Impact of Financial Crisis on The Banking Sector

Updated: Mar 26, 2021

The Global Financial crisis was a tough time for the entire world economy. The precipitating factor for the Financial Crisis of 2007–2008 was a high default rate in the United States subprime home mortgage sector – and what came to be known as – the bursting of the “subprime bubble”.

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.

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Freddie Mac and Fannie Mae were taken over by the government on September 7, 2008. Then came the tip of the iceberg and on September 15, 2008 Lehman Brothers filed for bankruptcy. This triggered the Domino effect and all other banks followed suit- Merrill Lynch, AIG, HBOS, Royal Bank of Scotland, Fortis, Hypo Real Estate, and Alliance & Leicester coupled with a US federal bailout of $85 billion to AIG.

Let’s go through the dreadful timeline of 20017-08 in detail.

Throughout April to June, The Fed continued to lower the rates and bought more toxic bank debt. Before the big explosion there were several little sparks here and there like the failure of Indymac Bank in July 2008 or when Fannie and Freddie was nationalized and put under conservatorship.

Fannie and Freddie were two huge firms that had guaranteed thousands of sub-prime mortgages.

But it wasn’t until 15th September, 2008 when Lehman Brothers filed for bankruptcy, prompting the worldwide financial panic. Excessive risk-taking by the bank helped to magnify the financial impact globally

On Septmber 16th, The American International Group turned to the Federal Reserve for emergency funding and was bought by Fed for 85 billion dollars.

And this wasn’t just in the United States, UK faced a similar fate. The World economy faced a similar fate.

Lloyds TSB came to the rescue of HBOS, one of UKs largest mortagage lenders, after a huge drop in its share price.

Iceland became the first European country to collapse. Ireland’s government promised to underwrite the entire Irish banking system – a pledge that they were ultimately unable to fulfill.

Due to losses from Lehman’s bankruptcy, investors fled money market of mutual funds. On September 17, the attack started to spread. Investors withdrew a record $144.5 billion from their money market accounts. During a typical week, only about $7 billion is withdrawn.

By this point, all banks were seeking Fed’s protection. Goldman Sachs and JP Morgan Chase changed their status to normal banking holding companies, marking the end of the investment banking model.

By the end of September, Two more American banks collapsed– Washington Mutual and Wachovia.

But it wasn’t until the rejection of the Bailout Bill by the US House of Representatives that the stock market crashed.

Dow Jones Industrial Average was down 770 points, the lowest ever recorded in history. Similar things were seen for London and Brazil, Gold and oil prices soared. The economy faced its worst meltdown since 1929. Eventually the congress had to pass the bailout bill. Almost 700 billion US dollars were injected into the frozen financial market but despite several bank actions and loan programs, the stock market continued to crash.

Several banks were bailed out by the British Government to avert a complete collapse of the UK banking sector. These included banks like Lloyds TBS, Royal Bank of Scotland (RBS) and HBOS. RBS, HBOS and Lloyds were experiencing a professional bank run, where the markets were no longer willing to fund the UK banks. 

With the collapse of the banking sector, the global economy went through a lot with extreme consequences on its hands.

In the short term, an enormous bail-out: governments pumping billions into stricken banks – averted a complete collapse of the financial system, but in the long term, the impact of the crash has been enormous. The economy became the victim of depressed wages, austerity and deep political instability.

Ten years on and I think we’re still living with the consequences.


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