler shifted away resources
from midsize and compact cars to lead the "SUV Craze".
Since the late 1990s, over half of their profits have come from
light trucks and SUVs, while they often could not break even
on compact cars unless the buyer chose options.[72] Ron
Harbour, in releasing the Oliver Wyman’s 2008 Harbour
Report, stated that many small “econoboxes” of the past acted
as loss leaders, but were designed to bring customers to the A Chevrolet TrailBlazer, one of General Motors SUVs
brand in the hopes they would stay loyal and move up to more
profitable models. The report estimated that an automaker needed to sell ten small cars to make the same profit as
one big vehicle, and that they had to produce small and mid-size cars profitably to succeed, something that the
Detroit three have not yet done.[73] SUV sales peaked in 1999 but have not returned to that level ever since, due to
higher gas prices.
In the case of Chrysler Corporation, compact and mid-sized vehicles such as the Dodge Neon, Dodge Stratus and
Chrysler Cirrus were produced profitably during the 1990s concurrently with more profitable larger vehicles.
However, following the DaimlerChrysler merger in 1998, there was a major cost-cutting operation at the company.
The result was the lowering of benchmarked standards for Chrysler to aim at. This directly led to the following in
Chrysler's case. There was realignment of the Chrysler Group model range with those of GM and Ford (i.e. a skew
towards larger vehicles).
The Detroit Big Three had been slower to bring new vehicles to the market compared with foreign competitors. The
Big Three have battled initial quality perceptions in spite of reports showing improvements.[74]
Falling sales resulted in the Big Three's plants operating below capacity. GM's plants were operating at 85% in
November 2005, well below the plants of its Asian competitors, and was only maintained by relying on cash
incentives and subsidized leases.[75] Rebates, employee pricing, and 0% financing boosted sales but drained the
automaker's cash reserves. The subprime mortgage crisis and high oil prices of 2008 caused the popularity of once
best-selling trucks and SUVs to plummet. Automakers were forced to continue offering heavy incentives to help
clear excess inventory.[76] Due to the declining residual value of their vehicles, Chrysler and GM stopped offering
leases on a most of their vehicles in 2008.[77]
In September, 2008 the Big Three asked for $50 billion to pay for health care expenses and avoid bankruptcy and
ensuing layoffs, and Congress worked out a 25$ billion loan.[78] By December, President Bush had agreed to an
emergency bailout of $17.4 billion to be distributed by the next administration in January and February.[79] In early
2009, the prospect of avoiding bankruptcy by General Motors and Chrysler continued to wane as new financial
information about the scale of the 2008 losses came in. Ultimately, poor management and business practices forced
Chrysler and General Motors into bankruptcy. Chrysler filed for chapter 11 bankruptcy protection on May 1, 2009
[80]
followed by General Motors a month later.[81]
On June 2, GM Motors announced the sale of the Hummer brand of off-road vehicles to Sichuan Tengzhong Heavy
Industrial Machinery Company Ltd., a machinery company in western China, a deal which later fell through.[82] [83]
[84]
Effects of environmental expectations and changing product demand

Environmental politics and related concerns regarding carbon emissions have heightened sensitivity to gas mileage
standards and environmental protection worldwide. In a 2007 edition of his book An Inconvenient Truth, Al Gore
criticized the Big Three. "They keep trying to sell large, inefficient gas-guzzlers even though fewer and fewer people
are buying them." For example, Japan requires autos to achieve 45 miles per US gallon (5.2 L/100 km; 54 mpg-imp) of
gasoline and China requires 35 mpg-US (6.7 L/100 km; 42 mpg-imp). The European Union requires 47 mpg-US
(5.0 L/100 km; 56 mpg-imp) by 2012. By comparison, U.S. autos are required to achieve only 25 mpg-US
(9.4 L/100 km; 30 mpg-imp) presently. Other nations have adopted standards that are increasing mpg requirements in
the future. When California raised its own standards, the auto companies sued.[85] [86]
The Big Three received funding for a $25 billion government loan during October 2008 to help them re-tool their
factories to meet new fuel-efficiency standards of at least 35 mpg-US (6.7 L/100 km; 42 mpg-imp) by 2020. The $25
billion in loans from the Department of Energy to the auto manufacturers were actually authorized by Congress early
this year but not funded. Automakers could use these loans to "equip or establish facilities to produce ‘advanced
technology vehicles’ that would meet certain emissions and fuel economy standards; component suppliers could
borrow funds to retool or build facilities to produce parts for such vehicles."[87]
Effect of 2008 oil price shock and economic crisis

In 2008, a series of damaging blows drove the Big Three to
the verge of bankruptcy. Part of the cause was very high labor
costs (much higher than the foreign plants in the U.S.). The
Big Three had in recent years manufactured SUVs and large
pickups, which were much more profitable than smaller,
fuel-efficient cars. Manufacturers made 15% to 20% profit
margin on an SUV, compared to 3% or less on a car.[88] When
gasoline prices rose above $4 per gallon in 2008, Americans
stopped buying the big vehicles and Big Three sales and
profitability plummeted. Robert Samuelson has advocated a
more consistent energy policy, arguing "wild swings between
Medium term crude oil prices 2003-2008, (not adjusted for
low and high fuel prices have crippled the U.S. industry by inflation)
erratically shifting buyer preferences -- to and from
SUVs."[89]
The financial crisis played a role, as GM was unable to obtain credit to buy Chrysler. Sales fell further as consumer
credit tightened and it became much harder for people with average or poor credit to obtain a bank loan to buy a car.
During 2007, nearly 2 million new U.S. cars were purchased with funds from home equity loans. Such funding was
considerably less available in 2008.[90] In addition, stock prices fell as shareholders worried about bankruptcy; GM's
shares fell below 1946 levels. Furthermore, the instability of the job market and individual consumers' finances
discourages consumers who already have a working vehicle from taking on a new loan and payments, which affected
almost all major manufacturers.
The annual capacity of the industry is 17 million cars; sales in 2008 dropped to an annual rate of only 10 million
vehicles made in the U.S. and Canada. All the automakers and their vast supplier network account for 2.3% of the
U.S. economic output, down from 3.1% in 2006 and as much as 5% in the 1990s. Some 20% of the entire national
manufacturing sector is still tied to the automobile industry. The transplants can make a profit when sales are at least
12 million; the Big Three when sales are at least 15 million.[91]
The crisis has affected auto companies around the world, with large sales decreases experienced by all.
As of December 19, 2008, oil prices had fallen to $33.87 per barrel, but the automobile crisis continues.[92]
See also
• Automotive industry
• Corporate welfare
• Chrysler bailout / Chrysler bankruptcy
• Effects of the 2008-2009 automotive industry crisis on the United States
• General Motors bankruptcy
• Global financial crisis of 2008
• Lemon socialism
• Presidential Task Force on the Auto Industry
• Too Big to Fail policy
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External links
• CAR industry news (http://www.carmagazine.co.uk/News/Search-Results/Industry-News/
News-watch-October-2010-todays-auto-industry-news/).
• Auto Industry Financing and Restructuring Act (http://senateconservatives.files.wordpress.com/2008/12/
ayo08e32_xml4.pdf).
• Capitalism and the auto crisis (http://wsws.org/articles/2008/dec2008/pers-d20.shtml).
• Toyota losses highlight global auto collapse (http://wsws.org/articles/2008/dec2008/japa-d24.shtml).
• GM closes plants in Wisconsin and Ohio (http://wsws.org/articles/2008/dec2008/clos-d24.shtml).
• Crisis grips German auto industry (http://wsws.org/articles/2008/dec2008/germ-d06.shtml).
• Thousands of jobs threatened in Swedish auto industry (http://wsws.org/articles/2008/dec2008/swed-d13.
shtml).
• European auto industry in crisis (http://wsws.org/articles/2008/oct2008/germ-o25.shtml).
• Feb 2009 Restructuring Plans: General Motors (http://publicservice.evendon.com/GMRestruct17Feb2009M.
htm) Chrysler (http://publicservice.evendon.com/ChryslerRestruct17Feb2009M.htm)
2010 European sovereign debt crisis

In early 2010, fears of a sovereign debt crisis, the 2010 Euro Crisis[1] (also known as the Aegean Contagion),[2]
developed concerning some European nations,[3] including European Union members Greece, Spain,[4] and
Portugal.[5] This led to a crisis of confidence as well as the widening of bond yield spreads and risk insurance on
credit default swaps between these countries and other EU members, most importantly Germany.[6] [7]
Concern about rising government deficits and debt levels[8] [9] across the globe together with a wave of downgrading
of European government debt[10] has created alarm in financial markets. The debt crisis has been mostly centred on
recent events in Greece, where there is concern about the rising cost of financing government debt. On 2 May 2010,
the Eurozone countries and the International Monetary Fund agreed to a €110 billion loan for Greece, conditional on
the implementation of harsh Greek austerity measures.[11] On 9 May 2010, Europe's Finance Ministers approved a
comprehensive rescue package worth almost a trillion dollars aimed at ensuring financial stability across Europe by
creating the European Financial Stability Facility.[12]
Greek government funding crisis
Causes
The Greek economy was one of the fastest growing in the eurozone during the 2000s; from 2000 to 2007 it grew at
an annual rate of 4.2% as foreign capital flooded the country.[13] A strong economy and falling bond yields allowed
the government of Greece to run large structural deficits. According to an editorial published by the Greek
newspaper Kathimerini, large public deficits are one of the features that have marked the Greek social model since
the restoration of democracy in 1974. After the removal of the right leaning military junta, the government wanted to
bring disenfrachised left leaning portions of the population into the economic mainstream.[14] In order to do so,
successive Greek governments have, among other things, run large deficits to finance public sector jobs, pensions,
and other social benefits.[15] Since 1993 debt to GDP has remained above 100%.[16]
Initially currency devaluation helped finance the borrowing. After the
introduction of the euro Greece was initially able to borrow due the
lower interest rates government bonds could command. The global
financial crisis that began in 2008 had a particularly large effect on
Greece. Two of the country's largest industries are tourism and
shipping, and both were badly affected by the downturn with revenues
falling 15% in 2009.[16] Public debt as a percent of GDP (2007).
To keep within the monetary union guidelines, the government of

Greece has been found to have consistently and deliberately
misreported the country's official economic statistics.[17] [18] In the
beginning of 2010, it was discovered that Greece had paid Goldman
Sachs and other banks hundreds of millions of dollars in fees since
2001 for arranging transactions that hid the actual level of
borrowing.[19] The purpose of these deals made by several subsequent
Public debt as a percent of GDP (2009/2010).
Greek governments was to enable them to spend beyond their means,
while hiding the actual deficit from the EU overseers.[20] The emphasis
on the Greek case has tended to overshadow similar irregularities, usage of derivatives and "massaging" of statistics
(to cope with monetary union guidelines) that have also been observed in cases of other EU countries, especially
Italy,[21] [22] [23] however Greece was seen as the worst case.
In 2009, the government of George Papandreou revised its deficit from an estimated 6% (8% if a special tax for
building irregularities were not to be applied) to 12.7%.[24] In May 2010, the Greek government deficit was
estimated to be 13.6%[25] which is one of the highest in the world relative to GDP.[26] Greek government debt was
estimated at €216 billion in January 2010.[27] Accumulated government debt is forecast, according to some
estimates, to hit 120% of GDP in 2010.[28] The Greek government bond market is reliant on foreign investors, with
some estimates suggesting that up to 70% of Greek government bonds are held externally.[29]
Estimated tax evasion costs the Greek government over $20 billion per year.[30] Despite the crisis, Greek
government bond auctions have all been over-subscribed in 2010 (as of 26 January).[31] According to the Financial
Times on 25 January 2010, "Investors placed about €20bn ($28bn, £17bn) in orders for the five-year, fixed-rate
bond, four times more than the (Greek) government had reckoned on." In March, again according to the Financial
Times, "Athens sold €5bn (£4.5bn) in 10-year bonds and received orders for three times that amount."[32]
Downgrading of debt
On 27 April 2010, the Greek debt rating was decreased to the first levels of 'junk' status by Standard & Poor's amidst
fears of default by the Greek government.[33] Yields on Greek government two-year bonds rose to 15.3% following
the downgrading.[34] Some analysts question Greece's ability to refinance its debt. Standard & Poor's estimates that
in the event of default investors would lose 30–50% of their money.[33] Stock markets worldwide declined in
response to this announcement.[35]
Following downgradings by Fitch, Moody's and S&P,[36] Greek bond yields rose in 2010, both in absolute terms and
relative to German government bonds.[37] Yields have risen, particularly in the wake of successive ratings
downgrading. According to the Wall Street Journal "with only a handful of bonds changing hands, the meaning of
the bond move isn't so clear."[38] As of 6 May 2010, Greek 10-year bonds were trading at an effective yield of
11.31%.[39]
On 3 May 2010, the European Central Bank suspended its minimum threshold for Greek debt "until further
notice",[40] meaning the bonds will remain eligible as collateral even with junk status. The decision will guarantee
Greek banks' access to cheap central bank funding, and analysts said it should also help increase Greek bonds'
attractiveness to investors.[41] Following the introduction of these measures the yield on Greek 10-year bonds fell to
8.5%, 550 basis points above German yields, down from 800 basis points earlier.[42]
Austerity and loan agreement

On 5 March 2010, the Greek parliament passed the Economy Protection Bill, expected to save €4.8 billion[43]
through a number of measures including public sector wage reductions. On 23 April 2010, the Greek government
requested that the EU/IMF bailout package be activated.[44] The IMF had said it was "prepared to move
expeditiously on this request".[45] Greece needed money before 19 May, or it would face a debt roll over of
$11.3bn.[46] [47] [48]
On 2 May 2010, a loan agreement was reached between Greece, the other Eurozone countries, and the International
Monetary Fund. The deal consisted of an immediate €45 billion in loans to be provided in 2010, with more funds
available later. A total of €110 billion has been agreed.[49] [50] The interest for the Eurozone loans is 5%, considered
to be a rather high level for any bailout loan. The government of Greece agreed to impose a fourth and final round of
austerity measures. These include:[51]
• Public sector limit of €1,000 introduced to bi-annual bonus, abolished entirely for those earning over €3,000 a
month.
• An 8% cut on public sector allowances and a 3% pay cut for DEKO (public sector utilities) employees.
• Limit of €800 per month to 13th and 14th month pension installments; abolished for pensioners receiving over
€2,500 a month.
• Return of a special tax on high pensions.
• Changes were planned to the laws governing lay-offs and overtime pay.
• Extraordinary taxes imposed on company profits.
• Increases in VAT to 23%, 11% and 5.5%.
• 10% rise in luxury taxes and taxes on alcohol, cigarettes, and fuel.
• Equalization of men's and women's pension age limits.
• General pension age has not changed, but a mechanism has been introduced to scale them to life expectancy
changes.
• A financial stability fund has been created.
• Average retirement age for public sector workers has increased from 61 to 65.[52]
• Public-owned companies to be reduced from 6,000 to 2,000.[52]
On 5 May 2010, a nationwide general strike was held in Athens to protest to the planned spending cuts and tax
increases. Three people were killed, dozens injured, and 107 arrested.[53]
According to research published on 5 May 2010, by Citibank, the EMU loans will be pari passu and not senior like
those of the IMF. In fact the seniority of the IMF loans themselves has no legal basis but is respected nonetheless.
The amount of the loans will cover Greece's funding needs for the next three years (estimated at 30bn for the rest of
2010 and 40bn each for 2011 and 2012). Citibank finds the fiscal tightening "unexpectedly tough". It will amount to
a total of €30 billion (i.e. 12.5% of 2009 Greek GDP) and consist of 5% of GDP tightening in 2010 and a further 4%
tightening in 2011.[54]
Danger of default
Without a bailout agreement, there was a possibility that Greece would have been forced to default on some of its
debt. The premiums on Greek debt had risen to a level that reflected a high chance of a default or restructuring.
Analysts gave a 25% to 90% chance of a default or restructuring.[55] [56] A default would most likely have taken the
form of a restructuring where Greece would pay creditors only a portion of what they were owed, perhaps 50 or 25
percent.[57] This would effectively remove Greece from the euro, as it would no longer have collateral with the
European Central Bank. It would also destabilise the Euro Interbank Offered Rate, which is backed by government
securities.[58]
Because Greece is a member of the eurozone, it cannot unilaterally stimulate its economy with monetary policy. For
example, the U.S. Federal Reserve expanded its balance sheet by over $1.3 trillion USD since the global financial
crisis began, essentially printing new money and injecting it into the system by purchasing outstanding debt.[59]
The overall effect of a probable Greek default would itself be small for the other European economies. Greece
represents only 2.5% of the eurozone economy.[60] The more severe danger is that a default by Greece will cause
investors to lose faith in other Eurozone countries. This concern is focused on Portugal and Ireland, all of whom
have high debt and deficit issues.[61] Italy also has a high debt, but its budget position is better than the European
average, and it is not considered amongst the countries most at risk.[62] Recent rumours raised by speculators about a
Spanish bail-out were dismissed by Spanish Prime Minister Mr. Zapatero as "complete insanity" and
"intolerable".[63] Spain has a comparatively low debt amongst advanced economies, at only 53% of GDP in 2010,
more than 20 points less than Germany, France or the US, and more than 60 points less than Italy, Ireland or
Greece,[64] and it doesn't face a risk of default.[65] Spain and Italy are far larger and more central economies than
Greece, both countries have most of their debt controlled internally, and are in a better fiscal situation than Greece
and Portugal, making a default unlikely unless the situation gets far more severe.[66]
Objections to proposed policies

See also May 2010 Greek protests
The crisis is seen as a justification for imposing fiscal austerity[67] on
Greece in exchange for European funding which would lower
borrowing costs for the Greek government.[68] The negative impact of
tighter fiscal policy could offset the positive impact of lower
borrowing costs and social disruption could have a significantly
negative impact on investment and growth in the longer term. Joseph
Stiglitz has also criticised the EU for being too slow to help Greece,
insufficiently supportive of the new government, lacking the will
power to set up sufficient "solidarity and stabilisation framework" to
support countries experiencing economic difficulty, and too deferential
to bond rating agencies.[69] GIPS: Greece, Italy, Portugal and Spain
GIIPS: with Ireland GGIIPS: with
An alternative to the bailout agreement, would have been Greece United Kingdom
leaving the Eurozone. Wilhelm Hankel, professor emeritus of
economics at the University of Frankfurt am Main suggested[70] in an article published in the Financial Times that
the preferred solution to the Greek bond 'crisis' is a Greek exit from the euro followed by a devaluation of the
currency. Fiscal austerity or a euro exit is the alternative to accepting differentiated government bond yields within
the Euro Area. If Greece remains in the euro while accepting higher bond yields, reflecting its high government
deficit, then high interest rates would dampen demand, raise savings and slow the economy. An improved trade
performance and less reliance on foreign capital would result.
Possible spread beyond Greece

One of the central concerns prior to the
bailout was that the crisis could spread
beyond Greece. The crisis has reduced
confidence in other European
economies. Ireland, with a government
deficit of 14.3 percent of GDP, the
U.K. with 12.6 percent, Spain with
11.2 percent, and Portugal at 9.4
percent are most at risk.[71] [72] [73]
In April 2010, following a marked

increase in Irish 2-year bond yields,
Ireland's NTMA state debt agency said
that it had "no major refinancing
obligations" in 2010. Its requirement
for €20 billion in 2010 was matched
by a €23 billion cash balance, and it
The government surplus or deficit of Portugal, Italy, Ireland, Greece, United Kingdom,
remarked: "We're very comfortably and Spain against the European Union and Eurozone 2002–2009
circumstanced".[74] On 18 May the
NTMA tested the market and sold a €1.5 billion issue that was three times oversubscribed.[75]
According to the Financial Times: "So far, investors have concentrated their ire on peripheral eurozone economies
because of the zone's inability to resolve cleanly the Greek crisis. That is understandable, say many economists, but
they add that the focus on continental Europe is unfair."[76] According to the European Commission, the U.K. budget
deficit will surpass Greece's as worst in EU this calendar year.[77]
Shortly after the announcement of the EU's new "emergency fund" for eurozone countries in early May 2010, Spain's
government announced new austerity measures designed to further reduce the country's budget deficit.[78] The
socialist government had hoped to avoid such deep cuts, but weak economic growth as well as domestic and
international pressure forced the government to expand on cuts already announced in January. As one of the largest
eurozone economies the condition of Spain's economy is of particular concern to international observers, and faced
pressure from the United States, the IMF, other European countries and the European Commission to cut its deficit
more aggressively.[79] [80]
Niall Ferguson writes that "the sovereign debt crisis that is unfolding ... is a fiscal crisis of the western world".[81]
Financing needs for the Eurozone in 2010 come to a total of €1.6 trillion, while the US is expected to issue
US$1.7 trillion more Treasury securities in this period,[82] and Japan has ¥213 trillion of government bonds to roll
over.[83] The countries most at risk are those that rely on foreign investors to fund their government sector.
According to Ferguson similarities between the U.S. and Greece should not be dismissed.[84]
For 2010, the OECD forecasts $16,000bn will be raised in government bonds among its 30 member countries.
Greece has been the notable example of an industrialised country that has faced difficulties in the markets because of
rising debt levels. Even countries such as the US, Germany and the UK, have had fraught moments as investors
shunned bond auctions due to concerns about public finances and the economy.[85] According to Niall Ferguson in
the Financial Times: "Only two things have thus far stood between the US and higher bond yields: purchases of
Treasuries by the Federal Reserve and reserve accumulation by the Chinese monetary authorities. But now the Fed is
phasing out such purchases and is expected to wind up quantitative easing. Meanwhile, the Chinese have sharply
reduced their purchases of Treasuries from around 47 per cent of new issuance in 2006 to 20 per cent in 2008 to an
estimated 5 per cent last year."[86]
On the positive side, The Economist acknowledged on 27 May 2010 that while Europe's "profligate economies will
struggle ... as austerity kicks in," it also pointed out that "waning confidence will be mitigated by the boost that
exports receive from the euro’s plunge."[87]
Long-term solutions
European Union leaders have made two major proposals for ensuring fiscal stability in the long term. The first
proposal is the creation of the European Financial Stability Facility.[88] The second is a single authority responsible
for tax policy oversight and government spending coordination of EU member countries, temporarily called the
European Treasury.[89] The stability facility is financially backed by the EU and the IMF. The European Parliament,
the European Council, and especially the European Commission, can all provide some support for the treasury while
it is still being built. However, strong European Commission oversight in the fields of taxation and budgetary policy
and the enforcement mechanisms that go with it have been described as infringements on the sovereignty of
eurozone member states[90] and are opposed by key EU nations such as France and Italy, which could jeopardise the
establishment of a European Treasury.
Some think-tanks such as the CEE Council have argued that the predicament some EU countries find themselves in
is the result of a decade of debt-fueled macroeconomic policies pursued by local policy makers and complacent EU
central bankers,[91] and have recommended the imposition of a battery of corrective policies to control public debt.
Some senior German policy makers went as far as to say that emergency bailouts should bring harsh penalties to EU
aid recipients such as Greece.[92] Others argue that an abrupt return to "non-Keynesian" financial policies is not a
viable solution and predict the deflationary policies now being imposed on countries such as Greece and Spain might
prolong and deepen their recessions.[93] The Economist has suggested that ultimately the Greek "social contract,"
which involves "buying" social peace through public sector jobs, pensions, and other social benefits, will have to be
changed to one predicated more on price stability and government restraint if the euro is to survive.[94] As Greece
can no longer devalue its way out of economic difficulties it will have to more tightly control spending than it has
since the inception of the Third Hellenic Republic.
Regardless of the corrective measures chosen to solve the current predicament, as long as cross border capital flows
remain unregulated in the Euro Area,[95] asset bubbles[96] and current account imbalances are likely to continue. For
example, a country that runs a large current account or trade deficit (i.e., it imports more than it exports) must also be
a net importer of capital; this is a mathematical identity called the balance of payments. In other words, a country
that imports more than it exports must also borrow to pay for those imports. Conversely, Germany's large trade
surplus (net export position) means that it must also be a net exporter of capital, lending money to other countries to
allow them to buy German goods.[97] The 2009 trade deficits for Spain, Greece, and Portugal were estimated to be
$69.5 billion, $34.4B and $18.6B, respectively ($122.5B total), while Germany's trade surplus was $109.7B.[98] A
similar imbalance exists in the U.S., which runs a large trade deficit (net import position) and therefore is a net
borrower of capital from abroad. Ben Bernanke warned of the risks of such imbalances in 2005, arguing that a
"savings glut" in one country with a trade surplus can drive capital into other countries with trade deficits, artificially
lowering interest rates and creating asset bubbles.[99] [100]
A country with a large trade surplus would generally see the value of its currency appreciate relative to other
currencies, which would reduce the imbalance as the relative price of its exports increases. This currency
appreciation occurs as the importing country sells its currency to buy the exporting country's currency used to
purchase the goods. However, many of the countries involved in the crisis are on the Euro, so this is not an available
solution at present. Alternatively, trade imbalances might be addressed by changing consumption and savings habits.
For example, if a country's citizens saved more instead of consuming imports, this would reduce its trade deficit.
Likewise, reducing budget deficits is another method of raising a country's level of saving. Capital controls that
restrict or penalize the flow of capital across borders is another method that can reduce trade imbalances. Interest
rates can also be raised to encourage domestic saving, although this benefit is offset by slowing down an economy
and increasing government interest payments.[101]
The suggestion has been made that long term stability in the eurozone requires a common fiscal policy rather than
controls on portfolio investment.[102] In exchange for cheaper funding from the EU, Greece and other countries, in
addition to having already lost control over monetary policy and foreign exchange policy since the euro came into
being, would therefore also lose control over domestic fiscal policy.
Finally, there has been some criticism over the austerity measures implemented by most European nations to counter
this debt crisis. Apart from arguments over whether or not austerity, rather than increased or freezed spending, is a
macroeconimic solution, there has also been a sense of unjust crisis management which mostly stems from the
notion that, as a direct consequence of the Financial crisis of 2007–2010, the working population should not be held
responsible for the economic mismanagement errors of economists, investors, and bankers. Over 23 million EU
workers have become unemployed as a cosequence of the global economic crisis of 2007-2010, whilst thousands of
bankers across the EU have become millionaires despite collapse or nationalisation (ultimately paid for by taxpayers)
of institutions they worked for during the crisis, a fact that has lead many to call for additional regulation of the
banking sector across not only Europe, but the entire world.[103]
Controversies
Credit rating agencies

The international credit rating agencies – Moody's, S&P and Fitch – have played a central[104] and controversial
role[105] in the current European bond market crisis.[106] As with the housing bubble[107] [108] and the Icelandic
crisis,[109] [110] the ratings agencies have been under fire. The agencies have been accused of giving overly generous
ratings due to conflicts of interest.[111] Ratings agencies also have a tendency to act conservatively, and to take some
time to adjust when a firm or country is in trouble.[112] In the case of Greece, the market responded to the crisis
before the downgrades, with Greek bonds trading at junk levels several weeks before the ratings agencies began to
describe them as such.[104]
Government officials have criticised the ratings agencies and the German finance minister has said traders should not
take global rating agencies "too seriously" following downgrades of Greece, Spain and Portugal. Guido Westerwelle,
German foreign minister, called for an "independent" European rating agency, which could avoid the conflicts of
interest that he claimed US-based agencies faced.[113] According to the Financial Times "The latest furore over the
agencies' role in the sovereign debt market"[113] is likely to bring about more supervision of these agencies.
Germany's foreign minister suggested the European Union should create its own rating agency. He spoke after
downgrades of Greece and Portugal roiled financial markets.[104]
European leaders are reportedly studying the possibility of setting up a European ratings agency in order that the
private U.S.-based ratings agencies have less influence on developments in European financial markets in the
future.[114] [115] Due to the failures of the ratings agencies, European regulators will be given new powers to
supervise ratings agencies.[105] These supervisory powers will come into effect in December 2010.
In a response to the actions of the private U.S. based ratings agencies the ECB announced on 3 May that it will
accept as collateral all outstanding and new debt instruments issued or guaranteed by the Greek government,
regardless of the nation's credit rating.[116]
Media
There has been considerable controversy about the role of the English-language press in the regard to the bond
market crisis.[117] [118] Spanish Prime Minister José Luis Rodríguez Zapatero ordered the Centro Nacional de
Inteligencia intelligence service to investigate the role of the "Anglo-Saxon media" in fomenting the crisis.[119] [120]
[121] [122]
No results have so far been reported as a result of this investigation.
According to the Madrid daily El País, "the National Intelligence Center (CNI) was investigating 'whether investors'
attacks and the aggressiveness of some Anglo-Saxon [sic] media are driven by market forces and challenges facing
the Spanish economy, or whether there is something more behind this campaign.'"[123] [124] [125] The Spanish Prime
Minister has suggested[126] that the recent financial market crisis in Europe is an attempt to draw international capital
away from the euro[127] in order that countries, such as the U.K. and the U.S., can continue to fund their large
external deficits which are matched by large government deficits.[8] The U.S. and U.K. do not have large domestic
savings pools to draw on and therefore are dependent on external savings.[128] This is not the case in the Eurozone
which is self funding.[129]
Greek Prime Minister Papandreou is quoted as saying that there was no question of Greece leaving the euro and
suggested that the crisis was politically as well as financially motivated. "This is an attack on the eurozone by certain
other interests, political or financial".[130] On the same time, a statistic on the articles referenced here shows that only
"bad" news were propagated by the media and never "good" news.
Role of speculators
Financial speculators and hedge funds engaged in selling euros have also been accused by both the Spanish and
Greek Prime Ministers of worsening the crisis.[131] [132] Angela Merkel has stated that "institutions bailed out with
public funds are exploiting the budget crisis in Greece and elsewhere."[133]
The role of Goldman Sachs[134] in Greek bond yield increases is also under scrutiny.[135] It is not yet clear to what
extent this bank has been involved in the unfolding of the crisis or if they have made a profit as a result of the sell-off
on the Greek government debt market.
In response to accusations that speculators were worsening the problem, some markets banned naked short selling
for a few months.[136]
Timeline of Greek crisis

Below is a brief summary of some of the main events in the Greek Sovereign debt crisis.[137]
October 2009
• A new Greek government is formed after the election, led by PASOK, which received 43.92% of the popular
vote, and 160 of 300 parliament seats.
November 2009
• 5 Nov.: Update of government budget reveals an estimate deficit of 12.7% of GDP for 2009, more than twice the
previously announced figure, and 4 times the initial (December 2008) estimate.
• 8 Nov.: Budget draft aims to cut deficit to 8.7% of GDP for 2010. Draft also projects total debt rising to 121% of
GDP in 2010 from 113.4% in 2009.
December 2009
• 8 Dec.: Fitch Ratings cuts Greece's rating to BBB+ from A-, with a negative outlook.
• 14 Dec.: Greek PM Papandreou outlines first round of policies to cut deficit and regain investor trust.
• 16 Dec.: S&P cuts Greece's rating to BBB+ from A-.
• 22 Dec.: Moody's cuts Greece's rating to A2 from A1.
January 2010
• 14 Jan.: Greece unveils the Stability and Growth Program which aims to cut deficit from 12.7% in 2009 to 2.8%
in 2012.
• Jan. xx: 5-year bond issue is five-times oversubscribed but yields and spreads rise.
February 2010
• 2 Feb.: Government extends public sector wage freeze to those earning less than EUR 2,000 a month.
• 3 Feb.: EU Commission backs Greece's Stability and Growth Program and urges it to cut its overall wage bill.
• 24 Feb.: One-day general strike against the austerity measures halts public services and transport system.
• 25 Feb.: EU mission in Athens with IMF experts delivers grim assessment of country's finances.
March 2010
• 5 Mar.: New public sector wage cuts and tax increases is passed and estimated to generate savings of EUR 4.8 bn.
Measures include increasing VAT by 2% to 21%, cutting public sector salary bonuses by 30%, increases on fuel,
tobacco and alcohol consumption taxes and freezing state-funded pensions in 2010.
• 11 Mar.: Public and private sector workers strike.
• 15 Mar.: EMU finance ministers agree on mechanism to help Greece but reveal no details.
• 18 Mar.: Papandreou warns Greece will not be able to cut deficit if borrowing costs remain as high as they are and
may have to go to the IMF.
• 19 Mar.: European Commission President José Manuel Barroso urges EU member states to agree a standby aid
package for Greece. Barroso says the EMU countries should be on stand by to make bilateral loans.
• 25 Mar.: ECB President Jean-Claude Trichet says his bank will extend softer rules on collateral (accepting BBB?
instead of the standard A-) for longer (up to 2011) in order to avoid a situation where one ratings agency
(Moody's) basically decides if an EMU country's bonds are eligible for use as ECB collateral.
• Mar.: €5bn in 10-year Greek bonds sold – orders for three times that amount are received.
April 2010
• 9 Apr.: Greek government announces that the deficit for the first trimester was reduced by 39,2%.[138] The news
fails to impact the market, since it is ignored by the main financial media.
• 11 Apr.: EMU leaders agree bailout plan for Greece. Terms are announced for EUR 30 bn of bilateral loans
(roughly 5% for a three-year loan). EMU countries will participate in the amount based on their ECB country
keys. Rates for variable rate loans will be 3m-Euribor plus 300 bp + 100 bp for over three-year loans plus a
one-off 50 bp charge for operating expenses. For fixed rate loans rates will be swap rate for the loan's maturity,
plus the 300 bp (as in variable) plus the 100 bp for loans over three years plus the 50 bp charge.
• 13 Apr.: ECB voices its support for the rescue plan.
• 15 Apr.: Olli Rehn says there is no possibility of a Greek default and no doubt that Germany will participate in the
bail out plan. In the mean time there had been serious objections from parts of German society to the country's
participation in the Greek bail-out.
• Apr. Sale of more than 1.5 billion euros Greek Treasury bills met with "stronger-than-expected" demand, albeit at
a high interest rate.
• 23 Apr.: Greece officially asks for the disbursement of money from the aid package effectively activating it.
• 27 Apr.: Standard and Poor's downgrades Greece's debt ratings below investment grade to junk bond status.
• 27 Apr.: S&P downgrades Portuguese debt two notches and issues negative outlook, warning that further
downgrades to junk status are likely. Stock indices around the world drop two to six percent on the news.
• 28 Apr. S&P downgrades Spanish bonds from AAA to AA-
May 2010
• 1 May: Protests, yearly taking place for the day, this year add "the proposed austerity measures", in Athens.
• 2 May: Greece announces the latest, fourth, raft of austerity measures.
• 3 May: The ECB announces that it will accept Greek Government Bonds as collateral no matter what their rating
is. This effectively means scrapping the BBB-floor in the case of Greece and increasing the likelihood of similar
announcements in case other countries run the risk of being downgraded to junk status.[139]
• 4 May: First day of strikes against the austerity measures. Global stock markets react negatively to fears of
contagion.[140]
• 5 May: General nationwide strike and demonstrations in two major cities in Greece turned violent. Three people
were killed when a group of masked people threw petrol bombs in a Marfin Bank branch on Stadiou street.[141]
[142]
• 6 May: Concerns about the ability of the Eurozone to deal with a spreading crisis effectively caused a severe
market sell off, particularly in the US where electronic trading glitches combined with a high volume sell off
produced a nearly 1,000 point intra-day drop in the Dow Jones Industrial Average, before it recovered somewhat
to close down 347.
• 7 May: Volatility continued to accelerate with an increasing CBOE VIX index and a major widening in currency
spreads, particularly dollar-yen and dollar-euro.
• 8 May: Leaders of the eurozone countries resolved in Brussels to take drastic action to protect the euro from
further market turmoil after approving a $100 billion bailout plan for Greece.[143]
• 20 May: Fourth strike in Greece against wage cuts.
• 24 May: Greek government is announcing deficit reduction by 41.5% for the first four months,[144] but the news
again fails the main financial media.
• 27 May: Debate rages in UK House of Commons about the prospect of Great Britain entering a similar financial
crisis. These exchanges become known as The Greek Defence.
• 29 May: Fitch downgrades Spanish government bonds one notch from AAA to AA+.[145]
June 2010
• 4 June: The Hungarian PM Viktor Orban's spokesman said it was not an exaggeration that the prospect of a
national default is very real, although Moody's still affirmed that Hungary had a good record of paying its
obligations.[146] The Euro fell to a four-year low[147] and major American markets fell more than 3%.
July 2010
• 5 July : The central Bank of Greece announced a reduction of central government cash deficit by 41.8%, for the
first half-year 2010.[148]
September 2010
• 5 September Spreads on longer-term Greek government debt have surged back to crisis levels of about 800 basis
points, implying a high risk of default.[149]
EU emergency measures
On 9 May 2010 the 27 member states of the European Union agree to create the European Financial Stability Facility
(EFSF), a legal instrument[150] aiming at preserving financial stability in Europe by providing financial assistance to
eurozone states in difficulty.[151]
In order to reach these goals the Facility is devised in the form of a special purpose vehicle (SPV) that will sell bonds
and use the money it raises to make loans up to a maximum of € 440 billion to eurozone nations in need. The bonds
will be backed by guarantees given by the European Commission representing the whole EU, the eurozone member
states, and the IMF. The new entity will sell debt only after an aid request is made by a country.[152]
The EFSF will be combined to a € 60 billion loan coming from the European financial stabilisation mechanism
(reliant on guarantees given by the European Commission using the EU budget as collateral) and to a € 250 billion
loan backed by the IMF in order to obtain a financial safety net up to € 750 billions.[153] [154] The agreement allows
the European Central Bank to start buying government debt which is expected to reduce bond yields.[155] (Greek
bond yields fell from over 10% to just over 5%;[156] Asian bonds also fell with the EU bailout.[157] )
The ECB has announced a series measures aimed at reducing volatility in the financial markets and at improving
liquidity:[158]
• First, it began open market operations buying government and private debt securities.
• Second, it announced two 3-month and one 6-month full allotment of Long Term Refinancing Operations
(LTRO's).
• Thirdly, it reactivated the dollar swap lines[159] with Federal Reserve support.[160]
Subsequently, the member banks of the European System of Central Banks started buying government debt.[161]
Stocks worldwide surged after this announcement as fears that the Greek debt crisis would spread subsided,[162]
some rose the most in a year or more.[163] The Euro made its biggest gain in 18 months,[164] before falling to a new
four-year low a week later.[165] Commodity prices also rose following the announcement.[166] The dollar Libor held
at a nine-month high.[167] Default swaps also fell.[168] The VIX closed down a record almost 30%, after a record
weekly rise the preceding week that prompted the bailout.[169]
Despite the moves by the EU, the European Commissioner for Economic and Financial Affairs, Olli Rehn, called for
"absolutely necessary" deficit cuts by the heavily indebted countries of Spain and Portugal.[170] Private sector
bankers and economists also warned that the threat from a double dip recession has not faded. Stephen Roach,
chairman of Morgan Stanley Asia, warned about this threat saying "When you have a vulnerable post-crisis
economic recovery and crises reverberating in the aftermath of that, you have some very serious risks to the global
business cycle."[171] Nouriel Roubini said the new credit available to the heavily indebted countries did not equate to
an immediate revival of economic fortunes: "While money is available now on the table, all this money is
conditional on all these countries doing fiscal adjustment and structural reform."[172]
After initially falling to a four-year low early in the week following the announcement of the EU guarantee
packages, the euro rose as hedge funds and other short-term traders unwound short positions and carry trades in the
currency.[173]
See also
• Economy of Greece
• 2000s commodities boom
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[150] (http:/ / euobserver. com/ 9/ 30293) "The European Financial Stability Facility (EFSF), a legal instrument agreed by finance ministers
earlier this month following the risk of Greece's debt crisis spreading to other weak economies."
[151] (http:/ / www. consilium. europa. eu/ uedocs/ cms_Data/ docs/ pressdata/ en/ misc/ 114976. pdf) "The 27 Member States agreed on 9 May
2010 that the Commission will be allowed to be tasked by the euro area Member States in the context of the assistance decided through a
special purpose vehicle (the European Financial Stability Facility (EFSF)) up to EUR 440 billion and aiming at preserving financial stability in
Europe. For the purposes of this support, the euro area Member States entrust the Commission, where appropriate in liaison with the ECB,
with the task of:
(i) negotiating and signing on their behalf after their approval the memoranda of understanding related to this support;
(ii) providing proposals to them on the loan facility agreements to be signed with the beneficiary Member State(s);
(iii) assessing the fulfilment of the conditionality laid down in the memoranda of understanding;
(iv) providing input, together with the EIB, to further discussions and decisions in the Eurogroup on EFSF related matters and, in a transitional
phase, in which the EFSF is not yet fully operational, on building up its administrative and operational capacities.
In addition, the Commission may be entrusted with certain additional tasks relating to the implementation of the support in accordance with
the framework agreement to be concluded between the EFSF and the euro area Member States. The Commission shall also ensure consistency
between EFSF operations and other operations of assistance by the EU.
The role of the Commission will not imply an increase in the expenditure of the Commission or of any other item of expenditure under the EU
budget.
The Commission and the ECB are invited to nominate an observer to the Board of Directors of the EFSF."
[152] (http:/ / www. bloomberg. com/ apps/ news?pid=20601068& sid=ajCcUH0_os58) "8 June (Bloomberg) -- European finance ministers put
the finishing touches on a rescue fund being backed by 440 billion euros ($524 billion) in national guarantees, seeking to halt the spread of
Greece’s debt crisis. The European Financial Stability Facility would sell bonds backed by the guarantees and use the money it raises to make
loans to euro-area nations in need, the finance ministers agreed yesterday in Luxembourg. The new entity would sell debt only after an aid
request is made by a country."
[153] (http:/ / www. europeanvoice. com/ article/ 2010/ 06/ spain-seeks-to-reassure-eu-leaders/ 68293. aspx) "Media reports said that Spain
would ask for support from two EU funds for eurozone governments in financial difficulty: a €60bn ‘European financial stabilisation
mechanism', which is reliant on guarantees from the EU budget."
[154] (http:/ / www. ft. com/ cms/ s/ 0/ 49b000ae-79a7-11df-85be-00144feabdc0. html) "The EFSF is expected to start operations in a few weeks,
as soon as national parliaments representing 90 per cent of the fund's shareholding have approved it. At that point, all eurozone governments
will be obliged to issue guarantees for the EFSF's debt instruments. If a country should need emergency funds before then, it can turn to a
€60bn balance of payments facility that is under the European Commission's authority and uses the EU budget as collateral. This, plus the
availability of up to €250bn in International Monetary Fund loans, makes up the €750bn package."
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[157] Asian Bond Risk Tumbles Most in 18 Months on EU Loan Package (http:/ / www. bloomberg. com/ apps/ news?pid=20601087&
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[161] Euro-Area Central Banks Are Buying Government Bonds (http:/ / www. bloomberg. com/ apps/ news?pid=20601087&
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sid=aE1_UY3fU. og& pos=1)
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[166] Oil, Copper, Nickel Jump on European Bailout Plan; Gold Drops (http:/ / www. bloomberg. com/ apps/ news?pid=20601087&
sid=aGoSOn0SC6Sk& pos=7)
[167] Dollar Libor Holds Near Nine-Month High After EU Aid (http:/ / www. bloomberg. com/ apps/ news?pid=20601087&
sid=ae6tRKLmr_H0& pos=3)
[168] Default Swaps Tumble After EU Goes 'All In': Credit Markets (http:/ / www. bloomberg. com/ apps/ news?pid=20601087&
sid=axZ17v8gTwZY& pos=5)
[169] VIX Plunges by Record 36% as Stocks Soar on European Loan Plan (http:/ / www. bloomberg. com/ apps/ news?pid=20601087& sid=a.
KDLwz0TnmM& pos=3)
[170] Rehn Says Deficit Cuts Absolutely Necessary in Spain, Portugal (http:/ / www. bloomberg. com/ apps/ news?pid=20601087&
sid=acX149MfijWU& pos=4)
[171] Roach Says Debt Crisis Raises Risk of 'Double Dip' Recession (http:/ / www. bloomberg. com/ apps/ news?pid=20601087&
sid=ag29h7Czezxw& pos=5)
[172] Roubini Says European Resolution an 'Open Question': Tom Keene (http:/ / www. bloomberg. com/ apps/ news?pid=20601087&
sid=aHwLirAaqp60& pos=5)
[173] Kitano, Masayuki (21 May 2010). "Euro surges in short-covering rally, Aussie soars" (http:/ / uk. finance. yahoo. com/ news/
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External links
• New York Times Map of European Debts (http://www.nytimes.com/interactive/2010/04/06/business/
global/european-debt-map.html)
• Protests in Greece in Response to Severe Austerity Measures in EU, IMF Bailout (http://www.democracynow.
org/2010/5/4/protests_in_greece_in_response_to) – video report by Democracy Now!
• 'The Greek Crisis – Politics, Economics, Ethics' Audio podcast of debate held at Birkbeck College University of
London on 5 May 2010 (http://backdoorbroadcasting.net/2010/05/
the-greek-crisis-politics-economics-ethics-a-debate/)
• 'Eurozone in Crisis: Reform or Exit?' Audio podcast of debate held at Birkbeck College Univerity of London on 2
June 2010 (http://backdoorbroadcasting.net/2010/06/eurozone-in-crisis-reform-or-exit/)
• NYT Diagram – Interlocking Debt Positions of European Countries – 1 May 2010 (http://www.nytimes.com/
interactive/2010/05/02/weekinreview/02marsh.html)
• Argentina: Life After Default (http://www.soundsandcolours.com/articles/argentina/
argentina-lessons-learnt-from-the-aftermath-of-default/) Article comparing the Argentine financial crisis of 2002
with the current situation in Greece
• Google - public data (http://www.google.com/publicdata/overview?ds=ds22a34krhq5p_): Government Debt
in Europe
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Athkalani, Bart133, Benson85, BrendelSignature, Bumphois, Carabinieri, Carltonz, Chris Henniker, ConanBaltar, Corpx, Curbrook, Dmwilliams, Dr Gangrene, Eddiecrochet, Erntab72,
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Rjwilmsi, Robofish, Sarakoth, Subsolar, Surv1v4l1st, Tomsega, Vegetator, Wayland, We hold these truths to be self-evident, Zeimusu, Zulitz, Zzuuzz, Ángel Luis Alfaro, 76 anonymous edits
Subprime crisis impact timeline Source: http://en.wikipedia.org/w/index.php?oldid=391155147 Contributors: Aequus, American2, AnOddName, Bender235, Bep verberk, Bequw,
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Subprime mortgage crisis Source: http://en.wikipedia.org/w/index.php?oldid=391173463 Contributors: 03md, 155ws, 164CL, 17Drew, 2ArgArg, ABF, ALL HAIL MEGATRON!,
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Financial crisis of 2007–2010 Source: http://en.wikipedia.org/w/index.php?oldid=391247429 Contributors: 155ws, 164CL, 1ForTheMoney, 84user, A. B., AaThinker, Acegikmo1, Acropolis
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Causes of the financial crisis of 2007–2010 Source: http://en.wikipedia.org/w/index.php?oldid=390893640 Contributors: Bender235, Ceoil, Cretog8, Didero, Edward, Farcaster, Gandalf61,
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Financial Crisis of 2000s

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Financial Crisis of 2000s

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Financial Crisis of the Late

History of the financial crisis 36

Why does financial innovation occur?

Historical examples of financial innovation

Examples of spanning the market

Examples of mathematical innovation

Examples of innovation to avoid taxes and regulation

The role of technology in financial innovation

Financial sector, Real / Theses Authority

"Economy Bill Gross

Earned No theses required These terms are

Examples of FIRE economies

Shadow banking system

Entities that make up the system

Shadow institutions like investment

Contribution to the 2007–2010 financial crisis

Democracy and economic freedom

Monetary democracy and corporate growth

Some skeptics of capitalism argue that public demand plays a

Skeptics focus on the unspoken and suppressed "non-crucial"

In Capital, Karl Marx identified the commodity as the basic unit of

Imperialism and political oppression

Inefficiency and waste

In the early 20th century, Vladimir Lenin argued that

inequalities are a fundamental cause of financial

— Che Guevara, Marxist revolutionary [40]

Title page of Karl Marx's Das Kapital, first

Marxists define capital as "a social, economic relation" between people

Some Christian critics of capitalism may not oppose capitalism

• Information and Economics: A Critique of Hayek (http://reality.gn.apc.org/econ/hayek.htm) by Allin F.

Origin of the term

Criticism of the Concept

Notes and References

Main Theories of post-Fordism

Changes from Fordism to post-Fordism

History of the financial crisis

Subprime crisis impact timeline

head off a possible crisis[85]

January 2008 to August 2008

warren-buffett-why-i-bought-ge-why-we-have-terrible-terrible-problems-). Clusterstock. 2008-10-01. .

Subprime mortgage crisis

Background and timeline of events

In the years leading up to the crisis, significant amounts of foreign

The value of American subprime mortgages was estimated at $1.3

Boom and bust in the housing market

While housing prices were increasing, consumers were saving less[47]

High-risk mortgage loans and lending/borrowing practices

Inaccurate credit ratings

Policies of central banks

Financial institution debt levels and incentives

Credit default swaps

Boom and collapse of the shadow banking system

Impact in the U.S.

Financial market impacts, 2007

Financial market impacts, 2008

Federal Reserve and central banks

Bank solvency and capital replenishment

Bailouts and failures of financial firms

Homeowners Affordability and Stability Plan

Regulatory proposals and long-term solutions

Law investigations, judicial and other responses

Financial crisis of 2007–2010

Growth of the housing bubble