Name: Sophiya Siraj Shaikh 128

Fatima Hafiz Dalwai 85

Anil Kewlani 144
Henal Pramod Parmar 158
Shalini Kumari 181
Shivshankar Wattamwar 184
Srushti Parekar 191

Specialization: Finance
Subject: Behavioural Finance

Case Study of the 2008 Financial Crisis

Summary
The 2008 financial crisis, often referred to as the Great Recession, was a global economic
downturn triggered by the collapse of the U.S. housing market and the widespread default on
subprime mortgages. Financial institutions, enticed by rising housing prices and lax regulations,
created complex financial products such as mortgage-backed securities (MBS) and collateralized
debt obligations (CDOs). When housing prices began to decline in 2007, defaults on these
mortgages surged, resulting in massive losses across the financial sector.
The crisis reached a critical point with the bankruptcy of Lehman Brothers in September 2008,
which set off a domino effect of financial instability worldwide. Stock markets plummeted,
credit markets froze, and unemployment skyrocketed as businesses cut back on spending. In
response, governments and central banks implemented unprecedented measures, including the
U.S. government's $700 billion Troubled Asset Relief Program (TARP) and global interest rate
cuts aimed at stabilizing the economy.
The crisis exposed systemic risks in financial markets, such as excessive leveraging, inadequate
risk management, and regulatory failures. It also highlighted the role of behavioral factors—like
overconfidence, herd behavior, and loss aversion—in exacerbating market volatility. In the
aftermath, stricter financial regulations were introduced, including the Dodd-Frank Act, to help
prevent future crises. The 2008 financial crisis serves as a critical lesson in the need to balance
financial innovation with oversight to ensure economic stability.

Introduction
The 2008 financial crisis, often referred to as the Great Recession, was one of the most severe
economic downturns since the Great Depression. It originated in the United States housing
market and quickly spread globally, impacting financial institutions, governments, and
individuals. The crisis exposed significant vulnerabilities in financial systems, including over-
leveraging, poor risk management, and inadequate regulation.

Origins and Causes

1. The Housing Bubble
• In the early 2000s, housing prices in the U.S. rose rapidly, fueled by low interest rates
and easy access to credit.
• Lenders issued subprime mortgages—loans to borrowers with poor credit histories—
under the assumption that housing prices would continue to rise.
• Financial institutions bundled these loans into complex financial products, such as
mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), which
were sold to investors globally.
2. Overleveraging by Financial Institutions
• Banks and financial institutions, including Lehman Brothers, Bear Stearns, and AIG,
heavily invested in subprime mortgages and related derivatives.
• Many institutions used high levels of leverage to amplify returns, leaving them
vulnerable to declines in asset values.
3. Lack of Regulatory Oversight
• Rating agencies assigned high credit ratings to risky securities, misrepresenting their
safety.
• Regulators failed to identify and address systemic risks within the financial system,
allowing excessive risk-taking.
4. Trigger: The Collapse of the Housing Market
• In 2007, housing prices began to decline, leading to a surge in mortgage defaults.
• As defaults rose, the value of mortgage-backed securities plummeted, causing massive
losses for investors and institutions holding these assets.

Key Events of the Crisis

1. Bear Stearns Collapse (March 2008)
• Bear Stearns, heavily exposed to subprime mortgages, faced a liquidity crisis.
• The Federal Reserve brokered a sale to JPMorgan Chase to prevent a wider collapse.
2. Lehman Brothers Bankruptcy (September 2008)
 • Lehman Brothers, unable to secure a bailout or buyer, filed for bankruptcy, marking the
largest bankruptcy in U.S. history.
• Its collapse sent shockwaves through global financial markets.
3. Global Financial Contagion
• Banks worldwide, interconnected through complex financial instruments, faced liquidity
shortages and insolvency risks.
• Stock markets plunged, and credit markets froze as trust between institutions eroded.
4. Government Interventions
• The U.S. government launched the Troubled Asset Relief Program (TARP), a $700 billion
bailout for banks and financial institutions.
• Central banks worldwide slashed interest rates and injected liquidity into the financial
system to stabilize markets.
5. Economic Impact
• Unemployment surged as companies cut costs and scaled back operations.
• Millions of people lost their homes due to foreclosures.
• Global GDP contracted, with severe recessions in many countries.

Effects on Different Stakeholders

1. Financial Institutions
• Many banks collapsed or were forced into mergers.
• Survivors faced tighter regulations, including stress tests and increased capital
requirements.
2. Individual Investors and Households
• Stock portfolios and retirement savings suffered significant losses.
• Widespread foreclosures displaced families and disrupted communities.
3. Governments
• Massive bailout programs increased public debt.
• Political debates emerged about accountability and the ethics of rescuing financial
institutions.
4. Global Economy
 • Trade and investment flows contracted sharply.
• Emerging economies experienced capital outflows and currency depreciation.

Analysis of the 2008 Financial Crisis

1. Systemic Risks
The 2008 financial crisis highlighted numerous systemic vulnerabilities in the global financial
system. These included:
• Overleveraging: Financial institutions significantly increased their use of debt to amplify
returns. Major banks like Lehman Brothers had leverage ratios exceeding 30:1, meaning
a small drop in asset values could render them insolvent.
• Interconnectedness: Financial systems were deeply interconnected through complex
instruments like mortgage-backed securities (MBS) and collateralized debt obligations
(CDOs). The failure of one institution (e.g., Lehman Brothers) caused ripple effects across
the global financial network, creating a cascade of failures.
• Shadow Banking System: Non-bank financial entities, such as hedge funds and
investment firms, operated outside traditional regulatory frameworks. Their inability to
access central bank support during the crisis exacerbated liquidity shortages.
To mitigate systemic risks, global regulators introduced stricter requirements for leverage,
capital adequacy, and transparency. The Basel III framework, for instance, mandated higher
capital reserves and introduced stress testing.
2. Regulatory Failures
The crisis exposed critical lapses in regulatory oversight:
• Rating Agencies' Role: Credit rating agencies, such as Moody’s and S&P, assigned high
ratings to risky securities. These inflated ratings misled investors into underestimating
the risks associated with MBS and CDOs.
• Inadequate Oversight: Regulators failed to monitor excessive risk-taking by financial
institutions. The deregulation of derivatives through the Commodity Futures
Modernization Act of 2000 left instruments like credit default swaps unregulated.
• Moral Hazard: Policies like the bailout of Bear Stearns in March 2008 set a precedent
that large institutions would be rescued, potentially encouraging reckless behavior (the
"too big to fail" mindset).
Regulatory reforms, including the Dodd-Frank Act in the U.S., were enacted to increase
oversight of financial markets, regulate derivatives, and reduce moral hazard.
3. Behavioral Insights
Investor psychology played a pivotal role in the crisis:
• Overconfidence: Investors and financial institutions overestimated their understanding
of the housing market and the safety of financial instruments like MBS. They believed
housing prices would rise indefinitely, underestimating risks.
• Herd Behavior: During the market collapse, herding behavior magnified the crisis.
Investors followed the actions of others, leading to panic selling and exacerbating
market declines.
• Loss Aversion: Many investors held onto declining assets in hopes of a rebound, leading
to greater financial losses as market conditions worsened.
• Anchoring: Investors anchored their expectations to pre-crisis asset valuations, delaying
critical decisions to adjust their portfolios.
Behavioral finance principles are now integrated into investment strategy training, emphasizing
the importance of emotional discipline and risk management.
4. Policy Lessons
Government and central bank interventions played a decisive role in stabilizing the financial
system. Key lessons include:
• Swift Policy Action: The Troubled Asset Relief Program (TARP) and central bank
measures (e.g., liquidity injections and interest rate cuts) were critical in preventing a
complete collapse. These actions demonstrated the need for rapid and decisive
intervention during financial crises.
• Global Coordination: The crisis underscored the importance of international
cooperation. Organizations like the G20 coordinated responses to stabilize global
markets.
• Preventive Measures: Post-crisis, governments emphasized preventive policies to avert
future crises. Measures included higher capital requirements, stress testing, and the
establishment of resolution mechanisms for failing institutions.

Critical Outcomes
1. Financial Sector
• Institutions faced stricter regulations, such as increased capital buffers, stress testing,
and oversight under the Dodd-Frank Act.
• Many banks restructured their operations, reducing reliance on high-risk investments.
2. Global Economy
 • The recession caused GDP contractions worldwide, with many countries experiencing
prolonged economic stagnation.
• Emerging economies, despite initial resilience, faced challenges due to declining trade
and capital outflows.
3. Social Impact
• The crisis led to widespread unemployment and homelessness, eroding public trust in
financial institutions.
• Political movements, such as Occupy Wall Street, arose to protest perceived inequities
and corporate greed.

Conclusion :
The 2008 financial crisis was a pivotal moment in global economic history, exposing significant
flaws in financial systems and permanently changing the way markets, institutions, and
regulators operate. The crisis highlighted several critical issues that continue to resonate today:
1. Systemic Risks
The crisis uncovered inherent systemic risks within the global financial system, emphasizing
the dangers posed by interconnectedness and excessive leverage. These factors demonstrated
how shortcomings in one institution could rapidly spread to others, threatening the stability of
the entire financial landscape.
2. Regulatory Failures
A lack of rigorous oversight regarding lending practices, credit rating agencies, and derivatives
trading significantly exacerbated the crisis. The absence of effective regulations allowed risky
behaviors to flourish, and it underscored the need for a comprehensive review of existing
frameworks to ensure stronger safeguards against future crises.
3. Behavioral Insights
Investor psychology played a substantial role in the crisis, particularly through phenomena
such as overconfidence and herd behavior. These behavioral biases contributed to market
instability and illustrated the need for a deeper understanding of how human psychology can
affect financial decisions and market movements.
4. Policy Lessons
The crisis also provided vital lessons regarding the role of governments and central banks. It
highlighted the importance of swift intervention to prevent complete economic collapse,
reinforcing the need for contingency plans and rapid response mechanisms in times of financial
distress.
The 2008 financial crisis serves as a powerful reminder of the fragility of financial systems and
the devastating impact of unchecked risk-taking. While significant progress has been made in
strengthening financial regulations and enhancing systemic resilience, the lessons of 2008
remain critical in a world where financial innovation continues to evolve. Policymakers,
regulators, and market participants must remain vigilant to emerging risks, ensuring that
financial markets operate in a stable, transparent, and sustainable manner.
Ultimately, the legacy of the 2008 crisis lies not just in the reforms it inspired but in the
collective responsibility to prevent its recurrence. By fostering a culture of accountability,
enhancing risk management practices, and addressing behavioral biases, the global financial
system can be better equipped to navigate future challenges, preserving economic stability and
trust in markets.