Too Big to Fail: An Analysis of Systemic Risk in the 2008 Financial Crisis

Abstract

The recent bankruptcy of Silicon Valley Bank and the awarding of the Nobel Prize in Economics have both brought attention back to the issue of how to lower systemic risk in the banking industry and stop or lessen the severity of a financial crisis. To study this issue, this paper reviews the 2008 U.S. subprime mortgage crisis, explaining the causes of the crisis and its tremendous adverse effects from the perspectives of, among others, the U.S. monetary policy, the emergence of the Credit Default Swap (CDS) frenzied property market, and the lack of regulation in the financial sector. It also describes the measures taken by the government and banks to resolve the crisis from their perspectives. Further among them, the paper reviews the process of Basel III in strengthening the regulation of large financial institutions, prompting them to improve their capital adequacy ratios and reduce systemic risk. The key role played by systemic risk in preventing the crisis and reducing its impact is emphasized. Thereafter, this paper compares and unfolds the subprime crisis of 2008, the Japanese financial crisis of the 1990s, and the recent Covid-19 crisis to illustrate the responsibility of the banking sector to society. The paper also suggests that banks should increase their capital adequacy ratio, reduce excessive risky investments, reduce systemic risk, ensure their credibility in society, and prevent bankruptcies in today's fluctuating national monetary policies and tense economic situation.