1990 to 2009: Financial History and Market Events

The dot-com bubble of the late 1990s was distinctive in several ways. It was driven by genuine technological transformation, the early commercialization of the internet, which made it difficult to distinguish speculative excess from legitimate repricing of long-run growth expectations. Many companies with no earnings and business models that required years of losses went public and achieved market capitalizations exceeding established profitable businesses. The bubble was also characterized by a network of incentive distortions: investment banks that earned fees from IPOs had conflicts of interest in analyst coverage, venture capital investors needed exits before business models were proven viable, and retail investor participation reached unusual levels. The Nasdaq peak in March 2000 was followed by a roughly 80% decline over two and a half years.

A mortgage-backed security is a financial instrument that pools individual mortgages and issues bonds backed by the cash flows from those loans, distributing principal and interest payments to holders. In the years before 2008, the securitization chain transformed U.S. mortgage origination: lenders originated loans and sold them to investment banks, who pooled and securitized them, distributing credit risk across global investors. This originate-and-distribute model reduced the originator's incentive to verify borrower quality. Rating agencies assigned high ratings to senior tranches of pools containing subprime loans, based on models that used short historical periods without significant house price declines. When U.S. house prices fell nationally, default rates exceeded model assumptions and the assumed diversification in the pools failed, causing losses across the structured finance system globally.

The Asian Financial Crisis of 1997 to 1998 left several legacies that shaped subsequent crises and policy responses. Asian central banks that had insufficient reserves to defend currency pegs responded by building large foreign exchange reserve buffers, contributing to the global savings imbalances of the 2000s. The IMF's conditionality requirements during the crisis were perceived as inappropriate austerity, leading emerging market governments to self-insure through reserve accumulation rather than rely on IMF support. The crisis also demonstrated how quickly contagion could spread across countries sharing similar vulnerability profiles even without direct financial linkage. The Russian and LTCM crises of 1998 followed partly from the risk-off sentiment that the Asian crisis had already generated among global investors.