Financial crisis of 2007-2008

The financial crisis of 2007–2008, also known as the global financial crisis and the 2008 financial crisis, is considered by many economists to have been the worst financial crisis since the Great Depression of the 1930s.

It began in 2007 with a crisis in the subprime mortgage market in the US, and developed into a full-blown international banking crisis with the collapse of the investment bank Lehman Brothers on September 15, 2008. Excessive risk-taking by banks such as Lehman Brothers helped to magnify the financial impact globally. Massive bail-outs of financial institutions and other palliative monetary and fiscal policies were employed to prevent a possible collapse of the world financial system. The crisis was nonetheless followed by a global economic downturn, the Great Recession. The European debt crisis, a crisis in the banking system of the European countries using the euro, followed later.

The Dodd–Frank Act was enacted in the US in the aftermath of the crisis to "promote the financial stability of the United States". The Basel III capital and liquidity standards were adopted by countries around the world.

The precipitating factor was a high default rate in the United States subprime home mortgage sector. The expansion of this sector was encouraged by the Community Reinvestment Act (CRA), a US federal law designed to help low- and moderate-income Americans get mortgage loans. Many of these subprime (high risk) loans were then bundled and sold, finally accruing to quasi-government agencies (Fannie Mae and Freddie Mac). The implicit guarantee by the US federal government created a moral hazard and contributed to a glut of risky lending. Many of these loans were also bundled together and formed into new financial instruments called mortgage-backed securities, which could be sold as (ostensibly) low-risk securities partly because they were often backed by credit default swaps insurance. Because mortgage lenders could pass these mortgages (and the associated risks) on in this way, they could and did adopt loose underwriting criteria (encouraged by regulators), and some developed aggressive lending practices. The accumulation and subsequent high default rate of these mortgages led to the financial crisis and the consequent damage to the world economy.

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