US Stock Market Crash - What Caused The 2008 Meltdown?

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What Caused The 2008 US Stock Market Crash?

Summary: This page looks at some of the causes of the US stock market crash in 2008 and their impacts. These of course include the monetary problems caused by a banking crisis.

In his book, "The Return of Depression Economics", 2008 Nobel Prize winner Paul Krugman looks at the financial crisis from the perspective of the banking and credit crises that went before in Argentina, Mexico, Asia and then LTCM. In other words, he questions the notion from the early 2000s made by US economists that recessions, depressions, banking and credit market problems were 'fixed' and a thing of the past.

In his way, he is telling us that our confidence was misplaced - as confidence often is - and that we need a still greater understanding of monetary policy.

He describes the 2008 crash thus, "I'm tempted to say that the crisis is like nothing we've ever seen before. But it might be more accurate to say it's like everything we've seen before, all at once: a bursting real estate bubble comparable to what happened in Japan at the end of the 1980s; a wave of bank runs comparable to those of the 1930s (albeit mainly involving the shadow banking system rather than the conventional banks); a liquidity trap in the United States, again reminiscent of Japan; and, most recently, a disruption of international capital flows and a wave of currency crises all too reminiscent of what happened to Asia in the late 1990s."

Each of the factors mentioned above was enough to pull the country or region metioned into a downward economic spiral including recession, unemployment, currency devaluation and banking crisis. The real difference is that in the US in 2008, all of these factors seemed to be converging. The hopes for a 'quick fix', a 'soft landing' or a 'shallow recession' seem to be quite limited.

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As Krugman describes it, the impact of Alan Greenspan's policies (blowing bubbles) and hedge fund managers and their use of short-term financing for long-term trades and commitments, caused much of the problems. But of course, that was not all. We can only recommend that you read the book for a full description - it is very readable for a book about economics.

Of course, none of the factors explain the 2009 stock market recovery. In a period of worsening financial statistics, rising unemployment / bankruptcies and reposessions, currency devaluations, bailouts, quantitative easing and much more, any positive stock market progress seems rather foolish. At the time of writing, many major world stock exchanges seem to be showing David Blaine-like levitational abilities. Time will tell...

Krugman does not look into the elements of interconnectivity and the notion that some financial institutions are 'too big to fail', instead he spends time discussing the 'shadow banking system' and the 'Masters of the Universe' (hedge fund managers) and the impact each had when it failed to operate and their borrowed money could no longer be re-borrowed. Fascinating.

Needless to say, the impact - as we all know - was not contained to the United States or the S&P, far from it. The positive correlation between many major bourses around the world, when combined with the global nature of most major financial companies and investment banks, and the use of global diversification of investment funds, meant that the problem was felt virtually everywhere and by the majority of people on earth in one way or another.

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