The crisis was triggered by the collapse of the U.S. housing market after years of rising home prices, aggressive lending, and the belief that housing “never goes down.”
Banks issued large volumes of subprime and adjustable-rate mortgages to borrowers with limited ability to repay.
These mortgages were bundled into mortgage-backed securities (MBS) and complex products like CDOs, which were rated far safer than they truly were.
When home prices stopped rising in 2006–07 and defaults increased, the value of these securities collapsed.
Major institutions such as Lehman Brothers, Bear Stearns, and AIG were heavily exposed and lacked sufficient capital.
The result was a global liquidity freeze and the deepest economic downturn since the Great Depression.

What Drove the Crisis

Distorted incentives: Originators were paid to issue loans, not assess credit quality; investment banks were rewarded for creating products, not ensuring safety.
Rating agency failures: Conflicts of interest led to overly optimistic ratings on risky mortgage securities.
Investor appetite for yield: Investors bought complex products they did not fully understand.
Extreme leverage: Thin capital ratios, heavy reliance on short-term funding, and massive exposure to mortgage-linked assets magnified every loss.
Interconnected markets: Defaults spread rapidly through derivatives and wholesale funding networks.
Once confidence broke, the entire system unraveled.

Investor Lessons

Systemic risk grows quietly when incentives reward volume over solvency.
Markets can look stable while hidden risks accumulate off balance sheet or inside complex products.
Liquidity disappears exactly when it is most needed.
Financial models fail when their assumptions fail; correlations rise sharply under stress.
Investors must understand underlying collateral, avoid dependence on continuous refinancing, and evaluate counterparty risk.
Financial systems break when confidence breaks — the most fragile layer in the entire structure.

The Great Financial Crisis (2008–2009)