Introduction

In this chapter, we will delve into the historical context that paved the way for the infamous financial crisis of 2007-2009. Understanding the background is essential to grasp the underlying factors that contributed to the crisis. We will provide an insightful overview of the crisis, setting the stage for a deeper exploration of its intricacies.

The financial crisis of 2007-2009, often referred to as the Global Financial Crisis (GFC), was a seismic event that reverberated across the global economy. While its immediate impacts were evident in the financial sector, its roots extended into various aspects of the economy.

Historical Background

The early 2000s were marked by a period of robust economic growth and seemingly stable financial markets. However, beneath the surface, there were brewing vulnerabilities. The period saw significant innovation in financial products, including the rise of complex derivatives and securitized assets. These innovations were intended to mitigate risk but, paradoxically, contributed to heightened risk exposure.

Overview of the Crisis

The crisis unfolded in multiple phases. It commenced with the bursting of the U.S. housing bubble in 2006, followed by an escalating wave of mortgage delinquencies and foreclosures. The turmoil rippled through financial markets, exposing the fragility of interconnected institutions.

As institutions faced mounting losses, a liquidity crisis emerged. The interbank lending market froze, causing a credit crunch that reverberated globally. Prominent financial institutions faced collapse, and governments intervened with unprecedented bailouts.

Example: To illustrate, consider the housing market bubble. During the years preceding the crisis, housing prices soared to unsustainable levels, driven by loose lending practices and speculative fervor. When the bubble burst, homeowners found themselves trapped in mortgages with higher balances than their homes’ values—resulting in a surge in mortgage defaults.