Lecture 19: What Caused the 2008 Financial Crisis, Crash, and Government Response?

Transcript

• So, today, we're talking about crisis, crash and response. So just to remind us of where we were in September of 2008. - [Narrator] This is gonna be one of the watershed days in financial markets history. - [Narrator] It was a manic Monday in the financial markets. The Dow tumbled more than 500 points after two pillars of the street tumbled over ... Read More

Key Insights

• 🙈 Technocratic regulation assumes there are clear answers to regulatory issues based on economic analysis, but it often ignores the role of power, politics, and ideology in shaping outcomes.
• 😃 Stigler's theory suggests that big firms and producer interests dominate the regulatory process, using their lobbying power to shape regulations and protect their own interests.
• 🪟 Coffee's voter-oriented model highlights the intermittent nature of voter sentiment and the limited windows of opportunity for regulatory change.
• 😃 The regulatory response to the 2008 financial crisis was influenced by all three perspectives, with big firms dominating the process, intermittent voter concerns, and technocratic analysis guiding certain aspects.
• 🛩️ The regulatory response did not fully address concerns of consumers and smaller institutions, and the influence of the financial industry resulted in weakened regulations and administrative challenges.

Questions & Answers

Q: What happened during the September 2008 financial crash?

Lehman Brothers filed for bankruptcy, Merrill Lynch agreed to merge with Bank of America, and the Dow fell more than 500 points. Within six months, Bear Stearns, Lehman Brothers, and Merrill Lynch had disappeared as independent Wall Street firms.

Q: Why did Lehman Brothers file for bankruptcy?

Lehman Brothers was brought down by bad mortgage investments and was set to be liquidated. Henry Paulson attempted to arrange a sale, but the government would not provide the financial guarantees used in the Bear Stearns deal.

Q: What happened to Merrill Lynch during the crisis?

Merrill Lynch agreed to merge with Bank of America because it feared it could be the next firm to collapse. The brokerage had 60,000 employees and nearly $50 billion in mortgage-related losses.

Q: How much household wealth disappeared during the financial crisis?

From the market peak to the trough, $16.4 trillion in household wealth disappeared. The lecture uses this figure to show how rapidly wealth evaporated during the crash.

Q: What was the government’s proposed bank bailout in September 2008?

Henry Paulson asked Congress for $700 billion to bail out failing banks. Congress initially rejected the brief request for a blank check, but passed a version of the TARP bailout three days later with more regulatory oversight.

Q: What happened after Congress initially rejected the bailout?

The Dow lost another 700 points the following day. Congress then passed a version of the TARP bailout three days later.

Q: How did Alan Greenspan explain the failure of his financial-market model?

Alan Greenspan said he was in shocked disbelief that lending institutions’ self-interest had failed to protect shareholder equity. He acknowledged a flaw in the model that had shaped his view of how the world worked for 40 years or more.

Q: How did big banks influence the regulatory response to the crisis?

Big banks lobbied heavily during the legislative and rule-writing processes. According to the existing page analysis, they prevented or weakened some regulations, including the Volcker Rule, while Dodd-Frank still introduced measures such as the Consumer Financial Protection Bureau.

Summary & Key Takeaways

• When: In September of 2008, Lehman Brothers filed for bankruptcy after bad mortgage investments brought down the firm.

• Number: The Dow fell more than 500 points after Lehman Brothers collapsed and Merrill Lynch agreed to merge with Bank of America.

• Number: Lehman Brothers was a 158 year old firm with 25,000 employees and was set to be liquidated.

• Number: Merrill Lynch had 60,000 employees and nearly $50 billion in mortgage-related losses.

• Number: Three of the five biggest independent Wall Street firms disappeared within six months: Bear Stearns, Lehman Brothers, and Merrill Lynch.

• Number: Keeping Lehman Brothers afloat would have required an $85 billion subsidy.

• Number: AIG sought $40 billion in bridge loans, while its eventual bailout cost four times that amount.

• Step 1: Henry Paulson asked Congress on the 29th of September for $700 billion to bail out failing banks.

• Step 2: Congress rejected the initial bailout request, and the Dow lost another 700 points the following day.

• Step 3: Three days later, Congress passed a version of the TARP bailout with more regulatory oversight.

• Number: From the market peak to the trough, $16.4 trillion in household wealth disappeared.

• Who: Alan Greenspan acknowledged that the model guiding his worldview for 40 years or more contained a flaw.