What role did the financial institutions play in the Great Recession?
Financial institutions were to blame for the Great Recession, because they created trillions of dollars in risky mortgages and they packaged, repackaged, and sold those loans to investors around the world.
Increased borrowing by banks and investors
Borrowing money to purchase an asset (known as an increase in leverage) magnifies potential profits but also magnifies potential losses. As a result, when house prices began to fall, banks and investors incurred large losses because they had borrowed so much.
The root cause was excessive mortgage lending to borrowers who normally would not qualify for a home loan, which greatly increased risk to the lender. Lenders were willing to take this risk as they could simply package the loans into an instrument they sold, passing the risk on to investors.
By the spring of 2008, with the failure of many subprime originators (including top lenders Countrywide Financial Corporation and Ameriquest Mortgage Company), the U.S. subprime mortgage industry had essentially collapsed.
The financial crisis of 2007–08 was a major shock to the U.S. banking sector. From 2007 through 2013, the number of independent commercial banks shrank by 14 percent — more than 800 institutions. Most of this decrease was due to the dwindling number of community banks.
In September 2008 Lehman Brothers collapsed in the biggest U.S. bankruptcy ever. When the bubble burst, financial institutions were left holding trillions of dollars worth of near-worthless investments in subprime mortgages.
Many of the small banks had lent large portions of their assets for stock market speculation and were virtually put out of business overnight when the market crashed. In all, 9,000 banks failed--taking with them $7 billion in depositors' assets.
Financial institutions were to blame for the Great Recession, because they created trillions of dollars in risky mortgages and they packaged, repackaged, and sold those loans to investors around the world.
The major causes of the initial subprime mortgage crisis and the following recession include lax lending standards contributing to the real-estate bubbles that have since burst; U.S. government housing policies; and limited regulation of non-depository financial institutions.
- Michael J. Cullen, founder, King Kullen Grocery.
- Scott Boilen, Allstar Products, Snuggie creator.
- Charles Darrow, inventor of the Monopoly board game.
- Michael Burry and John Paulson, hedge fund managers.
- Warren Buffett, business magnate and investor.
- David Royce, owner of Aptive Environmental.
What were the three effects of the Great Recession?
Given the prospects for a prolonged period of sluggish growth, high unemployment, depressed housing prices, and severe fiscal constraints on government, the Russell Sage Foundation has decided to support a battery of studies of the social and economic effects of the Great Recession.
On Sept. 15, 2008, Lehman Brothers, a well-known and respected investment bank, filed for bankruptcy protection after the Bush Administration's Treasury Secretary, Hank Paulson, refused to grant them a bailout.
The housing sector led not only the financial crisis, but also the downturn in broader economic activity. Residential investment peaked in 2006, as did employment in residential construction.
From 2008 through 2015, more than 500 banks failed as a result of this crisis, however, due to the protection extended by the FDIC and NCUA, insured deposits were safe once again. For comparison, in the 7 years prior to 2008 only 25 banks failed.
In 2008, 25 banks failed, according to the Federal Deposit Insurance Corporation's database. Included in that count is Washington Mutual, the largest bank failure in US history. Over the three years that followed, nearly 400 banks failed.
For those keeping tabs, the total assets of the major financial institutions in 2008 that collapsed or were saved with public support—Bear Stearns, Lehman Brothers, AIG, Washington Mutual, Citigroup—were $4.5 trillion at the time. Freddie and Fannie add a further $1.8 trillion.
The Great Depression of 1929–39
Encyclopædia Britannica, Inc. This was the worst financial and economic disaster of the 20th century. Many believe that the Great Depression was triggered by the Wall Street crash of 1929 and later exacerbated by the poor policy decisions of the U.S. government.
This took a sharp turn after the U.S. declared a recession in December 2007. From 2008 to 2012, bank failures shot up to an average of 93 per year. Of the 568 bank failures from 2000 to 2023, 465—or 82%—occurred from 2008 to 2012.
The monetary contraction, as well as the financial chaos associated with the failure of large numbers of banks, caused the economy to collapse. Less money and increased borrowing costs reduced spending on goods and services, which caused firms to cut back on production, cut prices and lay off workers.
Milton Friedman and Anna Schwartz argued that steady withdrawals from banks by nervous depositors ("hoarding") were inspired by news of the fall 1930 bank runs and forced banks to liquidate loans, which directly caused a decrease in the money supply, shrinking the economy.
Why did bank failures cause the Great Depression?
There was a recession in 1937-38 some argue because the money supply fell. When the money supply recovered, the economy started expanding again. That is the monetary explanation for the Great Depression. Bank failures, bank runs caused a contraction of the money supply, causes a decline in spending, investing, and GDP.
Michael Burry rose to fame after he predicted the 2008 U.S. housing crash and managed to net $100 million in personal profits, and another $700 million for his investors with a few lucrative, out-of-consensus bets.
The interest rate hikes increased the monthly payments on subprime loans, and many homeowners were unable to afford their payments. They were also unable to refinance or sell their homes due to the real estate market slowing down. The only option was for homeowners to default on their loans.
JPMorgan weathered the 2008 financial crisis better than most. It was perhaps the healthiest of America's big banks but felt compelled to join others in taking billions of dollars in a government bailout—a plan meant to avoid singling out banks with truly dire problems.
Banks stopped lending to each other in fear of being stuck with subprime mortgages as collateral. Foreclosures rose, & the housing bust caused the market to dive and eventually crash in September 2008, ultimately losing more than half its value.
