The Global Financial Crisis and Its Aftermath

Abstract

This review of the 2008 financial crisis discusses the triggers of the crisis, the direct consequences, and the policy responses to the crisis. Pre-crisis condition is analyzed in linear time order: the Federal monetary policy, with the motivation to stimulate the economy, set loose lending criteria and facilitated the increase of subprime mortgages. Based on the subprime mortgage, credit default swaps (CDS) emerged as a new derivative of arbitrage and speculation without adequate regulation. Rather than its original use of risk diversification and transfer, such expansion of CDS eventually led to contagion, dragging the whole market into crisis. Direct consequences include mass unemployment, reduction in corporate investment, and bankruptcy of giant banks such as Lehman Brothers. A series of policies were released to suppress the contagion of the crisis and help the economy recover, among which the Dodd-Frank Act and Basel III serve as necessary regulations. The government had interfered with the housing market, which suffered from the burst bubble; bank regulators had re-examined the rules, adjusting the fraction of capital reserves required for banks.