Almost two decades on, the global financial crisis still shapes how banks are regulated and how governments respond to shocks. Here’s what caused it, how it spread, and why Australia came through better than most.
The global financial crisis, or GFC, was a severe worldwide financial and economic crisis that peaked in 2008 and 2009. It was the worst since the Great Depression of the 1930s.
How it started
In the early 2000s, U.S. house prices rose rapidly. Lenders made many “subprime” mortgages to borrowers with poor credit histories, often with low introductory interest rates that later jumped.
Banks bundled thousands of these mortgages into complex investments, known as mortgage-backed securities, and sold them to investors around the world. Credit ratings agencies gave many of them top ratings, suggesting they were safe.
When U.S. house prices began to fall in 2006 and 2007, and interest rates reset higher, many borrowers stopped paying. The value of mortgage-backed investments collapsed, and nobody was sure which banks were holding the biggest losses.
The panic
Banks stopped trusting each other and stopped lending to each other. Several large financial firms ran into trouble. In March 2008, investment bank Bear Stearns was rescued and sold.
On 15 September 2008, Lehman Brothers, one of Wall Street’s biggest investment banks, filed for bankruptcy. The U.S. Government chose not to rescue it. Its collapse sent shockwaves through global markets. Days later, insurance giant AIG needed a massive government bailout.
Share markets crashed, credit froze, businesses couldn’t borrow, and the world fell into recession. Millions of people in the U.S. and Europe lost their jobs and homes.
The response
Governments and central banks took unprecedented action. They cut interest rates to near zero, injected money into banks, guaranteed deposits and launched huge spending programs. The U.S. created a US$700 billion fund to rescue banks, and central banks began buying bonds on a massive scale, known as quantitative easing.
How Australia avoided recession
Australia was one of the few developed countries to avoid a recession.
The Rudd government guaranteed bank deposits and wholesale funding, and spent tens of billions of dollars in stimulus, including cash payments to households, school building programs and home insulation. The Reserve Bank cut the cash rate rapidly, from 7.25% to 3%.
Australia’s big banks were also in relatively strong shape, having avoided the worst of the risky U.S. investments, and Chinese stimulus kept demand for iron ore and coal strong.
The Australian share market still fell by more than half from its peak, and unemployment rose.
What changed
The crisis led to tougher rules for banks worldwide, requiring them to hold more capital and cash. Some critics argue that ordinary people bore much of the cost, while few senior bankers were held to account.
