The 2008 financial crisis

In the autumn of 2008 the global financial system came within days of seizing up entirely. Banks that had stood for over a century vanished or were rescued overnight; governments pledged sums that would have been unthinkable months earlier; and the world tipped into the deepest recession since the 1930s. The crisis began in a corner of the American mortgage market but, through the hidden plumbing of modern finance, spread to every major economy — Britain included. Understanding how it unfolded, and what came after, is essential to making sense of the politics and economics of the decade that followed.

The roots: subprime and securitisation

The story starts with the US housing boom. As prices climbed, lenders extended ever more mortgages to “subprime” borrowers — people with weaker credit histories who were more likely to default. The reasoning was that rising house prices would cover any losses: if a borrower failed to pay, the home could be repossessed and sold for more than the loan. Lending standards slipped accordingly.

What made this local problem global was securitisation. Rather than holding mortgages on their own books, banks bundled thousands of them together into financial products — mortgage-backed securities and collateralised debt obligations — and sold them on to investors around the world. In theory this spread risk safely. In practice it scattered the danger so widely, and disguised it so thoroughly, that almost no one could tell who ultimately held the losses. When US house prices stopped rising and then fell in 2006-07, subprime defaults surged, and the value of these complex securities collapsed — but the losses now sat inside banks and funds across the entire global system.

Leverage and the descent into panic

The damage was magnified enormously by leverage — the use of borrowed money to fund investments. The big banks were extraordinarily leveraged, holding only a thin sliver of capital against vast assets. With so small a cushion, even modest losses could wipe out a bank’s capital and render it insolvent. As doubts grew about who was exposed to bad mortgage securities, banks grew afraid to lend to one another, and funding markets began to freeze.

The decisive moment came in September 2008, when the US investment bank Lehman Brothers was allowed to go bankrupt. Its failure shattered the assumption that the authorities would always step in, and it triggered outright panic. Lending between banks froze almost completely in a “credit crunch”, as institutions hoarded cash rather than risk lending to a counterpart that might collapse. Credit dried up for ordinary businesses and households too, and the financial crisis spilled into the real economy, deepening a sharp global recession.

Britain was not spared. In fact one of the earliest warning signs had come a year before Lehman, when Northern Rock — a UK bank heavily dependent on short-term market funding rather than depositors — suffered the first run on a British bank in over a century as its funding evaporated. It was propped up with emergency support and eventually taken into public ownership, a foretaste of what was to come.

Bailouts and quantitative easing

Faced with the prospect of cascading bank failures, governments concluded they had no choice but to intervene. Because banks sit at the heart of the payment system and the supply of credit, the disorderly collapse of a major one threatened to bring down the whole economy. So states injected capital directly into banks, guaranteed their liabilities, and in several cases took large stakes — partially nationalising institutions such as Royal Bank of Scotland and Lloyds in the UK. These were the bank bailouts, hugely controversial then and since. They exposed the problem of institutions “too big to fail”: so large and interconnected that they must be rescued, which in turn tempts banks to take greater risks in the expectation of being saved, a danger economists call moral hazard.

Monetary policy was thrown into the fight too. Central banks slashed interest rates to near zero, but with the financial system still impaired, that was not enough. So the Bank of England and others turned to quantitative easing: creating new money electronically to buy financial assets, chiefly government bonds. By pushing down longer-term interest rates, QE was intended to support spending, lending and asset prices when conventional rate cuts had run out of road. It marked an extraordinary expansion of central bank activity that would persist for years.

The aftermath: recession, debt and austerity

The crisis left deep scars. The recession was severe, with output falling sharply, unemployment rising and a lasting hit to living standards and productivity growth. Crucially for the politics that followed, government borrowing ballooned: tax revenues fell as the economy shrank, while the costs of bailouts and supporting the economy mounted. Britain, like many countries, emerged with a large budget deficit and a much higher national debt.

The response, from 2010, was austerity. Successive UK governments pursued cuts to public spending alongside some tax rises, aiming to bring the deficit back under control and restore the public finances. Whether this was necessary prudence or a self-defeating drag on recovery remains one of the most contested questions in recent British economic history, debated by writers such as Adam Tooze in Crashed. Alongside the fiscal response came a wave of regulatory reform: banks were required to hold much more capital and liquidity, subjected to regular stress tests, and made easier to wind down safely. In the UK, financial supervision was restructured and the Bank of England, whose Governor Mervyn King later reflected on the episode in The End of Alchemy, was handed a stronger role in safeguarding financial stability. The hope was to ensure that the events of 2008 could never unfold in quite the same way again.