A Tale of Two Economic Crises

The global financial crisis that unfolded between 2007 and 2009 did not only impact the financial sector but also extended its reach to banks worldwide.

- Dr Rajiv Khosla and Pooja Khosla

Stemming from the rupture of the housing bubble in the United States, the crisis swiftly proliferated across the globe. Following the terrorist attacks of September 11, 2001, the US Federal Reserve aimed to revive the economy by reducing the interest rate to 1% over the next 2-3 years. Prior to the attacks, interest rates in the United States ranged between 5-6% from 1995 to 2000.

However, dissatisfaction among depositors with the low 1% returns led them to seek alternative investment avenues. At this juncture, the housing sector emerged as an attractive option due to steadily rising prices. Capitalizing on the low interest rates, numerous borrowers took out loans to purchase or construct homes. Even those who had never considered loans began to benefit from the low interest costs, initiating a surge in home buying and construction. Consequently, housing prices soared, and the inflation in the housing market spilled over into other commodities. Between 2004 and 2006, the US Federal Reserve had to implement a series of interest rate hikes to combat inflation.

These costly loans acted as a hindrance to growth, initially impacting investment, followed by a decline in employment and income. The inability of millions of unemployed individuals to repay their loans triggered defaults, resulting in losses for banks and financial institutions. This domino effect first affected small banks, followed by larger ones, ultimately engulfing financial institutions worldwide.