The 2008 financial crisis is the most significant economic event since the Great Depression. Understanding it requires following a chain of increasingly reckless decisions across the US housing market, the banking system, and global financial markets.
The story begins with US housing. Through the early 2000s, low interest rates (the Fed kept rates very low after the 2001 recession), financial innovation, and misaligned incentives drove a housing bubble. Mortgage originators — often not traditional banks but specialist lenders — abandoned lending standards, offering mortgages to borrowers with no income verification, no down payment, and adjustable interest rates. These were called "subprime" mortgages.
The critical innovation that transformed a local housing bubble into a global catastrophe was securitisation. Mortgages were bundled together and sold as Mortgage-Backed Securities (MBS) — financial instruments whose returns depended on the underlying mortgage payments. Banks packaged these MBS into further tranched structures called Collateralised Debt Obligations (CDOs), which credit rating agencies (Moody's, S&P, Fitch) rated as investment grade, even though the underlying collateral was subprime loans.
Because securitisation moved the mortgages off banks' balance sheets and onto global investors' balance sheets, originators had no incentive to maintain lending standards — they earned fees from originating and selling mortgages regardless of quality. This "originate to distribute" model severed the link between lending quality and lender consequences.
When US house prices peaked in 2006 and began falling, subprime borrowers could no longer refinance their adjustable-rate mortgages. Default rates surged. MBS and CDO values collapsed. Banks that had retained exposure — either directly or through off-balance-sheet vehicles they had created — faced enormous losses. Lehman Brothers filed for bankruptcy on 15 September 2008, the largest bankruptcy in US history. AIG, a massive insurance conglomerate that had sold credit default swap protection on CDOs, required an $85 billion government bailout. The entire inter-bank lending market froze as banks refused to lend to each other, not knowing who else was exposed.
The policy response was unprecedented: TARP ($700 billion), Federal Reserve emergency facilities, coordinated global central bank action, and fiscal stimulus. The US economy contracted sharply in late 2008 and early 2009, unemployment reached 10%, and global trade collapsed. Recovery was slow, uneven, and expensive.