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The Political Impacts of the 2008 Financial Crisis

It’s . The chairman and CEO of Merrill Lynch, one of the biggest banks in the United States, resigns after 21 years. Why would anyone give up such a lucrative position?

Less than a week earlier, Merrill Lynch stunned Wall Street by announcing a staggering $7.9 billion in losses. They never recovered, and were bought by Bank of America almost a year later. These kinds of losses were not unique to Merrill Lynch—essentially every major American financial institution was similarly exposed. The United States’ economy began to dip into a recession that would eventually spread across the world and devastate the global economy.

This recession, called the “Great Recession,” was the worst economic downturn in the United States between and . Major financial markets lost more than 30% of their value, home foreclosures skyrocketed, and unemployment roughly doubled.

As much of this was occurring during an election year, the consequences weren’t limited to economics. The crisis and subsequent recession had enormous political consequences in the United States, greatly impacting the political climate throughout the country. However, the crisis itself may have had less of a political impact than the government’s response to it.

How did the financial crisis and the federal government’s response to it impact American politics?

The Financial Crisis

First, a brief overview of the crisis itself. In the early 2000s, relaxed financial regulations and loan standards led to growth in the subprime mortgage market. These are home loans issued to people who have a higher risk of defaulting on their debt. They carry more risk, but also have higher rates of return. Subprime borrowers believed that the housing market would continue trending upwards and that they could resell their homes and profit if they couldn’t make their payments. Subprime mortgages increased tenfold between and .

The lenders didn’t mind making risky loans because they rarely assumed the risk. Instead of holding and collecting on subprime mortgages, they packaged hundreds of them into securities, a type of financial product, which they then sold to investors. The seller is freed from risk and uses the money from the sale to issue more loans. This can be very profitable, as long as home prices continue to rise and default rates remain low.

Even though mortgage securities would carry risk in the event of an economic downturn, they were consistently assessed to be low risk, safe investments. Regulators, investors, lenders, and bond ratings agencies were all unable to accurately evaluate these new and complex mortgage securities, as well as other mortgage-related investment products.

This contributed to a bubble, as the value of the securities increased far beyond the value of the underlying mortgages. When the bubble burst, the housing market crashed, raising the default rate and wiping out trillions of dollars in mortgage-related investment products. Home equity and stock market losses alone amounted to $10 trillion of lost value between and . Large financial institutions saw losses in the tens of billions of dollars. Investors and homeowners saw their savings and pension funds disappear.

On several occasions lenders responded to market uncertainty by raising their loan standards. This caused a credit crunch, worsening liquidity conditions and forcing many businesses to protect themselves in various ways, including layoffs and cutting spending. This was reminiscent of the deflationary spiral that occurred during the Great Depression. The Bush administration responded to the crisis in three main ways. First, there was damage control to stop the immediate bleeding. Second, there was the Emergency Economic Stabilization Act, which gave the Treasury the tools it needed to truly combat the panic. Third, there was the Federal Reserve’s monetary policy to combat liquidity issues.

The Governmental Response

The Bush Administration's Response

Damage Control

Damage control consisted of actions by the Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation to save financial institutions from collapse. To this end, the Federal Reserve organized the sale of Bear Stearns to JPMorgan Chase in . They lent JPMorgan $30 billion to cover Bear’s toxic assets. This prevented the spread of the crisis for 6 months, which proved to be crucially valuable time. and are considered to be two of the worst financial months in American history.

On , the Treasury nationalized Fannie Mae and Freddie Mac, two government-sponsored enterprises that guaranteed 50% of all mortgages in the United States.

Eight days later, Lehman Brothers was allowed to fail in a $691 billion dollar bankruptcy, still the largest to ever occur. This failure caused markets to reel, triggering a global panic.

The next day, the Federal Reserve was forced to lend American Insurance Group $85 billion. AIG insured many large financial institutions, often using unregulated, “insurance-like” financial products. Their failure would have caused investors to completely abandon the people they insured, collapsing the global banking system. In exchange for the loan, the Federal Reserve took ownership of 80% of AIG’s equity, and used their majority stake to replace their management.

Ten days later, Washington Mutual filed for a $327 billion dollar bankruptcy after being seized by the FDIC, the second-largest bankruptcy in history.

The Emergency Economic Stabilization Act

With major financial institutions dropping like flies, the Treasury lacked the firepower to combat the panic, even with the help of the Federal Reserve. The Emergency Economic Stabilization Act allocated $700 billion dollars to stabilize the economy and restore liquidity. This law is often called the “bank bailout of .” The bill initially failed in the House of Representatives, prompting the market to correct by $1.4 trillion. The bill was passed in a second vote in .

The primary purpose of EESA was to establish the $700 billion Troubled Assets Relief Program, or TARP. This allowed the Treasury to stop the worst of the panic. The Treasury did this by heavily pressuring the heads of 9 large banks to take cash injections totaling $125 billion. Another $125 billion was distributed to about 700 smaller banks. This prompted the 6th biggest single-day jump in the history of the stock market, an 11% increase.

Monetary Policy

Although the panic was under control, the recession had just begun. Despite avoiding complete collapse, the economy wouldn’t bottom out until the second quarter of , and the credit crunch still forced businesses to make layoffs and cut spending. To encourage lending, the Federal Reserve engaged in quantitative easing, or QE, an unconventional monetary policy that increases liquidity. The Federal Reserve normally only buys short-term treasuries, but in QE, they bought longer-term debts other than treasuries, including mortgage securities. The liquidity this introduced made lenders more confident, leading to lower interest rates that kept the housing market afloat during the first round of QE, or QE1, which lasted from to .

The Obama Administration's Response

The crisis itself was over by the time Obama entered office. The biggest problem facing him was the recovery. Several actions were taken to spur economic growth.

The American Recovery and Reinvesetment Act

The Obama administration’s first major action was signing the American Recovery and Reinvestment Act, or ARRA. Passed just a month after Obama entered office, ARRA was a massive stimulus package. It was intended to save existing jobs while creating new jobs and promoting general economic growth. Sharply contrasting the Bush administration’s EESA, ARRA was jobs-oriented, and deliberately focused on Main Street instead of Wall Street, which it actively avoided. ARRA made investments into healthcare, education, infrastructure, and renewable energy sources, but was and continues to be criticized for its impact on the deficit.

The Auto Bailout

There was only one major bailout under the Obama administration: an $80 billion dollar bailout of the “big three” auto manufacturers, consisting of GM, Chrysler, and Ford. Auto loans are the third biggest category of household debt in the United States, behind only home and student loans. For this reason, the auto industry was hit hard by the credit crunch. GM and Chrysler needed a true bailout from the Treasury’s TARP funds, which they received after reorganizing under bankruptcy. Ford, however, only needed a loan from the Energy Department. Overall, the auto bailout cost taxpayers $10 billion. However, its primary purpose was to save jobs, which it did successfully, adding almost 350,000 jobs between auto manufacturers and dealerships.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank for short, was an expansive set of financial reforms designed to prevent a similar crisis from occurring in the future. It directly addressed many if not all of the commonly-cited causes of the crisis. Among other things, Dodd-Frank increased oversight of financial institutions that were too big to fail, curbed predatory lending practices and expanded the Securities and Exchange Commission to verify credit ratings. In total, Dodd-Frank contained 2,300 pages of rules and regulations designed to protect Americans and the American economy.

Monetary Policy

In order to support the recovery, the Federal Reserve used all of its normal tools, including lowering the federal funds rate to near-zero for several years. In addition to its normal tools, the Federal Reserve engaged in three more rounds of quantitative easing. These later rounds are regarded as generally successful with varying levels of effectiveness, though none of them were as important as QE1.

The Impact

It’s no secret: everyone hated the bank bailout. They had every right to. It was not fair or just by any stretch of the imagination. People who hurt others through their recklessness and irresponsibility were rescued and even benefitted from the massive fallout that resulted from their poor decisions.

The sheer magnitude of the anger over the bailouts made their real-world effectiveness immaterial. To date, the government has made $121.1 billion on the bailouts. The Federal Reserve has made more than $30 billion every year since . The bailout anger crossed party lines, and could be found in every demographic. It represented a splintered will for change. There was no clear direction on where to go from here, except very far away.

This was most clearly visible in the presidential election, in which it was occasionally said that both Obama and McCain were running against Bush, who had achieved the third-lowest presidential approval rating ever just a month before election day. Bush had a 25% approval rating in the first week of , compared with an average of 37% throughout his second term.

Widespread Frustration

The bailouts found a way to alienate everyone. To conservatives, the bailouts were an affront to many of their core values. They didn’t like the government being so involved in the private sector. They didn’t like spending so much taxpayer money on financial institutions while spending so little on ordinary people. They didn’t like how much power was being wielded by unelected officials. They especially didn’t like how those unelected officials were nationalizing major financial institutions, seemingly at will. This seemed to them to be the path to, if not the arrival of, socialism in the United States.

Liberals were not opposed to bailouts in theory, but in practice, many were frustrated with the bailouts’ specifics. One concern was the lack of strings attached to the money. The bailouts included minimal limits on bonuses and executive pay. Frustration grew over time as bailout recipients continued to pay large bonuses at the same time they were tightening loan qualifications for businesses and reporting multibillion dollar losses. This prompted scrutinization of Treasury Secretary Hank Paulson, who was also a former CEO of bailout recipient Goldman Sachs. This seemed to them to be clear evidence of the corporate control of American politics.

While both federally elected independents at the time caucused with Democrats, third-party and independent voices were being heard. Republican representative Ron Paul channeled the ideas of Libertarians, blaming the Federal Reserve for the crisis and calling for its abolishment, along with the abolishment of paper money. Perennial presidential candidate Ralph Nader criticized the “corporate state” and held many campaign rallies and protests in and around Wall Street in a way that resembled what the Occupy movement would eventually do.

Division

How did a universally hated bailout divide United States politics? The public believed that policymakers had failed both to initially regulate and to eventually punish Wall Street, leading to a large decline in institutional trust. As people lost faith in the political establishment, they turned to a wide range of ideologies for solutions on how to move forward.

As the sources of people’s ideas diversified, the window of discourse broadened to include issues that weren’t necessarily new, but weren’t previously being paid attention to. These issues were often related to the problems people experienced as economic conditions worsened. The doubling of unemployment turned heads towards automation and outsourcing. The credit crunch turned heads to income inequality and wage stagnation. Other examples of such issues include upward mobility, mental health, and forms of non-mortgage debt, like student loans.

The government’s efforts to address these kinds of issues reflected another political impact of the crisis—the expansion of both the scope and degree of government intervention. This trend was expressed in many ways, including the bailouts themselves, which considerably expanded the role of the government in the private sector. Additionally, the government increased its spending on social programs 42% between and , as worse economic conditions necessitated more aid. The Federal Reserve massively expanded their balance sheet, which tripled in size between and . This set a precedent that has lasted to the present day. Between and , the Federal Reserve’s balance sheet has octupled to $7.1 trillion.

One of the most important political impacts of the financial crisis is its impact on disinformation and misinformation. The financial crisis coincided with unrelated developments in media and contributed to lower journalistic standards in many news organizations, as well as a larger platform for people looking to appeal to the lowest common denominator. Outrage is a massive driver of engagement, and the bailouts provided an easy target for that outrage. When the bailouts faded from relevance, the need for engagement remained, and some outlets chose to exaggerate or manufacture that outraging content. Americans’ trust in mass media has gone down over time, and social media has become increasingly saturated with misleading headlines, conspiracy theories, and in some cases, even propaganda.

Perhaps one of the most underestimated impacts of the financial crisis was the increase in divisiveness, which has been expressed in many ways. Political polarization is at its highest level since the Civil War, as low institutional trust and dissatisfaction with the political establishment drove people towards more radical positions. The overlap between the parties has decreased. This partisanship has vastly decreased congressional productivity. The last five Congresses have been five of the six least productive ever recorded.

Increased polarization combined with decreased legislative change to create even more dissatisfaction. This has increased incidents of civil unrest, especially in election years. The average number of election-year protests and riots has increased, from an average of 1.6 between and , to an average of 8.5 since. In presidential election years, the average has increased tenfold.

Political Movements

The financial crisis also launched several political movements.

The Tea Party

The Tea Party began in to organize opposition against Obama's deficit spending. It wasn't a real political party; it was a movement, largely defined by its massive protests. It advocated for small government, low taxes, and a reduced deficit. It was formed after CNBC’s Rick Santelli criticized Obama’s programs in a viral rant. Ron Paul’s ideas were another large influence on the movement. The movement succeeded in organizing protests, giving the Republicans huge victories in the and midterms, and getting tax cuts during the Trump administration. The movement failed in balancing the budget and remaining prevalent. The movement’s legacy is its backlash against Obama, which eventually overtook the movement’s stated goals. With Republicans in power, taxes were cut, but the deficit increased, as did the size of the government.

The Occupy Movement

The Occupy movement was an initiative against social and economic inequality. The movement was started online in 2011 and was inspired in part by the Arab Springs. The goal of the movement was to reduce corporate influence on politics, increase regulations on the financial sector, and provide relief to people deep in debt. The bankers, executives, and financiers that went unpunished during the financial crisis were another focus of the Occupy movement. There were 45 Occupy demonstrations that were confirmed to have more than 100 participants. It is likely the real number is higher. The movement did not have many legislative accomplishments, but it succeeded in shifting the window of discourse towards the left, allowing for the Congressional Progressive Caucus to make gains in the following years. Occupy was generally regarded as a failure when it ended, but the progress of the CPC and the increasing approval of the reforms they advocated for may hint that they’ve had more of an impact than previously thought.

Neo-Nationalism

Although these movements are significant, they aren’t the political legacy of the financial crisis. That title would go to the global Neo-Nationalism movement, an ongoing trend towards far-right populism and nationalism that began after the financial crisis. Although it is associated with the western countries of Europe, India’s Narendra Modi, Brazil’s Jair Bolsonaro, and Zimbabwe’s Emmerson Mnangagwa are global examples of this phenomenon.

Neo-Nationalism is characterized by unilateralism, or the lack of international cooperation; protectionism, or the restriction of international trade; and nativism, or the promotion of native citizens’ interests over those of immigrants.

In America, those viewpoints are commonly associated with Donald Trump, who has claimed to be a nationalist.

One of Trump's strongest demographics in the election was "people that consider their financial situation to be worse now than it was four years ago." Trump won that demographic, which represents 25% of voters, 78 to 19. Trump won in from flipping swing states in the Great Lakes Region. These are centers of mining, manufacturing, agriculture, and other sectors hit hard during the financial crisis. That's not a coincidence. People who lost their jobs in these sectors during the financial crisis did not, for the most part, get them back. Trump's "turn back the clock" economics hit close to home for many people who were hurting at this time.

The part of Trump's Neo-Nationalism that's intolerable is his dog whistling of white nationalists. Using language like "we're going to take our country back," but never clarifying who you mean by "we" lets people fill in their own blanks.

This sort of thing isn’t an isolated incident. Trump has given white nationalists, who rebranded as the “alt-right” in , the most centralized platform they've had in half a century. Alt-Right leader Richard Spencer said, “Before Trump, our identity ideas, national ideas, they had no place to go.”

There is a direct pipeline between Trump’s rhetoric and white nationalist violence. The Christchurch mosque shooter, who killed 51, called Trump “a symbol of renewed white identity.” Overall, roughly 21% of hate violence perpetrators in the United States in explicitly referenced Trump, his policies, or his slogans.

Conclusion

Many wonder how politics has become so divisive recently. The financial crisis offers some promising answers in this regard, especially when it comes to the United States and the western countries of Europe. Despite the bailout anger being virtually ubiquitous, it drove many different developments that often contradicted one another. This is indicative of some of the larger underlying problems with how information is produced, distributed, and consumed in the modern world. The trend of decreasing institutional trust met the trend of increasing availability of platforms for disinformation, allowing many people to unknowingly fall victim to these underlying problems.

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