The Credit Crisis Of 2008: An Overview

9-110-048
APRIL 8, 2010

V.G. NARAYANAN
FABRIZIO FERRI
LISA BREM

The Credit Crisis of 2008: An Overview
The current crisis has once again confirmed the fundamental recognition that our growth and prosperity are
interconnected, and that no region of the globe can wall itself off in a globalized world economy.
— G20 Leaders’ Statement, September 20091
In December 2009, the BaselCommittee, part of the Bank of International Settlements, issued two
ry
reports outlining their plans for regulator reform for the international banking industry. The
reforms were in response to the credit crisis that erupted in the United States in the fall of 2008 and
continued to send shockwaves throughout the world. The crisis was so far reaching that it brought
the country of Iceland to thebrink of bankruptcy and threatened both the solvency of Greece and the
stability of the Economic Union. In the United States, unemployment was at its highest point in
decades, credit remained scarce, and both the financial industry and auto manufacturers required
unprecedented and enormous public bailouts. In January 2010, a few days before the start of the
World Economic Forum in Davos,Switzerland, President Obama announced far reaching reforms of
the financial sector in the United States, including a tax on banks and limits on size and investment
activities. As financial regulators, business leaders, and politicians met at Davos, debates raged on
e
how regulation should be conducted, what measures to take, and whether it was possible to avoid
another systemic crisis. Underlyingthese arguments were the questions of who was to blame for the
crisis, and how could a seemin ly minor issue—subprime loans in the United States—have affected
ng
economies in every corner of the globe?

Origins of the Credit Crisis
i
A number of factors influenced the evolution of U.S. financial markets at the turn of the 21st
century and set the stage for the financial meltdown: a “savingsglut” in countries such as China,
n
Japan, and Germany, which led to lower interest rates,2 which in turn led to a massive U.S. residential
housing bubble; over-leveragin in the financial sector; growth of largely unre ulated subprime
ng
eg
lendin ; the rise of new, complex, and extremely popular mortgage-based funds that lacked
ng
transparency; and a resulting inability to accuratelymeasure risk. Investment firms, under heavy
competitive pressure, and lured by the healthy returns of mortgage-backed securities (MBSs),
ag
levera ed themselves to buy and sell to investors—among them pension funds, municipalities, and
foreign governments—that wanted to invest in the United States.
Prior to the 1990s, the U.S. residential mortgage market was relatively simple. Banks and thriftsmade loans to qualified home buyers (which made up the primary market), and kept most of them on
their books. As time went by, banks sold some of their loans to publicly traded government
sponsored enterprises (GSEs),3 such as Fannie Mae and Freddie Mac, clearing their balance sheets to________________________________________________________________________________________________________________
This case is an abridged version of “Executive Pay and the Credit Crisis of 2008 (A),” HBS No. 109-036, which was developed from published
sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary
data, or illustrations of effective or ineffective management.
Copyright © 2010 President and Fellows ofHarvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized,
photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

This document is authorized for use only by...