Although it’s been over a decade since the 2008-09 financial crisis, there are still lessons to be followed from this economic downturn. The crisis sent the world into the Great Recession, the most significant economic downturn since the Great Depression.
The aftermath of the crisis produced new oversight agencies and policies like the Troubled Assets Relief Program (TARP), the Financial Stability Oversight Council (FSOC), and the Consumer Financial Protection Bureau (CFPB).
- The 2008-09 financial crisis sent the world into the Great Recession, the most significant economic downturn since the Great Depression.
- New legislation aimed to regulate financial activities, while also bailing out important industry sectors.
- The U.S. Federal Reserve initiated aggressive monetary policy measures including quantitative easing.
Dalio: Are we repeating a historical financial crisis?
Financial Crisis Statistics
- 8.8 million jobs lost
- Unemployment spiked to 10% by October 2009
- Eight million home foreclosures
- $17 trillion in household wealth evaporated
- Home price declines of 40% on average
- S&P 500 declined 38.5% in 2008
- $7.4 trillion in stock wealth lost from 2008-09, or $66,200 per household on average
- Employer-sponsored savings and retirement account balances declined 25% or more in 2008
- Delinquency rates for adjustable-rate mortgages (ARMs) climbed to nearly 30% by 2010
Following the crisis, changes were made, laws were passed, and promises were made. Banks were bailed out, stock markets eclipsed records, and the U.S. government threw lifelines at federally-backed institutions. Policymakers were forced to make critical decisions with conviction and speed that helped formulate legislation and changes for the future.
1. Too Big to Fail
The notion that global banks were “too big to fail” was the justification lawmakers and the governors of the Federal Reserve leaned upon to bail them out. To avoid a “systemic crisis,” the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed. The Act created agencies like the Financial Stability Oversight Council (FSOC) and the Consumer Financial Protection Board (CFPB) to serve as watchdogs on Wall Street. Dodd-Frank requires banks with assets over $50 billion to undergo stress tests and reduce speculative bets that could devastate balance sheets and hurt customers.
Banks, including regional banks and credit unions, decried the legislation, claiming it hobbled them with unnecessary paperwork and prevented them from serving their customers. President Trump approved a new version in May 2018, which included fewer limitations and bureaucratic hurdles.
2. Reducing Risk on Wall Street
During the crisis, banks engaged in “proprietary trading,” causing losses on their books and for their clients. Lawsuits piled up, and trust eroded. Named after former Chair of the Federal Reserve, the Volcker Rule, passed in 2014, aimed to prohibit banks from taking on too much risk with their trades in speculative markets that would be a conflict of interest with their customers in other products. In May 2018, Fed Chair Jerome Powell voted to weaken the legislation, citing its complexity and inefficiency.
In the wake of the financial crisis of 2008-2009, banks raised their capital requirements, reduced their leverage, and were less exposed to subprime mortgages. Neel Kashkari, President of the Minneapolis Federal Reserve Bank and former overseer of the Troubled Asset Relief Program (TARP), maintains that big global banks need regulation and high capital requirements. This is what he told Investopedia:
“Financial crises have happened throughout history; inevitably, we forget the lessons and repeat the same mistakes. Right now, the pendulum is swinging against increased regulation, but the fact is we need to be tougher on the biggest banks that still pose risks to our economy.”
3. Overheated Housing Market
The overheated housing market before the financial crisis was stoked by unscrupulous lending to unqualified borrowers and the reselling of loans through financial instruments called mortgage-backed securities. Banks bought insurance against those mortgages, creating a house of cards built on a foundation of homebuyers who could not afford them.
Fannie Mae and Freddie Mac, the two government-sponsored entities that underwrote much of the mortgage risk and resold it to investors, were bailed out with taxpayer money and taken into receivership by the federal government. Foreclosures spiked, many lost their homes, and home prices plummeted. In 2023, Fannie Mae and Freddie Mac exist under the conservatorship of the Federal Housing and Finance Agency (FHFA).
4. Blame All Around
In 2009, many individuals and agencies were culpable, though proving bad intentions was difficult. Many of the most storied institutions on Wall Street and Main Street put their interests ahead of their customers. Phil Angelides served as the chair of the Financial Inquiry Commission following the crisis. His goal was to discover how the global economy buckled and told Investopedia:
“Normally, we learn from the consequences of our mistakes. However, Wall Street, having been spared any real legal, economic, or political consequences from its reckless conduct, never undertook the critical self-analysis of its actions or the fundamental changes in culture warranted by the debacle which it caused.”
5. Investing in the Future
As of September 2023, the S&P 500 was up nearly 394% since 2009. Following the 2008 crisis, lower interest rates, bond-buying by the central bank, quantitative easing (QE), and the rise of the FAANG stocks added market value to global stock markets. Robo-advisors and automated investing tools brought a new demographic of investors to the market.
Central bankers combined lowered interest rates with quantitative easing to increase the money supply and ease pressure on the banking system.
Assets allocated to exchange-traded funds (ETFs) are over $7.6 trillion in 2023, up from $0.8 trillion in 2008. ETFs trade like stocks and offer liquidity to investors that mutual funds do not. ETFs were relatively new in 2008-09.
The lessons of the 2008 financial crisis, which began with the implosion of the subprime mortgage market in the United States, reappeared during the 2020 COVID-19 pandemic. Once again, central banks intercepted to reduce interest rates, increase the money supply, and support businesses.
What Is the Consumer Protection Act of 2010?
The Consumer Protection Act, also known as the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, created the Consumer Financial Protection Bureau (CFPB) to centralize the regulation of various financial products and services.
What Did TARP Do to Stabilize the Financial System?
The Troubled Asset Relief Program (TARP) was instituted by the U.S. Treasury following the 2008 financial crisis. TARP stabilized the financial system through a government purchase of mortgage-backed securities and bank stocks. From 2008 to 2010, TARP invested $426.4 billion in firms.
How Often Do Banks Fail?
According to the FDIC, 565 banks have failed from 2001-2023.
The Bottom Line
The lessons from the 2008-09 financial crisis were painful. Swift, unprecedented, and extreme measures were put into place by the government and the Federal Reserve to stem the crisis, and reforms were implemented to prevent another disaster. During the economic fallout from the worldwide COVID-19 pandemic in 2020-2021, global policymakers revisited lessons learned to quickly to prop up the financial economy.