Why Did the Global Financial Crisis Occur?

The global financial crisis (GFC) was a severe worldwide financial crisis which began in late 2007, with the full impact plunging many economies Opens in new window into severe recessions Opens in new window by 2008 and 2009.

The global financial crisis (GFC) caused the collapse of some major banks and financial institutions in many parts of the world, and led to some governments being unable to repay their debts.

The GFC originated in the United States as the result of very poor credit standards, high levels of borrowing—arguably assisted by the low interest rate policy of the US Federal Reserve Bank Opens in new window and enabled by China’s surplus of funds—and asset price bubbles (shares and real estate priced higher than their underlying value).

The lack of financial regulation Opens in new window by both the US government and its financial industry allowed home loans to be made to an enormous number of households that were not in a position to repay them.

People were able to buy homes with no deposit, very low incomes, poor credit histories, sometimes even when they were unemployed, and could, in some instances, borrow up to 110 percent of the value of their properties.

The risk associated with these sub-prime mortgages was spread as they were repackaged and sold as financial assets to other financial institutions in many parts of the world.

Therefore, when the inevitable loan defaults began to emerge towards the end of 2007 the impact spread throughout much of the world.

Australia’s financial system Opens in new window had minimal exposure to toxic debts Opens in new window due to existing prudential regulations, which were tightened by the then Treasurer, Peter Costello Opens in new window, and due to more responsible lending behavior and low exposure to risky assets by the majority of Australian banks and financial institutions.

By 2009 the GFC triggered (or hastened) a problem of public debts of unprecedented proportions, with some European governments in danger of defaulting.

This was due to massive financial institutions bailouts, which converted much private debt to government debt, a history of a lack of financial restraint and budget deficits by some governments, and large fiscal stimulus measures during the GFC.

In 2010 the governments of Greece and Ireland would have defaulted on debts without huge financial bailouts by the European Union (EU) Opens in new window and the International Monetary Fund Opens in new window.

By 2011 the governments of a number of other countries, including Spain, Portugal, Iceland, Italy and Cyprus, were considered by the EU to be at risk of defaulting on loans.

When compared with the severe recessions experienced by the United States, the United Kingdom and Europe, and parts of Asia, the Australian experience of an economic contraction in 2008 – 2009, followed by recovery in 2010, was remarkable.