Global Financial Crisis 2008 – Causes & Impact
🟠 Topic 96: Global Financial Crisis 2008 – Causes & Impact
📌 Introduction
The Global Financial Crisis (GFC) of 2008 was the most severe economic downturn since the Great Depression of 1929. It originated in the United States financial sector and spread globally, affecting banks, businesses, and economies across the world. The crisis exposed deep structural weaknesses in financial regulation, risk management, and corporate governance, reshaping global financial architecture in the following decade.
🔹 Background – The Subprime Mortgage Crisis
✔️ The crisis stemmed from excessive lending to subprime borrowers — individuals with poor credit histories.
✔️ These high-risk mortgages were bundled into Mortgage-Backed Securities (MBS) and sold to investors globally.
✔️ When housing prices collapsed, defaults soared, leading to severe financial losses across banks and investment funds.
Timeline of the Crisis (2007-2009)
| Year | Event |
|---|---|
| 2007 | Subprime mortgage defaults rise |
| March 2008 | Bear Stearns collapses |
| September 2008 | Lehman Brothers files for bankruptcy |
| October 2008 | Global stock markets crash |
| 2009 | US and other economies enter deep recession |
Timeline Graph (Key Events)
🔹 Causes of the Global Financial Crisis
1️⃣ Subprime Mortgage Lending
✔️ Banks aggressively lent mortgages to low-credit borrowers at teaser rates. ✔️ Assumption: Housing prices would always rise.
2️⃣ Financial Derivatives
✔️ Mortgages were bundled into complex securities (MBS, CDOs).
✔️ These were sold globally, spreading risk across banks, pension funds, and governments.
3️⃣ Over-Leverage & Excessive Risk-Taking
✔️ Investment banks operated with high debt levels (leverage ratios exceeding 30:1). ✔️ Small losses in assets triggered massive capital erosion.
4️⃣ Regulatory Failures
✔️ Inadequate oversight of: ✔️ Mortgage lenders. ✔️ Credit rating agencies. ✔️ Shadow banking system (Hedge Funds, SIVs).
5️⃣ Global Linkages
✔️ Global financial integration transmitted US problems to: ✔️ Europe (banks with toxic assets). ✔️ Emerging markets (capital outflows, export slump).
🔹 Impact on Global Economy
1️⃣ Banking Crisis
✔️ Major banks collapsed or required bailouts. ✔️ Lehman Brothers’ bankruptcy froze interbank lending.
2️⃣ Stock Market Crash
✔️ Global stock indices fell by over 50% in 2008. ✔️ Investor confidence collapsed, triggering panic withdrawals.
3️⃣ Global Recession
✔️ Advanced economies shrank by ~4% in 2009. ✔️ Unemployment soared to record levels in US, EU.
4️⃣ Trade & Investment Collapse
✔️ Global trade fell by over 20% in 2009. ✔️ FDI flows contracted sharply, especially to emerging markets.
5️⃣ Policy Responses – Bailouts & Stimulus
✔️ US TARP (Troubled Asset Relief Program) – $700 billion. ✔️ Coordinated interest rate cuts by central banks. ✔️ Fiscal stimulus packages to revive demand.
🔹 Impact on India
1️⃣ Financial Sector Shock
✔️ Limited direct exposure to subprime assets. ✔️ Capital outflows triggered stock market crash.
2️⃣ Trade Impact
✔️ Exports contracted sharply (down 16% in 2009). ✔️ Sectors hit: Textiles, IT, Gems & Jewellery.
3️⃣ GDP Growth Decline
✔️ India’s GDP growth slowed to 6.7% in 2008-09 (down from 9%).
4️⃣ Fiscal Stimulus
✔️ Government announced: ✔️ Tax cuts. ✔️ Higher public spending. ✔️ Focus on infrastructure and rural employment (MGNREGA).
5️⃣ Resilient Recovery
✔️ India’s strong domestic demand helped faster recovery. ✔️ By 2010, GDP growth rebounded to 8.5%.
Case Study – RBI’s Response
- Liquidity infusion of ₹1.6 lakh crore.
- CRR cut from 9% to 5%.
- Special refinancing for NBFCs, MSMEs, housing finance.
- Capital controls eased to stem capital flight.
🔹 Lessons from the Crisis
1️⃣ Importance of Regulation
✔️ Need for macroprudential oversight over: ✔️ Shadow banking. ✔️ Credit rating agencies. ✔️ Enhanced focus on systemic risk management.
2️⃣ Global Coordination
✔️ G20 emerged as the primary platform for global financial governance. ✔️ Coordinated fiscal and monetary policies helped prevent depression.
3️⃣ Financial Literacy & Consumer Protection
✔️ Unsuspecting consumers mis-sold toxic mortgages. ✔️ Transparency in financial products became a priority.
4️⃣ Diversification of Growth Drivers
✔️ Over-reliance on finance and housing sectors increases systemic risk. ✔️ Importance of promoting real economy sectors.
🔹 Way Forward for India
✔️ Strengthen financial stability frameworks (FSB, RBI’s FSDC).
✔️ Deepen corporate bond markets to reduce over-reliance on bank credit.
✔️ Improve credit quality assessment in banks & NBFCs.
✔️ Enhance stress testing and contingency planning in financial institutions.
✔️ Build counter-cyclical fiscal buffers to respond to future shocks.
📚 Practice MCQs
1️⃣ The Global Financial Crisis (2008) originated from which of the following?
✅ Options:
(a) European debt crisis
(b) US housing and mortgage markets
(c) Asian financial crisis
(d) Oil price shock
2️⃣ Which of the following was the first major financial institution to collapse during the Global Financial Crisis?
✅ Options:
(a) Lehman Brothers
(b) Bear Stearns
(c) Citibank
(d) AIG
3️⃣ Which program was introduced by the US government to bail out banks during the Global Financial Crisis?
✅ Options:
(a) QE
(b) TARP
(c) Basel III
(d) Swap Lines
