The 2008 Financial Crisis: What Happened and Why

The 2008 Financial Crisis

The 2008 financial crisis grew from a US housing bubble into a global banking panic. Learn the causes, the collapse of Lehman Brothers, the response and the lessons.

Beginner3 min readUpdated 3 Oct 2026

Lesson 4 of 14

The global financial crisis of 2007 to 2009 was the most severe financial crisis since the Great Depression. It began with falling US house prices and rising defaults on subprime mortgages, spread through complex securities held by banks worldwide, and peaked with the bankruptcy of Lehman Brothers in September 2008. Credit markets froze, stock markets fell by more than half, and governments and central banks launched unprecedented rescues. The crisis reshaped banking regulation, monetary policy and how investors think about risk.

Timeline#

Date	Event
2006	US house prices peak
2007	Subprime lenders fail; two Bear Stearns hedge funds collapse; interbank funding markets seize in August
9 October 2007	The S&P 500 peaks at 1,565.15
March 2008	Bear Stearns is rescued through a sale to JPMorgan backed by the Federal Reserve
September 2008	Fannie Mae and Freddie Mac are taken into conservatorship (7 September); Lehman Brothers files for bankruptcy (15 September); AIG is rescued (16 September); a money market fund "breaks the buck"
October 2008	Congress passes TARP, authorising $700 billion; global coordinated rate cuts
25 November 2008	The Fed announces its first large scale asset purchases. See Quantitative Easing and Tightening
9 March 2009	The S&P 500 bottoms at 676.53, about 57% below its peak

Causes#

Cause	Explanation
Housing bubble	Prices rose far above incomes, fuelled by easy credit
Subprime and risky lending	Loans to borrowers with weak credit, often with low initial "teaser" rates
Securitisation	Mortgages were packaged into securities and complex products such as CDOs, spreading risk widely and weakening lending standards
Credit ratings	Many mortgage securities received top ratings that proved far too optimistic. See Credit Ratings
Leverage	Investment banks and others ran very high leverage with short term funding
Derivatives	Credit default swaps concentrated exposures at firms such as AIG. See Credit Default Swaps (CDS)
Interconnection	Counterparty links meant one failure threatened many. See Market, Credit and Counterparty Risk

Why Lehman mattered#

Lehman Brothers was a large investment bank heavily exposed to real estate, funded with short term borrowing. When no buyer or government rescue emerged, it filed the largest bankruptcy in US history. Its failure froze client assets, triggered losses for counterparties and money market funds, and caused lenders to pull back from other firms. The crisis shifted from a housing problem to a systemic panic within days. See Systemic Risk.

The response#

Response	Detail
Rescues and capital injections	TARP funds recapitalised banks; AIG, Fannie Mae and Freddie Mac were rescued
Monetary policy	The Fed cut rates to near zero by December 2008 and began quantitative easing
Liquidity facilities	Emergency lending to banks, dealers and money markets
Stress tests	The 2009 bank stress tests restored confidence. See Stress Testing and Scenario Analysis
Regulation	Dodd Frank Act (2010), Basel III capital and liquidity rules, the Volcker Rule, central clearing of swaps. See Clearing Houses and Central Counterparties

Lessons#

Leverage plus short term funding is fragile.
Ratings and models can fail together when assumptions are wrong. See Operational and Model Risk.
Correlations jump in crises; diversified risky portfolios fell together. See Correlation Management.
Counterparty risk is real: know who holds your assets. See Market, Credit and Counterparty Risk.
Policy responses can be large and fast, changing market dynamics.

Sources#

Federal Reserve History, "The Great Recession and Its Aftermath": https://www.federalreservehistory.org/essays/great-recession-and-its-aftermath

Frequently asked questions#

What caused the 2008 financial crisis?#

A US housing bubble, risky mortgage lending, complex securitisation, flawed credit ratings, high leverage and interconnected financial firms.

Why did Lehman Brothers fail?#

It had large real estate exposures and relied on short term funding; when confidence collapsed, it could not refinance and no rescue was arranged.

How much did stocks fall in 2008?#

The S&P 500 fell about 57% from its October 2007 peak to its March 2009 low.

Next, learn about a crash that took minutes in The 2010 Flash Crash.

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Next lessonThe 2010 Flash CrashOn 6 May 2010, US stocks plunged and rebounded within about 36 minutes. Learn what happened, the role of a large futures sale and HFT, and the rules that followed.