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The 2008 financial crisis was a complex event with multiple, interconnected causes rather than a single point of failure. The crisis originated in the U.S. housing market but spread globally through complex financial instruments, ultimately threatening the entire international financial system. Key factors included a housing bubble fueled by risky mortgage lending, government policies promoting homeownership, financial innovations that obscured risk, and significant failures in regulation and corporate governance [3, 7].
1. The U.S. Housing Bubble Between 1998 and 2006, U.S. home prices rose dramatically, creating a speculative bubble. This was driven by a long period of low interest rates and a large inflow of foreign capital, which made borrowing money cheap [3, 7]. The belief that housing prices would only continue to rise encouraged homebuyers, lenders, and investors to take on increasing levels of risk [3].
2. Proliferation of Subprime and Risky Mortgages As the housing market boomed, lenders relaxed their standards to attract more borrowers and generate fees. This led to a surge in subprime mortgages—loans made to borrowers with poor credit histories. These often featured low initial “teaser” rates that would later reset to much higher rates, making them unaffordable for many homeowners [3, 5].
Other risky loan types also became common, such as “no-doc” or “liar loans,” where lenders did not require borrowers to provide documentation of their income, assets, or employment [4]. Mortgage originators like Countrywide Financial aggressively pushed these products, often using deceptive practices, because their profits came from the volume of loans they originated, not their long-term performance [5].
3. Government Policies and Housing Goals For decades, U.S. government policy aimed to expand homeownership. The George W. Bush administration intensified this effort, launching initiatives to close the “homeownership gap” for minority families [8, 9]. This policy was translated into specific mandates for the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. In 2004, the Department of Housing and Urban Development (HUD) mandated that an increasing percentage of the mortgages purchased by the GSEs must be from low- and moderate-income borrowers, with targets reaching 56% by 2008 [10]. Critics argue that these government-mandated goals created a massive, artificial market for subprime and other risky loans, encouraging lenders to originate them with the knowledge that Fannie and Freddie would buy them [2, 7].
4. Securitization and Complex Financial Products The risk from these individual mortgages was amplified and spread throughout the financial system via a process called securitization. Lenders adopted an “originate-to-distribute” model, where they sold the mortgages they created to investment banks [1, 5]. These banks bundled thousands of mortgages together to create mortgage-backed securities (MBS) and more complex instruments called collateralized debt obligations (CDOs) [6].
CDOs sliced these mortgage pools into different risk categories, or tranches. The senior tranches were marketed as extremely safe and received top AAA ratings from credit rating agencies, even though they were backed by risky subprime loans [6, 7]. This allowed the risk to be sold to institutional investors around the world, including pension funds, insurance companies, and banks, who believed they were buying safe investments [7]. This system created a fatal flaw: the original lender had little incentive to ensure the borrower could repay the loan, as the risk was quickly passed on to someone else [1].
5. Failures in Regulation and Corporate Governance The Financial Crisis Inquiry Commission (FCIC), the official government body charged with investigating the crisis, concluded that the event was “avoidable” [7]. The FCIC cited “widespread failures in financial regulation and supervision,” including the Federal Reserve’s failure to rein in the risky mortgage market and a lack of oversight for the “shadow banking system” where CDOs and other derivatives were created and traded. The report also pointed to a “systemic breakdown in accountability and ethics” at many financial firms, where executives pursued short-term profits and high bonuses while taking on catastrophic risks [7].
The crisis began when the housing bubble burst in 2006–2007. As home prices fell, many subprime borrowers with adjustable-rate mortgages could not afford their higher payments and could not refinance because their homes were now worth less than their mortgages. Defaults skyrocketed [3].
The wave of defaults caused the value of MBS and CDOs to plummet. Financial institutions that held these assets, or that had insured them, faced massive losses. In 2008, the crisis accelerated with the failure of the investment bank Bear Stearns, the government takeover of Fannie Mae and Freddie Mac, and finally, the bankruptcy of Lehman Brothers in September. This triggered a full-blown panic, freezing credit markets as banks became too afraid to lend to each other. The result was a severe global recession [3, 7].