# The Global Financial Crisis

Business I · Economic History · https://tryals.app/learn/business-i/the-global-financial-crisis

## When Finance Ate Itself

The **Global Financial Crisis** (GFC, 2007-2009) was the worst disruption since the Great Depression. It was a crisis of **leverage, complexity, and contagion** that caused global output to contract.

Prices doubled from 1997-2006, fuelled by **subprime mortgages**—loans to borrowers with poor credit. Banks bundled these into **mortgage-backed securities** (MBS) and sliced them into tranches. Credit agencies slapped AAA ratings on top tranches, masking the toxic risk inside.

Banks borrowed 30 to 40 times their equity. A tiny asset drop wiped their entire buffer:

$$\text{Leverage} \times \text{opacity} \times \text{interconnection} = \text{systemic risk}$$

> **Common pitfall:** Blaming subprime borrowers. Subprime losses alone were absorbable; leverage and opacity turned a housing correction into a global cardiac arrest.

## Amplifiers and Policy

When one bank fell, wholesale funding vanished and the interbank market froze, turning a local drop into worldwide **contagion**.

| Amplifier | Mechanism |
| --- | --- |
| **Leverage** | Banks at 30:1, a 3% asset fall wipes equity |
| **Securitisation** | Risk repackaged until nobody could price it |
| **Wholesale funding** | Overnight money vanished in a run |
| **Contagion** | Interconnection turned one failure into panic |

Depression lessons halted total collapse via aggressive policy:

- **Monetary**: Fed rate cuts to zero and **quantitative easing** (QE) to inject liquidity.
- **Fiscal**: Stimulus packages replacing private demand.
- **Financial**: Bank bailouts and the **Dodd-Frank Act** (2010) raising capital requirements.

US GDP fell 4% and unemployment hit 10%. Taxpayers funded bailouts, and trust plummeted.

## Practice questions

7 of this lesson's 14 practice questions, with answers. The full set is in the app.

### 1. The 2008 crisis began in a market, US subprime mortgages, far too small to bankrupt the world. How did it become a global catastrophe?

A. Because subprime mortgages were much larger than commonly reported
B. Leverage and opacity: multiplied losses of unknown location
C. Because the losses spread through international trade in goods
D. Because governments refused to intervene until it was too late

**Answer:** B. Leverage and opacity: multiplied losses of unknown location

**Why:** Thin equity turns a modest loss into insolvency, and securitisation meant nobody knew who held it, so counterparty doubt froze funding markets that had nothing to do with housing. Opacity did the contagion, which is why the post-crisis rules attack both leverage ratios and disclosure.

Page: https://tryals.app/practice/business-i/the-global-financial-crisis/the-2008-crisis-began-in-a-market-us-subprime-mortgages-far-too

### 2. Why did the GFC not become a second Great Depression?

A. Depression-era lessons were applied
B. Gold reserves cushioned the impact
C. Banks recovered on their own without government help
D. The crisis was less severe than it appeared

**Answer:** A. Depression-era lessons were applied

**Why:** The Fed flooded the system with liquidity, the FDIC guaranteed deposits, and governments spent to replace demand, all lessons learned from the 1930s failure to do exactly these things.

Page: https://tryals.app/practice/business-i/the-global-financial-crisis/why-did-the-gfc-not-become-a-second-great-depression

### 3. Post-crisis regulation raised bank capital requirements substantially. Why does that not make another financial crisis impossible?

A. Because capital requirements address liquidity rather than solvency
B. Because banks can always evade capital rules through accounting
C. Because the requirements were later repealed in most countries
D. Because buffers absorb known risks and crises come from unknown

**Answer:** D. Because buffers absorb known risks and crises come from unknown

**Why:** Rules bind what is measured, and the next crisis grows where nothing is being measured. Higher capital genuinely helps and genuinely does not close the question.

Page: https://tryals.app/practice/business-i/the-global-financial-crisis/post-crisis-regulation-raised-bank-capital-requirements

### 4. Subprime defaults were a small share of the mortgage market, yet the losses threatened the global banking system. What amplified them?

A. Leverage and interconnection through the counterparty chain
B. Central banks raising rates at exactly the wrong moment
C. The absolute size of the subprime market, which was larger than reported
D. Deposit insurance, which encouraged retail savers to withdraw

**Answer:** A. Leverage and interconnection through the counterparty chain

**Why:** Leverage converts a small loss into insolvency, and interconnection turns one insolvency into many. The trigger was modest; the transmission mechanism was not.

Page: https://tryals.app/practice/business-i/the-global-financial-crisis/subprime-defaults-were-a-small-share-of-the-mortgage-market-yet-the

### 5. Securitisation made the financial system safer by spreading risk more widely.

**Answer:** False

**Why:** In theory, securitisation spreads risk. In practice, it spread *opacity*: investors couldn't assess the underlying loans, ratings were inflated, and the "spread" actually concentrated risk in leveraged institutions that didn't understand what they held.

Page: https://tryals.app/practice/business-i/the-global-financial-crisis/securitisation-made-the-financial-system-safer-by-spreading-risk-more

### 6. Sort each factor: did it cause the crisis or respond to it?

**Answer:**

- Caused the crisis: Excessive leverage in banks, Subprime lending to unqualified borrowers, Opaque securitisation and inflated ratings
- Responded to the crisis: Quantitative easing, TARP bank bailouts

**Why:** Leverage, subprime lending, and opaque securitisation caused it. QE and bailouts responded to it, applying Depression-era lessons to prevent total collapse.

Page: https://tryals.app/practice/business-i/the-global-financial-crisis/sort-each-factor-did-it-cause-the-crisis-or-respond-to-it

### 7. Match each GFC concept to its meaning.

**Answer:**

- Subprime mortgage → Loan to a borrower with poor credit
- MBS → Mortgage-backed security, bundled loans sold as bonds
- Quantitative easing → Central bank buying bonds to inject liquidity
- Dodd-Frank → Post-crisis regulation tightening bank rules

**Why:** The cause vocabulary (subprime, MBS) and the response vocabulary (QE, Dodd-Frank).

Page: https://tryals.app/practice/business-i/the-global-financial-crisis/match-each-gfc-concept-to-its-meaning