The 2008 financial crisis explained

The 2008 crash was the greatest jolt to the global financial system in almost a century – it pushed
the world's banking system towards the edge of collapse. We explore the causes and consequences
of the crash, consider its historical parallels, and ask – how will history remember the crisis?

Within a few weeks in September 2008, Lehman Brothers, one of the world‟s biggest financial
institutions, went bankrupt; £90bn was wiped off the value of Britain‟s biggest companies in a single
day; and there was even talk of cash machines running empty.

On 15 September 2008, Lehman Brothers filed for bankruptcy. This is generally considered to be the
day the economic crisis began in earnest. The then-president George W Bush announced that there
would be no bail-out. “Lehmans, one of the oldest, richest, most powerful investment banks in the
world, was not too big to fail,” says the Telegraph.

The 2008 financial crash had long

roots but it wasn‟t until September
2008 that its effects became
apparent to the world. The
immediate trigger was a
combination of speculative activity in
the financial markets, focusing
particularly on property transactions
– especially in the USA and western
Europe – and the availability of
cheap credit, says Scott Newton,
emeritus professor of modern British
and international history at the
University of Cardiff.

“There was borrowing on a huge

scale to finance what appeared to
be a one-way bet on rising property prices. But the boom was ultimately unsustainable because, from
around 2005, the gap between incomes and debt began to widen. This was caused by rising energy
prices on global markets, leading to an increase in the rate of global inflation.

“This development squeezed borrowers, many of whom struggled to repay mortgages. Property
prices now started to fall, leading to a collapse in the values of the assets held by many financial
institutions. The banking sectors of the USA and the UK came very close to collapse and had to be
rescued by state intervention.”

“Excessive financial liberalisation from the late 20th century, accompanied by a reduction in
regulation, was underpinned by confidence that markets are efficient,” says Martin Daunton, emeritus
professor of economic history at the University of Cambridge.

“The crash first struck the banking and financial system of the United States, with spill-overs into
Europe,” Daunton explains. “Here, another crisis – one of sovereign debt – arose from the flawed
design of the eurozone; this allowed countries such as Greece to borrow on similar terms to Germany
in the confidence that the eurozone would bail out the debtors.

“When the crisis hit, the European Central Bank refused to reschedule or mutualise debt and instead
offered a rescue package – on the condition that the stricken nations pursued policies of austerity.”

A number of economists claim to have predicted or anticipated the 2008 crisis. Back in 2003, as editor
of The Real World Economic Outlook, the UK-based author and economist Ann Pettifor predicted an
Anglo-American debt-deflationary crisis. This was followed by The Coming First World Debt Crisis
(2006), which became a bestseller after the global financial crisis.

But, Newton explains, “the crash caught economists and commentators cold because most of them
have been brought up to view the free market order as the only workable economic model available.
This conviction was strengthened by the dissolution of the USSR, and China‟s turn towards capitalism,
along with financial innovations that led to the mistaken belief that the system was foolproof.”

Was the crisis unusual in being so sudden and so unexpected?

“There was a complacent assumption that crises were a thing of the past, and that there was a „great
moderation‟ – the idea that, over the previous 20 or so years, macroeconomic volatility had declined,”
says Daunton.

“The variability in inflation and output had declined to half of the level of the 1980s, so that the
economic uncertainty of households and firms was reduced and employment was more stable.

“In 2004, Ben Bernanke, a governor of the Federal Reserve who served as chairman from 2006 to
2014, was confident that a number of structural changes had increased economies‟ ability to absorb
shocks, and also that macroeconomic policy – above all monetary policy – was much better in
controlling inflation.

“In congratulating himself for the Fed‟s successful managing of monetary policy, Bernanke was not
taking account of the instability caused by the financial sector (and nor were most of his fellow
economists). However, the risks were apparent to those who considered that an economy is
inherently prone to shocks.”

Newton adds that the 2008 crisis “was more sudden than the two previous crashes of the post-1979
era: the property crash of the late 1980s and the currency crises of the late 1990s. This is largely
because of the central role played by the banks of major capitalist states. These lend large volumes
of money to each other as well as to governments, businesses and consumers.

“Given the advent of 24-hour and computerised trading, and the ongoing deregulation of the financial
sector, it was inevitable that a major financial crisis in capitalist centres as large as the USA and the
UK would be transmitted rapidly across global markets and banking systems. It was also inevitable
that it would cause a sudden drying up of monetary flows.”

How closely did the events of 2008 mirror previous economic crises, such as the Wall Street Crash of
1929? There are some parallels with 1929, says Newton, “the most salient being the reckless
speculation, dependence on credit, and grossly unequal distribution of income. “However, the Wall
Street Crash moved across the globe more gradually than its counterpart in 2007–08. There were
currency and banking crises in Europe, Australia and Latin America but these did not erupt until
1930–31 or even later. The US experienced bank failures in 1930–31 but the major banking crisis
there did not occur until late 1932 into 1933.”

Dr Linda Yueh, an economist at Oxford University and London Business School, adds: “Every crisis is
different but this one shared some similarities with the Great Crash of 1929. Both exemplify the
dangers of having too much debt in asset markets (stocks in 1929; housing in 2008).”

Highlighting distinctions between the two crises, Daunton says: “Crises follow a similar pattern –
overconfidence succeeded by collapse – but those of 1929 and 2008 were characterised by different
fault lines and tensions. The state was much smaller in the 1930s (constraining its ability to
intervene) and international capital flows were comparatively tiny.

“There were also differences in monetary policy. By abandoning the gold standard in 1931 and 1933,
Britain and America regained autonomy in monetary policy. However, the Germans and French
remained on gold, which hindered their recovery.
“The post-First World War settlement hampered international co-operation in 1929: Britain resented
its debt to the United States, and Germany resented having to pay war reparations. Meanwhile,
primary producers were seriously hit by the fall in the price of food and raw materials, and by
Europe‟s turn to self-sufficiency.”

How did politicians and policymakers try to „solve‟ the crisis?

Initially, policymakers reacted quite successfully, says Newton. “Following the ideas of [influential
interwar economist] John Maynard Keynes, governments didn‟t use public spending cuts as a means
of reducing debt. Instead, there were modest national reflations, designed to sustain economic
activity and employment, and replenish bank and corporate balance sheets via growth.

“These packages were supplemented by a major expansion of the IMF‟s resources, to assist nations
in severe deficit and offset pressures on them to cut back which could set off a downward spiral of
trade. Together, these steps prevented the onset of a major global slump in output and employment.

“By 2010, outside the USA, these measures had been generally suspended in favour of „austerity‟,
meaning severe economies in public spending. Austerity led to national and international slowdowns,
notably in the UK and the eurozone. It did not, however, provoke a slump – largely thanks to massive
spending on the part of China, which, for example, consumed 45 per cent more cement between
2011 and 2013 than the US had used in the whole of the 20th century.”

Daunton adds: “Quantitative easing worked in stopping the crisis becoming as intense as in the Great
Depression. The international institutions of the World Trade Organisation also played their part,
preventing a trade war. But historians might look back and point to grievances that arose from the
decision to bail out the financial sector, and the impact of austerity on citizens‟ quality of life.”

What were the consequences of the 2008 crisis?

In the short term, an enormous bail-out – governments pumping billions into stricken banks – averted
a complete collapse of the financial system. In the long term, the impact of the crash has been
enormous: depressed wages, austerity and deep political instability. Twelve years on, we‟re still living
with the consequences.