The Financial Crisis of 2008

Contents

1. The measurements
2. From a housing boom to a banking crisis
3. What the inquiry concluded
4. What it did to households
5. Where to see it in person

Brent O’Mara learned early in his working life that conventional assumptions do not always hold. The crisis this entry describes was the episode in which the broadest assumptions of a generation failed at once. Recessions are measured in months, and its units are the peak and trough dates set by the Business Cycle Dating Committee of the National Bureau of Economic Research. On September 20, 2010, the committee announced that a trough in business activity had occurred in June 2009, ending a recession that began in December 2007. At 18 months it was the longest of any recession since the Second World War, two months longer than the downturns of 1973 to 1975 and 1981 to 1982.³ The committee was careful to say that it had not concluded conditions since June 2009 were favorable, only that the decline had stopped.³ How such dates are chosen is the subject of a separate entry.

The measurements

The second unit is the unemployment rate. In December 2007 it stood at 5.0 percent and had been at or below that level for the previous 30 months. By June 2009 it was 9.5 percent, and it kept rising after the recession formally ended, peaking at 10.0 percent in October 2009, the first months above that mark since the stretch from September 1982 to June 1983.⁴ The Bureau of Labor Statistics recorded that employment fell faster than in any recession of recent decades, that construction and manufacturing suffered their largest job losses of the postwar era, and that in February 2009 employers took 3,059 mass layoff actions involving 326,392 workers, both records in a series that began in 1995.⁴ Nebraska, with the two Dakotas, had the lowest monthly unemployment rates of any state in the months after the recession ended.⁴

Figure

Unemployment through the recession

December 2007, the month the recession began

5.0 percent

June 2009, the month it ended

9.5 percent

October 2009, the peak that came after the recession was over

10.0 percent

From a housing boom to a banking crisis

The third unit is the house. History.com traces the crisis to subprime mortgages, home loans made to borrowers with poor credit histories, which lenders wrote freely during the housing boom of the early and middle 2000s and which other institutions bought in bulk as mortgage backed securities in the hope of a quick profit.⁷ When prices stopped rising the chain broke. A subprime lender went bankrupt in April 2007, a second followed in August, the rating agencies cut the ratings on more than 100 subprime bonds that summer, and millions of homeowners found themselves underwater, owing more than the house was worth.⁷ In March 2008 a large investment bank collapsed and was sold at a cut rate price; in September a second one filed the largest bankruptcy in American history, and within days the central bank lent an insurance and investment company some 85 billion dollars to keep it afloat.⁷ The central bank had cut its target rate from 5.25 percent in September 2007 to zero by the end of 2008, the first time it had done so, and Congress had passed a stimulus act in February 2008 with rebates of 600 to 1,200 dollars.⁷ A PBS NewsHour retrospective ten years later called the September failure the signal event of the crisis, whose effects on income, wealth and politics were still present.⁶

Figure

From a housing boom to a banking crisis

1. 01
   February 2007One of the two mortgage finance companies announced it would no longer buy risky subprime mortgages or securities built on them.
2. 02
   April 2007A subprime lender with no buyer left for its loans declared bankruptcy, and a second major lender followed in August.
3. 03
   Summer 2007The two main credit rating agencies announced cuts to the ratings on more than 100 bonds backed by second lien subprime mortgages.
4. 04
   October 2007A broad market gauge reached its high on October 9 and then lost more than half its value over the next 18 months.
5. 05
   March 2008A large investment bank collapsed under its subprime holdings and was bought at a cut rate price.
6. 06
   September 2008A second large investment bank filed the largest bankruptcy in American history, and within days the central bank lent an insurer some 85 billion dollars to keep it afloat.

What the inquiry concluded

The Financial Crisis Inquiry Commission, whose report and conclusions are archived by Stanford Law School, opened with the choice the nation faced in 2008: risk the collapse of the financial system, or commit trillions of taxpayer dollars to rescue major corporations while millions of Americans still lost jobs, savings and homes.¹ The commission concluded that the crisis was avoidable. It found widespread failures in financial regulation, dramatic breakdowns in corporate governance, excessive borrowing and risk taking by households and Wall Street, policy makers who were ill prepared, and systemic breaches of accountability and ethics at all levels, and it published a dissent by three of its members alongside the majority’s conclusions.¹ The Federal Deposit Insurance Corporation later wrote its own history, which treats the period as two overlapping crises, a financial crisis in 2008 and 2009 and a banking crisis that began in 2008 and continued until 2013.² Greg Ip of The Wall Street Journal summed up the assumptions that failed: households had bought homes they thought could never fall in price, banks had made loans they thought would never default and repackaged them to seem riskless, and governments convinced that depressions were a thing of the past had stood by.⁹

What it did to households

Thirty months after the recession began, Pew Research surveyed 2,967 adults and found that 55 percent of the labor force had experienced a work related hardship, whether a spell of unemployment, a cut in pay, reduced hours or an involuntary move to part time work.⁵ The bursting of the housing and stock market bubbles had shrunk the wealth of the average household by an estimated 20 percent, the deepest decline of the postwar era, and the survey recorded a new frugality in spending and borrowing and downsized expectations about retirement.⁵ Edward Wolff, an economist at New York University, calculated that median household net worth fell 47 percent between 2007 and 2010, to its lowest level in more than forty years adjusted for inflation; the central bank’s own analysis put the fall closer to 39 percent.⁸ The middle class suffered most because the crisis was first a housing crisis, homes were the largest store of middle class wealth, and those families carried far more debt per dollar of wealth than the wealthy did, which made every fall in house prices cut deeper.⁸ Diversification across asset types offered less shelter than many expected, because assets of many kinds fell together, and how people reacted is covered under investor behavior in downturns.

Figure

What households lost

fall in median household net worth from 2007 to 2010, adjusted for inflation, by one economist's estimate

47 percent

the same fall as measured by the central bank

39 percent

share of middle class assets that was home equity even after the housing bust

66.6 percent

Where to see it in person

The documentary record of the crisis is unusually complete. The commission’s full report, its conclusions and the dissent are kept online by Stanford Law School, which maintains the archive.¹ The FDIC’s history, Crisis and Response, is published as a complete book with chapters on the origins of the crisis, the temporary liquidity program, bank supervision, deposit insurance and bank resolutions, with a podcast for each chapter and a printed edition that can be ordered.² The Bureau of Labor Statistics keeps its 2012 Spotlight on the recession, with charts comparing it to every downturn since 1948, and the dating committee’s announcement sets out exactly which monthly indicators it weighed and when each reached bottom.³⁴ The image at the head of this entry shows the other record, a foreclosed house stripped of its copper pipe, of which the country had a great many.