How the 2008 financial crisis crashed the economy and changed the world

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• Judy Woodruff:

  It was one of the most profound events in generations, with huge consequences for on the American economy and households throughout the country.

  This was the time a decade ago when the financial crisis erupted, a crash that most experts didn't foresee.

  Its effects, and of the recession that followed, on income, wealth inequality, and our politics are still with us.

  Tonight, our economics correspondent, Paul Solman, revisits how it all went down, and the impact today of decisions made then.

  It's part of our weekly series, Making Sense.

• Paul Solman:

  So, this is where, in some sense, the crisis began.

• Adam Tooze:

  Yes, this was the place where people were stumbling out of offices on the 15th of September, 2008, the world having ended.

• Paul Solman:

  The midtown Manhattan headquarters of Lehman Brothers, whose collapse 10 years ago this week was the signal event of the 2008 financial crisis.

• Adam Tooze:

  It started in real estate, and it started with subprime, and that's the story everyone knows. How does that crisis in the suburbs of America move all the way back to the center of finance in New York?

• Paul Solman:

  OK. How does it?

• Adam Tooze:

  Banks are fragile things. Classically, we think of them as being funded by deposits, with households putting their savings into the bank, and then the householders begin to get panicked and take all their money out.

• Paul Solman:

  But, says economist and historian Adam Tooze, author of the new book "Crashed".

• Adam Tooze:

  Banks like Lehman don't have deposits. What they do is borrow money from other banks, and that money runs faster than any depositor can run.

• Paul Solman:

  So subprime mortgages begin to default. Lots of people are invested in those mortgages. Banks have a big stake. And so suddenly, when banks look vulnerable, then they don't lend to each other anymore, investors pull back. That's what happened?

• Adam Tooze:

  Yes, that's the crucial thing. Afterwards, there was a congressional inquiry that went after the banks for selling the bad securities to investors who ended up being ripped off. That wasn't in fact the dangerous bit. The real problem were the bad debts, the securities that America's banks kept on their balance sheets.

• Paul Solman:

  In other word, Lehman not only created debt securities, bonds, backed by iffy subprime mortgages. It held on to them. When the debts started going bad, faith in Lehman collapsed.

  No faith, no credit. No credit, no Lehman.

• Adam Tooze:

  We came as close as we have ever come in history to a total cardiac arrest, not just of the American economy, but the entire world economy.

• Paul Solman:

  Meaning everybody is afraid to lend to everybody else. Credit simply freezes, and an economy, a modern economy can't function that way?

• Adam Tooze:

  A modern economy can't function without credit for more than even a couple of hours, frankly, seconds. G.E., the pillar of American manufacturing, was having a hard time getting short-term credit. So was Harvard University. Wage bills were not being paid.

• Paul Solman:

  And soon enough, the whole world was watching, and enmeshed.

  To illustrate your point about how the crisis spread globally, I thought we'd go to a Greek food stand. But you said, no, no, an Irish pub. And, lo and behold, there's one right across the street from the old Lehman.

• Adam Tooze:

  Yes, because 2008 is all about banks. And the failure of the Irish banks in September 2008 is really the moment when the panic spreads to Europe in a way that the European states ultimately find almost impossible to handle.

• Paul Solman:

  Because European banks have a stake in Irish banks?

• Adam Tooze:

  All of Europe is tied up with the Irish banking boom, as using Dublin as an offshore financial center. And Dublin finds itself in a position on the 29th of September of having to guarantee the entire balance sheet of the Irish banking system.

• Paul Solman:

  Back in the U.S. of A., September 29 was also the day Congress rejected President Bush's bailout bill.

• Woman:

  The motion is not adopted.

• Paul Solman:

  And the Dow fell a record 777 points.

• Adam Tooze:

  This is where the crisis goes from being a banking crisis to a crisis of the American economy as a whole, with stock market values crashing in September 2008.

• Paul Solman:

  We were now in the belly of the beast.

• Adam Tooze:

  So, here we have Wall Street with all the global banks, and then over here, the New York Stock Exchange.

• Paul Solman:

  Which is where we are now.

• Adam Tooze:

  Which is where we are now.

  And the heart of the crisis-fighting effort, the Federal Reserve Bank of New York.

• Paul Solman:

  Ground zero 9/29, the New York Fed. Here is where the system was saved.

  And what the New York Fed decided to do, what the United States Federal Reserve system decided to do was play the classic role it's always intended to play, to be the lender of last resort to American financial institutions.

• Adam Tooze:

  Yes. There's a lot of emphasis, for obvious reasons, on the unconventional side of Fed policy in '08, the bailouts, taking equity stakes in banks or quantitative easing.

  But what really made the difference in the survival of the American and the global banking system in September 2008 was indeed liquidity provision, to take an asset which is very unattractive to sell in the moment of the crisis because its value may be suspect.

• Paul Solman:

  Assets like loans backed by failing mortgages, which the Fed took off the hands of the banks.

• Adam Tooze:

  And to give you in exchange a cash loan that will tide you over for a matter of days, weeks or months.

• Paul Solman:

  Ready cash. liquidity.

  And this saved the American financial system?

• Adam Tooze:

  This didn't just save the American financial system. It saved the financial system of the world. More than half of the liquidity provision to large banks in the United States was to European banks in the United States, and then on top of that, the Fed lent $4.5 trillion to European and Asian central banks, who indirectly provided dollars to their local banks in Europe and in Japan.

• Paul Solman:

  And this, says Adam Tooze, is the key to understanding the crash of '08, a global financial crisis because of global financial interconnectedness, a crisis that would have been far worse had the U.S. not dispensed dollars worldwide.

• Adam Tooze:

  Wall Street is a global banking center. So you have banks from all over the world. And the Fed is providing them liquidity not out of the goodness of its heart, but to stabilize the American financial system, to stabilize the American housing market.

• Paul Solman:

  And to stabilize the intricately interconnected global financial system, with players like Barclays of London, which bought the remains of Lehman.

• Adam Tooze:

  Yes, Barclays got hundreds of billions in liquidity too.

• Paul Solman:

  So, in the end, the system worked, right? I mean, we're on Wall Street, stock market almost double what it was before the crash.

• Adam Tooze:

  Well, it did, if you happened to be one of the minority of Americans who actually has stock. Most Americans don't. And large parts of America have not recovered from the crisis.

  The San Francisco Fed was estimating that, as a result of the lost growth in the U.S. economy, the decade in which America grew below where it might otherwise have been, the recession probably cost the average American about $70,000.

• Paul Solman:

  Seventy thousand dollars in lifetime income, that is.

• Adam Tooze:

  So that is not something we're ever going to get back, regardless of what happens in the stock market.

• Paul Solman:

  Which prompted a final question, about the political ramifications of the crash of '08, at a final location.

• Adam Tooze:

  This is Zuccotti Park, just by Wall Street, the site of the famous encampment in 2011 that spawned Occupy and the discourse of the 1 percent against the 99 percent, the place where inequality in America today was really put back on the political map.

  Huge rage against bailing out the banks. And the other great political reaction to the crisis came two years earlier in the form of the Tea Party, the idea that irresponsible borrowers who had taken on debts they couldn't afford were now going to be rescued by the federal government.

  One opens, if you like, the door to a more radical politics on the right. The other opens the door to a more radical politics on the left.

• Paul Solman:

  Which is, of course, just where we are on the 10th anniversary of the crash of '08.

  For the "PBS NewsHour," this is economics correspondent Paul Solman, reporting from New York.