Overview
This lecture explains the causes, unfolding, and impacts of the Global Financial Crisis (GFC) from 2007 to 2009, and reviews policy responses and Australia's experience.
Causes of the Global Financial Crisis
- Excessive risk-taking occurred during a period of strong economic growth, low inflation, and rising house prices.
- Borrowers, including subprime borrowers and speculators, took large and risky home loans expecting house prices to rise.
- Lenders issued risky loans with little assessment, sold them as mortgage-backed securities (MBS), and relied on flawed credit ratings.
- Banks and investors increased leverage by borrowing heavily to buy assets, magnifying gains and losses.
- Many banks relied on short-term borrowing to fund long-term investments, increasing vulnerability.
- Regulation was too lax; oversight of subprime lending and MBS was insufficient, and fraud was present.
- Policymakers underestimated the extent and spread of bad loans in the financial system.
How the GFC Unfolded
- US house prices fell and many borrowers defaulted on loans, leading to losses for lenders.
- The value of MBS dropped as investors tried to sell, causing bank and investor losses.
- Financial problems spread globally due to interconnected banks and investors.
- The panic peaked with the collapse of Lehman Brothers in September 2008, causing a freeze in financial markets and a major recession.
Policy Responses to the GFC
- Central banks rapidly cut interest rates and provided large-scale lending to banks.
- Quantitative easing involved central banks buying securities to support markets and stimulate activity.
- Governments boosted spending, guaranteed bank deposits and bonds, and took stakes in banks to prevent further failures.
- Stronger oversight and regulation of banks was introduced, including limits on leverage and greater focus on risk.
Australia and the GFC
- Australia avoided a large downturn due to minimal exposure to US housing, strong domestic regulation, and resilient resource exports to China.
- The Reserve Bank of Australia cut rates, and the government used fiscal stimulus and deposit guarantees.
- Australian regulators strengthened lending standards and adopted new global banking rules after the GFC.
Key Terms & Definitions
- Global Financial Crisis (GFC) — 2007–2009 period of severe global banking and market stress.
- Subprime Borrowers — Individuals with low creditworthiness or previous loan defaults.
- Mortgage-Backed Securities (MBS) — Financial products made from bundled mortgage loans sold to investors.
- Leverage — Using borrowed funds to amplify investment outcomes.
- Quantitative Easing — Central bank policy of buying assets to inject money into the financial system.
Action Items / Next Steps
- Review the main causes and policy responses of the GFC for exam preparation.
- Study Australia’s policies and why its economy was more resilient during the GFC.
- Learn definitions of key financial terms related to the GFC.