The 2008 financial crisis: what caused it, the stock market crash and a timeline

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The 2008 financial crisis was a collapse of the US housing and mortgage market that spread through banks and investment firms and reached its worst point with the bankruptcy of Lehman Brothers on September 15, 2008. The S&P 500 fell 57% from its October 2007 peak to its March 2009 trough, and the recession that came with it lasted 18 months, from December 2007 to June 2009, according to the NBER.

It is also the best-documented crash in US history. Congress set up the Financial Crisis Inquiry Commission, which published its final report in January 2011. This page uses that report, the Federal Reserve's own history essays and official data to explain what happened and why.

What caused the 2008 financial crisis?

The crisis grew out of a housing boom. According to the Federal Reserve History essay by John Weinberg, US home prices more than doubled between 1998 and 2006, home ownership rose from 64% in 1994 to 69% in 2005, and residential investment grew from 4.5% to 6.5% of GDP. Lending standards loosened as the boom went on, and a growing share of mortgages went to subprime borrowers with weaker credit.

Those mortgages did not stay with the lenders who made them. They were pooled into securities, sold to investors around the world and used as collateral for short-term borrowing. When house prices stopped rising and borrowers began to default, the losses turned up in places that regulators and investors had not been watching.

The Financial Crisis Inquiry Commission set out its main conclusions at the start of its report. In summary, the majority found that:

• the crisis was avoidable, the result of human action and inaction, with warnings ignored;
• widespread failures in financial regulation and supervision proved devastating to the stability of the markets;
• dramatic failures of corporate governance and risk management at systemically important firms were a key cause;
• a combination of excessive borrowing, risky investments and lack of transparency put the system on a collision course with crisis;
• the government was ill prepared, and its inconsistent response added to the uncertainty and panic;
• there was a systemic breakdown in accountability and ethics;
• collapsing mortgage-lending standards and the mortgage securitization pipeline spread the contagion;
• over-the-counter derivatives contributed significantly;
• the failures of the credit rating agencies were essential to the destruction, because mortgage securities could not have been marketed without their ratings.

The report also looked at Fannie Mae and Freddie Mac, the government-sponsored mortgage companies, and concluded that they contributed to the crisis but were not a primary cause.

Not every commissioner agreed. Six members voted to adopt the report and four dissented: Keith Hennessey, Douglas Holtz-Eakin, Bill Thomas and Peter J. Wallison. Their dissenting views are published with the report and give more weight to other factors, so the official record contains more than one explanation.

"Theirs was a big miss, not a stumble." (Financial Crisis Inquiry Commission, Final Report, 2011, on the leaders of finance and the public officials who oversaw them)

Why did the housing bust become a banking crisis?

Borrowed money made the difference. The Commission found that in the years before the crisis "too many financial institutions, as well as too many households, borrowed to the hilt", which left them exposed if the value of their investments fell even modestly. It named the five major investment banks of the time (Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley) as operating with extraordinarily thin capital.

Much of that borrowing ran through what the report calls the shadow banking system, including the repo lending market and off-balance-sheet entities. These were funded day to day by lenders who could pull their money quickly. Once doubts arose about the value of mortgage securities, those lenders asked for more collateral or stopped lending. The pattern resembles a classic bank run, but it happened between institutions rather than at teller windows.

House prices fell hard. The Federal Reserve History essay by Robert Rich puts the decline at roughly 30% from the mid-2006 peak to mid-2009. As prices fell, more borrowers owed more than their homes were worth, defaults rose and the securities built on those loans lost value.

2008 financial crisis timeline

Sources: Federal Reserve History essays (Duca; Rich; Weinberg); NBER; GAO; FRED.

What happened to the stock market in 2008?

The fall was long and deep. According to the Federal Reserve History essay on the Great Recession, the S&P 500 fell 57% from its October 2007 peak to its March 2009 trough. In the St. Louis Fed's daily data for the Nasdaq Composite, the index closed at 2,859.12 on October 31, 2007 and at 1,268.64 on March 9, 2009, a fall of 55.6%. It took until April 27, 2011 to close above the 2007 peak again.

The decline came in stages. By the end of June 2008, after the rescue of Bear Stearns, the Nasdaq stood at 2,292.98, about 20% below its peak. It was still at 2,261.27 on Friday, September 12, 2008, the last trading day before Lehman's bankruptcy. Ten weeks later, on November 20, 2008, it closed at 1,316.12, a further fall of 41.8%. October 2008 alone took 17.7% off the index, its worst month of the crisis. Prices fell again in early 2009 as the recession deepened, and the low came on March 9, 2009.

Compared with other stock market crashes, 2008 sits between the extremes. The Nasdaq's fall was smaller than its 77.9% loss in the dot-com bust, and far smaller than the Dow's 89% fall after 1929. It was much deeper than the S&P 500's 33.9% drop in the 2020 crash, and it lasted about 16 months instead of one.

How did the government and the Fed respond?

Interest rates and asset purchases

The Federal Reserve cut the federal funds rate from a target of 5.25% before September 18, 2007 to a target range of 0 to 0.25% on December 16, 2008. With rates at zero, it began buying large amounts of longer-term securities: purchases were announced in November 2008 and March 2009, a program later known as QE1.

Rescues of individual firms

The Fed also lent to specific institutions whose failure it judged would damage the whole system. The New York Fed lent $12.9 billion to help JPMorgan Chase take over Bear Stearns in March 2008, and then financed the purchase of about $30 billion of Bear's assets. AIG, with about $1 trillion in reported assets, received support from September 16, 2008, the day after Lehman's bankruptcy. Citigroup received a guarantee on a pool of about $306 billion of assets in November 2008. In January 2009 the government also announced that a similar protection on about $118 billion of Bank of America assets would have been provided; it was never put into effect.

Lehman was not rescued. Over the weekend before its bankruptcy, officials and bank leaders tried and failed to find a private buyer, and Lehman filed on Monday, September 15, 2008.

TARP

Congress created the Troubled Asset Relief Program through the Emergency Economic Stabilization Act in October 2008. It authorized the Treasury to buy or guarantee up to $700 billion of assets, an amount the Dodd-Frank Act cut to $475 billion in 2010. According to GAO, $443.5 billion had been spent by September 30, 2023, and after repayments, sales, dividends and interest the lifetime cost of TARP-funded programs was $31.1 billion.

How bad was the Great Recession?

The NBER dates the recession from December 2007 to June 2009, 18 months. Real GDP fell 4.3% from the fourth quarter of 2007 to the second quarter of 2009. Unemployment rose from 5% in December 2007 to 9.5% in June 2009 and peaked at 10% in October 2009. US household net worth fell from about $69 trillion in 2007 to $55 trillion in 2009, according to the Federal Reserve History essay by Robert Rich.

The recovery was slow. Weinberg's essay notes growth averaging about 2% in the first four years, and that house prices fell by more than a fifth on average from the first quarter of 2007 to the second quarter of 2011. The Duca essay records that foreclosure rates had declined to pre-recession levels by mid-2013. Our page on what a recession is explains how the NBER sets these dates.

What changed after 2008?

The largest legal change was the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which also reduced TARP's authority. The Fed's use of near-zero rates and large-scale asset purchases became part of its toolkit, and it used both again, faster, during the 2020 crash.

Whether the warning signs of 2007 could have been read in time is a separate question. Our page on the inverted yield curve looks at one of the indicators most often cited, and at how mixed its record is.

If you are reading about 2008 because you are worried about your own money, the right response depends on your circumstances and time horizon. We do not give investment advice. The SEC's Investor.gov site is a neutral place to start in the US, and MoneyHelper covers the same ground for UK readers.

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