The Global Financial Crisis and the Challenge to Neoliberalism
Russia's case was just one example of how the "shock therapy" of neoliberalism did not lead to
the ideal outcomes predicted by economists who believed in perfectly free markets. The greatest
recent repudiation of this thinking was the global financial crisis of 2008-2009.
Neoliberalism came under significant strain during the global financial crisis of 2007-2008 when
the world experienced the greatest economic downturn since the Great Depression. The crisis can
be traced back to the 1980s when the United States systematically removed various banking and
investment restrictions.
Regulations continued to decrease into the 2000s, which was leading to a looming crisis.
Government officials failed to regulate risky investments in the US housing market in their
efforts to promote the free market. Taking advantage of "cheap housing loans," Americans began
building houses that were beyond their financial capacities.
To mitigate the risk of these loans, banks that were lending houseowners' money pooled these
mortgage payments and sold them as "mortgage-backed securities" (MBSs). One MBS would be
a combination of multiple mortgages that they assumed would pay a steady rate.
Since there was so much surplus money circulating, the demand for MBSs increased as investors
clamored for more investment opportunities. In their haste to issue these loans, however, the
banks became less discriminating. They began extending loans to families and individuals with
dubious credit records—people who were unlikely to pay their loans back. These high-risk
mortgages became known as sub-prime mortgages.
Financial experts wrongly assumed that, even if many of the borrowers were individuals and
families who would struggle to pay, a majority would not default. Moreover, banks thought that
since there were so many mortgages in just one MBS, a few failures would not ruin the entirety
of the investment.
Banks also assumed that housing prices would continue to increase. Therefore, even if
homeowners defaulted on their loans, these banks could simply reacquire the homes and sell
them at a higher price, turning a profit.
Sometime in 2007, however, home prices stopped increasing as supply caught up with demand.
Moreover, it slowly became apparent that families could not pay off their loans. As a result,
MBSs were quickly resold, as banks and investors wanted to get rid of their disastrous assets.
This risky cycle came to a breaking point in September 2008, when big investment banks such as
Lehman Brothers went bankrupt, wiping off large investments.
The crisis spread beyond the United States since many investors were foreign governments,
corporations, and individuals. The loss of their money spread like wildfire back to their
countries.
These series of interconnections allowed for a global multiplier effect that sent ripples across the
world. For example, Iceland's banks heavily depended on foreign capital; so when the crisis hit
them, they failed to refinance their loans. Three of Iceland's largest commercial banks have
defaulted because of this credit crunch. Iceland's debt climbed by more than seven times between
2007 and 2008.
Until now, countries such as Spain and Greece, have been deeply indebted (nearly similar to
Third World countries), and debt relief has come at a heavy cost. To be specific, Germany and
the IMF have compelled Greece to reduce its social and public spending. Affecting services such
as pensions, health care, and various forms of social security, these cuts have been felt most
acutely by the poor. Moreover, the reduction in government spending has slowed down growth
and ensured high levels of unemployment.
The United States recovered relatively quickly; thanks to a large Keynesian-style stimulus
package that President Barack Obama pushed for in his first months in office. The same cannot
be said for many other countries. In Europe, the continuing economic crisis has sparked a
political upheaval. Far-right parties, such as Marine Le Pen's Front National in France, have
recently gained popularity by unjustly blaming immigrants for their troubles, saying that they
steal jobs and take advantage of welfare. These movements combine popular discontent with
outright racism and bigotry.