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

JUDY WOODRUFF: It was one of the most profound events in generations, with enormous consequences for the American

economy

and households across the country. This was the moment a decade ago when the

financial

crisis

erupted, a collapse that most experts did not foresee. Its effects, and those of the recession that followed, on incomes, wealth inequality, and our politics are still with us. Tonight our economics correspondent Paul Solman looks at how it all happened and the current impact of the decisions made then. He is part of our weekly series, Making Sense. PAUL SOLMAN: So this is where, in a sense, the

crisis

began.

ADAM TOOZE, Columbia University: Yes, this was the place where people stumbled out of offices on September 15,

2008

, when the

world

had ended. PAUL SOLMAN: The Lehman Brothers headquarters in midtown Manhattan, 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 in subprime mortgages, and that's the story everyone knows. How does this crisis in the suburbs of the United States return to the center of finance in New York? PAUL SOLMAN: Okay. As it does? ADAM TOOZE: Banks are fragile things. Classically, we think of them as deposit-funded: households put their savings in the bank and then start to panic and withdraw all their money.

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 start defaulting. Many people invest in these mortgages. Banks have a lot at stake. And suddenly, when banks appear vulnerable and no longer lend to each other, investors pull back. Is that what happened? ADAM TOOZE: Yeah, that's the crucial thing. Later, there was a congressional investigation that went after the banks for selling the bad securities to investors who ended up getting scammed.

In fact, that wasn't the dangerous part. The real problem was bad debts, the securities that American banks held on their balance sheets. PAUL SOLMAN: In other words, Lehman not only created debt securities, bonds, backed by dubious subprime mortgages. He clung to them. When debts began to go bad, faith in Lehman collapsed. No faith, no credit. Without credit, there is no Lehman. ADAM TOOZE: We came closer than ever in history to a complete cardiac arrest, not just of the American

economy

, but of the entire

world

economy. PAUL SOLMAN: Which means everyone is afraid to lend to others.

Credit just freezes and an economy, a modern economy, can't function that way? ADAM TOOZE: A modern economy cannot function without credit for more than a couple of hours, frankly, seconds. G.E., the pillar of American manufacturing, was having difficulty obtaining short-term credit. So was Harvard University. The salaries were not paid. PAUL SOLMAN: And pretty soon, the whole world was watching and caught up. To illustrate your point about how the crisis spread globally, I thought I'd go to a Greek food stand. But you said no, no, an Irish pub. Lo and behold, there's one right across from the old Lehman.

ADAM TOOZE: Yes, because 2008 is about banks. And the failure of the Irish banks in September 2008 is really the moment when panic spreads to Europe in a way that European states find it almost impossible to control. PAUL SOLMAN: Why do European banks have a stake in Irish banks? ADAM TOOZE: All of Europe is linked to the Irish banking boom, using Dublin as an offshore financial centre. And Dublin finds itself on September 29 in the position of having to guarantee the entire balance sheet of the Irish banking system. PAUL SOLMAN: Back in the United States of America, September 29 was also the day that Congress rejected President Bush's bailout bill.

WOMAN: The motion is not adopted. PAUL SOLMAN: And the Dow Jones fell a record 777 points. ADAM TOOZE: This is where the crisis turns from a banking crisis to a crisis of the American economy as a whole, with the stock market crash in September 2008. PAUL SOLMAN: Now we were in the belly of the beast. ADAM TOOZE: So here we have Wall Street with all the global banks, and then 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 Federal Reserve. This 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 to play the classic role that it was always intended to play: to be the lender of last resort for American financial institutions. ADAM TOOZE: Yes. For obvious reasons, there is a lot of emphasis on the unconventional side of Fed policy in 2008: bailouts, bank takeovers, quantitative easing. But what really made the difference in the survival of the American and global banking system in September 2008 was, in fact, the provision of liquidity, to take an asset that is very unattractive to sell at the time of the crisis because its value may be suspicious.

PAUL SOLMAN: Assets like loans backed by failed mortgages, which the Federal Reserve took off the hands of banks. ADAM TOOZE: And to give you in return a cash loan that will allow you to survive in a matter of days, weeks or months. PAUL SOLMAN: Cash ready. liquidity. And this saved the American financial system? ADAM TOOZE: This didn't just save the American financial system. He saved the world's financial system. More than half of the liquidity provision to large banks in the United States went to European banks in the United States, and on top of that, the Federal Reserve lent $4.5 trillion to European and Asian central banks, who indirectly provided dollars to their local banks. in Europe and Japan.

PAUL SOLMAN: And this, says Adam Tooze, is the key to understanding the crash of 2008: a global financial crisis due to global financial interconnectedness, a crisis that would have been much worse if the United States had not distributed dollars around the world. ADAM TOOZE: Wall Street is a global banking center. Then you have banks from all over the world. And the Federal Reserve is providing them with 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 also got hundreds of billions in liquidity. PAUL SOLMAN: So in the end, the system worked, right? I mean, we're on Wall Street, the stock market is almost double what it was before the crash. ADAM TOOZE: Well, that's how it was, if you were one of the minority of Americans who actually owns stocks. Most Americans don't. And much of the United States has not recovered from the crisis. The San Francisco Federal Reserve estimated that, as a result of the loss of growth in the American economy, the decade in which the United States grew below where it might otherwise have been, the recession probably cost the average American about $70,000.

Dollars. PAUL SOLMAN: Seventy thousand dollars in lifetime income, that is. ADAM TOOZE: So that's 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 2008 crash, in one final location. ADAM TOOZE: This is Zuccotti Park, right next to Wall Street, the place where the famous encampment that gave rise to Occupy and the speech of the 1 percent against the 99 percent, the place where inequality in America today really put itself back on the political plane. map. Huge anger against the bailout of the banks.

And the other big political reaction to the crisis came two years earlier with the Tea Party, the idea that irresponsible borrowers who had taken on debts they couldn't afford would now be bailed out by the federal government. It opens, if you will, the door to a more radical right-wing politics. The other opens the door to a more radical left-wing politics. PAUL SOLMAN: Which is, of course, just where we are on the 10th anniversary of the 2008 crash. For "PBS NewsHour," I'm economics correspondent Paul Solman, reporting from New York.