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What Is a Financial Crisis?

What causes a financial crisis, financial crisis examples, the 2008 global financial crisis, the 2020 financial crisis, the bottom line.

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Financial Crisis: Definition, Causes, and Examples

Gordon Scott has been an active investor and technical analyst or 20+ years. He is a Chartered Market Technician (CMT).

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• Financial Crisis CURRENT ARTICLE
• Circuit Breaker
• Plunge Protection Team
• Dutch Tulip Bulb Market Bubble
• Black Friday
• Bank Panic of 1907
• Stock Market Crash of 1929
• What Caused the Stock Market Crash of 1929
• Black Tuesday
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• Stock Market Crash of 1987
• Black Monday
• What Caused Black Monday: The Stock Market Crash of 1987
• The 2007-2008 Financial Crisis in Review
• The Fall of the Market in the Fall of 2008
• Components of the 2008 Bubble
• Financial Regulations: Glass-Steagall to Dodd-Frank
• Consequences of the Glass-Steagall Act Repeal
• Lessons from the 2008 Financial Crisis
• Major Players in the 2008 Financial Crisis: Where Are They Now?
• Too Big to Fail Banks: Where Are They Now?

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In a financial crisis, asset prices see a steep decline in value, businesses and consumers are unable to pay their debts, and financial institutions experience liquidity shortages. A financial crisis is often associated with a panic or a bank run  during which investors sell off assets or withdraw money from savings accounts because they fear that the value of those assets will drop if they remain in a financial institution.

Other situations that may be labeled a financial crisis include the bursting of a speculative financial bubble , a stock market crash , a sovereign default , or a currency crisis . A financial crisis may be limited to banks or spread throughout a single economy, the economy of a region, or economies worldwide.

Key Takeaways

• Banking panics were at the genesis of several financial crises of the 19th, 20th, and 21st centuries, many of which led to recessions or depressions.
• Stock market crashes, credit crunches, the bursting of financial bubbles, sovereign defaults, and currency crises are all examples of financial crises.
• A financial crisis may be limited to a single country or one segment of financial services, but is more likely to spread regionally or globally.

A financial crisis may have multiple causes. Generally, a crisis can occur if institutions or assets are overvalued and can be exacerbated by irrational or herd-like investor behavior. For example, a rapid string of selloffs can result in lower asset prices, prompting individuals to dump assets or make huge savings withdrawals when a bank failure is rumored.

Contributing factors to a financial crisis include systemic failures, unanticipated or uncontrollable human behavior, incentives to take too much risk, regulatory absence or failures, or contagions that amount to a virus-like spread of problems from one institution or country to the next . If left unchecked, a crisis can cause an economy to go into a recession or depression. Even when measures are taken to avert a financial crisis, they can still happen, accelerate, or deepen.

Financial crises are not uncommon; they have happened for as long as the world has had currency. Some well-known financial crises include:

• Tulip Mania (1637). Though some historians argue that this mania did not have so much impact on the Dutch economy, and therefore shouldn't be considered a financial crisis, it did coincide with an outbreak of bubonic plague which had a significant impact on the country. With this in mind, it is difficult to tell if the crisis was precipitated by over-speculation or by the pandemic.
• Credit Crisis of 1772. After a period of rapidly expanding credit, this crisis started in March/April in London. Alexander Fordyce, a partner in a large bank, lost a huge sum shorting shares of the East India Company and fled to France to avoid repayment. Panic led to a run on English banks that left more than 20 large banking houses either bankrupt or stopping payments to depositors and creditors. The crisis quickly spread to much of Europe. Historians draw a line from this crisis to the cause of the Boston Tea Party—unpopular tax legislation in the 13 colonies—and the resulting unrest that gave birth to the American Revolution.
• Stock Crash of 1929 . This crash, starting on Oct. 24, 1929, saw share prices collapse after a period of wild speculation and borrowing to buy shares. It led to the Great Depression , which was felt worldwide for over a dozen years. Its social impact lasted far longer. One trigger of the crash was a drastic oversupply of commodity crops, which led to a steep decline in prices. A wide range of regulations and market-managing tools were introduced as a result of the crash.
• 1973 OPEC Oil Crisis. OPEC members started an oil embargo in October 1973 targeting countries that backed Israel in the Yom Kippur War. By 1978, a barrel of oil stood at about $14, up from $3 in 1973. Given that modern economies depend on oil, the higher prices and uncertainty led to the stock market crash of 1973–74, when a bear market persisted from January 1973 to December 1974 and the Dow Jones Industrial Average lost about 49% of its value.
• Asian Crisis of 1997–1998. This crisis started in July 1997 with the collapse of the Thai baht . Lacking foreign currency, the Thai government was forced to abandon its U.S. dollar peg and let the baht float. The result was a huge devaluation that spread to much of East Asia, also hitting Japan, as well as a huge rise in debt-to-GDP ratios. In its wake, the crisis led to better financial regulation and supervision.
• The 2007-2008 Global Financial Crisis. This financial crisis was the worst economic disaster since the Stock Market Crash of 1929. It started with a subprime mortgage lending crisis in 2007 and expanded into a global banking crisis with the failure of investment bank Lehman Brothers in September 2008. Huge bailouts and other measures meant to limit the spread of the damage failed and the global economy fell into recession.
• COVID19 Pandemic . A global stock market crash began in February 2020. From February 20 until March 23, 2020 the S&P 500 lost over 30% of its value. This was a result of the COVID-19 pandemic, which caused widespread panic and uncertainty about the future of the global economy. Despite being severe and with global reach, markets and national economies rebounded quickly and by early April 2020, the S&P 500 had began a decisive rise, surpassing its pre-pandemic high in August 2020.

The 2008 Global Financial Crisis remains one of the deepest economic downturns in modern history and deserves special attention, as its causes, effects, response, and lessons are still relevant to the current financial landscape.

Loosened Lending Standards

The crisis was the result of a sequence of events, each with its own trigger and culminating in the near-collapse of the banking system. It has been argued that the seeds of the crisis were sown as far back as the 1970s with the Community Development Act, which required banks to loosen their credit requirements for lower-income consumers, creating a market for subprime mortgages .

The amount of subprime mortgage debt, which was guaranteed by Freddie Mac and Fannie Mae , continued to expand into the early 2000s when the Federal Reserve Board began to cut interest rates drastically to avoid a recession. The combination of loose credit requirements and cheap money spurred a housing boom, which drove speculation, pushing up housing prices and creating a real estate bubble.

A financial crisis can take many forms, including a banking/credit panic or a stock market crash, but differs from a recession, which is often the result of such a crisis.

Complex Financial Instruments

In the meantime, the investment banks, looking for easy profits in the wake of the dot-com bust and 2001 recession, created collateralized debt obligations (CDOs) from the mortgages purchased on the secondary market. Because subprime mortgages were bundled with prime mortgages, there was no way for investors to understand the risks associated with the product. When the market for CDOs began to heat up, the housing bubble that had been building for several years had finally burst. As housing prices fell, subprime borrowers began to default on loans that were worth more than their homes, accelerating the decline in prices.

Failures Begin, Contagion Spreads

When investors realized the CDOs were worthless due to the toxic debt they represented, they attempted to unload the obligations. However, there was no market for the CDOs. The subsequent cascade of subprime lender failures created liquidity contagion that reached the upper tiers of the banking system. Two major investment banks, Lehman Brothers and Bear Stearns, collapsed under the weight of their exposure to subprime debt, and more than 450 banks failed over the next five years. Several of the major banks were on the brink of failure and were rescued by a taxpayer-funded bailout.

The U.S. Government responded to the Financial Crisis by lowering interest rates to nearly zero, buying back mortgage and government debt, and bailing out some struggling financial institutions. With rates so low, bond yields became far less attractive to investors when compared to stocks. The government response ignited the stock market. By March 2013, the S&P bounced back from the crisis and continued on its 10-year bull run from 2009 to 2019 to climb to about 200%. The U.S. housing market recovered in most major cities, and the unemployment rate fell as businesses began to hire and make more investments.

New Regulations

One big upshot of the crisis was the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act , a massive piece of financial reform legislation passed by the Obama administration in 2010. Dodd-Frank brought wholesale changes to every aspect of the U.S. financial regulatory environment, which touched every regulatory body and every financial services business. Notably, Dodd-Frank had the following effects:

• More comprehensive regulation of financial markets, including more oversight of derivatives, which were brought into exchanges.
• Regulatory agencies, which had been numerous and sometimes redundant, were consolidated.
• A new body, the Financial Stability Oversight Council , was devised to monitor systemic risk.
• Greater investor protections were introduced, including a new consumer protection agency (the Consumer Financial Protection Bureau ) and standards for "plain-vanilla" products.
• The introduction of processes and tools (such as cash infusions) is meant to help with the winding down of failed financial institutions.
• Measures meant to improve standards, accounting, and regulation of credit rating agencies.

In February of 2020, the COVID19 virus was discovered in China. The disease soon made its way around the world, killing millions and stoking fear. This, in turn, caused markets to fall and credit to the financial system to grind to a halt.

The pandemic resulted in strict lockdowns and travel restrictions, which had a significant impact on global supply chains, consumer demand, and financial markets. Investors became increasingly concerned about the economic consequences of the pandemic, leading to a rapid sell-off in stock markets around the world. The crash was particularly severe in March 2020, when the Dow Jones Industrial Average (DJIA) experienced its worst day since 1987, falling over 2,000 points in a single day. Other major stock indexes, such as the S&P 500 and the FTSE 100, also experienced significant losses. From February 12 through March 23, 2020, the DJIA lost 37% of its value.

Central banks and governments around the world responded with various measures to stabilize the financial system and support the economy, including monetary stimulus and fiscal policies such as government spending and tax breaks.

Despite the severity of the initial crash, the markets rebounded somewhat in the following months, and many investors saw significant gains toward the end of 2020 and into 2021, where markets hit new all-time highs. However, the long-term economic consequences of the pandemic are still unclear, and many industries and countries are still struggling to recover fully.

A financial crisis is when financial instruments and assets decrease significantly in value. As a result, businesses have trouble meeting their financial obligations, and financial institutions lack sufficient cash or convertible assets to fund projects and meet immediate needs. Investors lose confidence in the value of their assets and consumers' incomes and assets are compromised, making it difficult for them to pay their debts.

A financial crisis can be caused by many factors, maybe too many to name. However, often a financial crisis is caused by overvalued assets, systemic and regulatory failures, and resulting consumer panic, such as a large number of customers withdrawing funds from a bank after learning of the institution's financial troubles. Some believe that financial crises are an inherent feature in how modern capitalist economies function, where the business cycle fuels speculative growth during economic booms, only to be met by contractions and recession. During these contractions, borrowers default on their loans and creditors tighten their lending criteria.

What Are the Stages of a Financial Crisis?

The financial crisis can be segmented into three stages, beginning with the launch of the crisis. Financial systems fail, generally caused by system and regulatory failures, institutional mismanagement of finances, and more. The next stage involves the breakdown of the financial system, with financial institutions, businesses, and consumers unable to meet obligations. Finally, assets decrease in value, and the overall level of debt increases.

What Was the Cause of the 2008 Financial Crisis?

Although the crisis was attributed to many breakdowns, it was largely due to the bountiful issuance of sub-prime mortgages, which were frequently sold to investors on the secondary market. Bad debt increased as sub-prime mortgagors defaulted on their loans, leaving secondary market investors scrambling. Investment firms, insurance companies, and financial institutions slaughtered by their involvement with these mortgages required government bailouts as they neared insolvency. The bailouts adversely affected the market, sending stocks plummeting. Other markets responded in tow, creating global panic and an unstable market.

What Was the Worst Financial Crisis Ever?

Arguably, the worst financial crisis in the last 90 years was the 2008 Global Financial Crisis, which sent stock markets crashing, financial institutions into ruin, and consumers scrambling.

A financial crisis occurs when asset prices drop steeply, businesses and consumers cannot pay their debts, and financial institutions experience liquidity shortages. Various factors contribute to a financial crisis, including systemic failures, unanticipated or uncontrollable human behavior, incentives to take excessive risks, regulatory absence or failures, or natural disasters such as pandemic viruses. Some of the historical examples of financial crises include Tulip Mania, the Credit Crisis of 1772, the Stock Crash of 1929, the 1973 OPEC Oil Crisis, the Asian Crisis of 1997-1998, and the 2008 Global Financial Crisis.

Barron's. " The Real Story of the Dutch Tulip Bubble Is Even More Fascinating Than the Myth You’ve Heard ."

Federal Reserve Bank of New York. " The First Global Credit Crisis ."

Paul Kosmetatos. " The 1772–73 British Credit Crisis ," Pages 2-8. Springer International Publishing, 2018.

Open Educational Resources, City University of New York. " The Destruction of the Tea and the Coercive Acts ."

Economic History Association. " The 1929 Stock Market Crash ."

Federal Reserve History. " Stock Market Crash of 1929 ."

Macrotrends. " Dow Jones - DJIA - 100 Year Historical Chart ."

Hervey, Jack L. " The 1973 Oil Crisis: One Generation and Counting ." Chicago Fed Letter , No. 86, October 1994.

Federal Reserve History. " Asian Financial Crisis: July 1997–December 1998 ."

Federal Deposit Insurance Corporation. " Crisis and Response: An FDIC History, 2008-2013: Overview ."

Federal Reserve Bank of St. Louis. " How COVID-19 Has Impacted Stock Performance by Industry ."

U.S. Congress. " S.3066 - Housing and Community Development Act of 1974 ."

Federal Reserve Bank of St. Louis, FRED. " Federal Funds Effective Rate ."

Thomas, Jason and Robert Van Order. " Housing Policy, Subprime Markets and Fannie Mae and Freddie Mac: What We Know, What We Think We Know and What We Don’t Know ." Past, Present, and Future of the Government Sponsored Enterprises (GSE's) at Federal Reserve Bank of St. Louis , November 2010, pp. 3.

U.S. Financial Crisis Inquiry Commission. " The Financial Crisis Inquiry Report ." Pages 127-154.

Federal Deposit Insurance Corporation. " Bank Failures in Brief – Summary ."

U.S. Financial Crisis Inquiry Commission. " The Financial Crisis Inquiry Report ." Pages 8, 256, 325, 339-340.

Macrotrends. " S&P 500 Index - 90 Year Historical Chart ."

Neil Baily, Martin and Aaron Klein, Justin Schardin. " The Impact of the Dodd-Frank Act on Financial Stability and Economic Growth ." Russell Sage Foundation Journal of the Social Sciences , vol. 3, no. 11, January 2017, pp. 20-47.

Financial Times Adviser. " FTSE on Track for Biggest Fall in 30 Years After 9% Drop ."

NPR. " Dow Dives More Than 2,000 Points; Steep Market Slide Triggered Trading Halt ."

Federal Reserve History. " Stock Market Crash of 1987 ."

NPR. " Stocks 2020: A Stunning Crash, Then A Record-Setting Boom Created Centibillionaires ."

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The Global Financial Crisis has been a watershed event not only for many advanced economies but also emerging markets around the world. This book brings together research and policy work over the last nine years from staff at the IMF. It covers a wide range of issues such as the origins of the financial crisis, the policy response, spillovers and contagion, case studies, bank stress testing, and debt sustainability and sovereign debt restructuring.

International Monetary Fund Copyright © 2010-2021. All Rights Reserved.

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The Global Financial Crisis, Essay Example

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The present paper is dedicated to the examination of the global financial crisis and its impact on the economy of the USA and other countries of the world. Major attention is drawn to the underlying causes of the crisis, the impact of the US critical situation on the world’s financial situation, international trade, and other aspects of international cooperation such as FDI and international stock exchange. Various aspects of the crisis impact are investigated, e.g. the effect on the US housing market, the impact on borrowing money, and the commodity boom and bust. Further on, the variety of global implications is observed: the impact of the US crisis on the global financial system, the impact on globalization etc. is in the center of focus. A brief overview of implications for separate countries and regions of the world is undertaken. Finally, a series of conclusions and recommendations for the future perspectives of the global crisis as well as the ways to have avoided the crisis are presented in the concluding part of the work.

Introduction

It is obvious that nowadays the world is still deeply involved in the global crisis, recession, and depression in the majority of significant sectors of national and international economy. Both the developed and developing countries of the world have been stuck by the soaring figures of economic growth, large-scale lays off and enormous financial losses due to the financial market collapse. As a result of the fall of the US financial market due to the prior boom of the housing and consumption market, the interconnected commodity and financial markets showed the sudden downturn in 2008. The financial consequences of the major financial firms’ collapse could not have been predicted at that period of time, but soon the situation revealed its dramatic image. The mass lays off led the country to the increased borrowing practices in an attempt of the nation to pay its debts off in a conventional manner. However, the second facet of the US market, an unrivaled fall of lending capacity and lender confidence, completed the picture by leaving people without borrowed money and without any possibility to find it.

One can imagine to what results the comprehensive troubles in the financial market of the US led; since the majority of capital in the country was mortgage-backed, it collapsed at the foreground of soaring housing prices and led to the overall despair. People without jobs and without money were urged to sell their homes, but they could not do that because of the collapsing housing market. The unpredictability of the financial situation, the dramatic problems in the banking sector leading the most stable financial firms, bankers, and insurers to nationalization and being bailed out by the Federal Reserve caused subsequent reactions in other countries. Capital was gathered from developing countries to save the economy of the US, thus aggravating the international relations situation and hindering the whole process of international cooperation. Developing countries feeling lack of finance showed in economic growth and decreased the levels of import, thus infecting the whole global economy. There seemed to be no way out of the situation, and there is hardly any at the present period of time, taking into consideration the disastrous consequences of the US economic destruction.

Taking into consideration the current catastrophic situation in practically all markets of the world, and consequently the field of international trade and financial exchange, one should think it is appropriate to investigate the causes and stages of the US financial crisis in depth, and to produce a set of conclusions on how the crisis emerged and expanded, how it managed to affect other countries of the world so bitterly, and whether there initially were any ways out to predict and prevent the crisis at its roots. It is logical that the US financial market turned out to be too much inter-related with other economies and markets of the world, which caused the global spread of the crisis infection. In addition, the US market was too reliable on the risky mortgage-backed securities, which led to the enormous systemic risk causing the downturn of one sector of economy after another. The US marker has always been of central importance in the global economy, which caused the serious impact on other countries. Hence, the ways to restore the situation in the USA and the whole world are seen in the reconsideration of reliance on risky securities, the comprehensive action on the macro- and micro-economic level, and the international cooperation and mutual support by countries deeply affected by the crisis in the USA.

Literature Overview

The present paper relies heavily on four major sources chosen for consideration. The first source deals with the exploration of the global financial crisis and its implications on the global economy. Baily and Elliott analyze the initial burst of the housing market as the first step to the critical situation that began to manifest itself in 2005, and overview the consequent stages of crisis development in the field of housing and commodity consumption (Baily & Elliott 6). The authors’ main thesis statement is that the problem was aggravated because of the large-scale unemployment that made the domestic economy literally stuck. People who had no jobs and no money for spending could not push the economy out of the economic recession because they had no purchasing power for that.

No purchases were undertaken, but only sales of property by citizens in despair were a typical image for 2008 and the beginning of 2009 (Baily and Elliott 7-8). Therefore, the authors see the systemic impact on the crisis from the consumption field and from the direct effect of the nation’s reaction to the situation. The conclusion they make is that too much reliance was evident on the banks with much lending power, much borrowing which was practically always mortgage-based and little economizing and saving for the sake of securing one’s future in case of trouble (Baily & Elliott 10).  The high-risk lending practices have also been indicated as the driving force of the US crisis by Brandon and Welch; the authors explored the role of financial planning in the outbreak of the crisis and as a measure of its mitigation (Brandon & Welch 96).

The purely financial angle of attention to the US financial crisis is taken in the work of Dick K. Nanto; the author provides a detailed analysis of the four stages of the financial crisis that were evident in the USA (Nanto 8-10). Among other issues of Nanto’s attention are the measures for coping with macroeconomic effects of the crisis and regulatory and financial market reform steps (Nanto 10-12). The author pays attention to the importance of eliminating political, social, and security effects of the crisis as well: among the problems of number one priority  he names coping with poverty and coping resources allocation, problems of international leadership and formulation of healthy attitude to the US, and organization of proactive political leadership on the national level (Nanto 15).

Baily and Elliott explore the causes for the global impact of the financial crisis in the US and see the prime reason for this in the excessive confidence in the mortgage-based CDOs and CDSs (the essence of notions will be explained further) that lost tremendously in price as soon as the troubles in the housing, and consequently financial, market became evident in the USA (Baily & Elliott 5). Nanto also pays much attention to CDOs and CDSs in the formation of the crisis in its current state, and indicates that CDOs appeared to be the primary cause of the AIG collapse (Nanto 4). The main reason for the global reach of the crisis is seen by Nanto in the overall reliance on American securities that lost their prices in 2008 and paralyzed economies of the major part of the world (Nanto 2).

The final source taken for the present analysis is the 2009 estimate of the critical situation all over the world by IMF. The measures IMF specialists outline as a source of overcoming the financial tragedy in the major part of the countries in the world include repairing the financial sectors in a domestic manner, supporting aggregate demand of the nation, easing the external financial constraints (through promotion of financial cooperation despite the hard financial conditions), and facing the medium-run policy challenges (IMF xiii). The most serious impact on the global economy is estimated in the IMF is seen in weakening the national currencies (especially the ones of developing countries), curtailed access to external financing, and fiscal deficits that widen sharply (IMF xvi). Speaking about finding the coping solutions, the IMF specialists underline the expected hardships in the process of building the saving potential by households, and the reduction of financial leverage that will inevitably occur (IMF xvii).

The Crisis in Perspective

Upon a thorough investigation of the crisis outbreak, the majority of researchers come to a unified conclusion that the problems in the housing market appeared the major cause of problems. Baily and Elliott note that the residential investment in the USA reached high volumes at the beginning of the 21 st century, which caused a rise in the commodity market as well (e.g. buying new furniture, appliances etc.) (Baily & Elliott 6). However, the market had become saturated by 2005, and the following years witnessed a growing decline (-18% in 2007, -21% in 2008, and -38% in 2009) (Baily & Elliott 6). The logical reaction to the decline was the fall in housing prices. As a result of that trend, households lost $13 trillion in equities and home prices – mortgages remained the same while the prices fell, and the families appeared unable to pay off their mortgage loans on the background of the declining economy and national financial prices (Baily & Elliott 6).

The problem revealed itself when the levels of consumer spending started to fall; during the period of the boom ‘innovative’ products of the financial market and consumer spending (and consequently borrowing) fueled each other to reinforce the economic growth. However, as soon as the decline started, the two deeply interrelated fields started to drown each other due to the systemic correlation they represented (Baily & Elliott 7). At that point, the problems in the housing market transformed into problems in the financial market, which was revealed in the borrowing issues (Brandon & Welch 96).

Borrowing money from the banks and large financial institutions has for a long time constituted the core of the US prosperity and high living standards. While the crisis was still not evident, people did not have saving habits and enjoyed the high level of trust from lenders, therefore obtaining many possibilities for financing their large-scale acquisitions like homes or cars with the help of borrowed capital. Confidence in the securities was also rather high, so people made investments and saved money in the form of CDOs and CDSs. The credit default swaps (CDSs) and collateralized debt obligations (CDOs) are the central figure in the financial side of the crisis. CDOs were primarily based on subprime mortgages. Payoffs and collateral calls on CDSs issued subprime mortgage CDOs became the largest cause of AIG problems (Nanto 3-4). The 2007 liquidity crisis hit was another point in the downward direction of the US financial market (Baily & Elliott 5).

Therefore, the crisis that began as a burst of US housing gave rise to the foreclosures in the market and resulted in the global financial and economic crisis. As the credit flows froze in 2008, and lenders’ confidence dropped, the fundamental weaknesses in the financial systems worldwide were revealed in the systemic inter-reliance on each other (Nanto 2). The US attempt to save its domestic economy from a crash resulted in the worldwide crash of less stable and more dependent economies. As a result of pulling capital from other countries, the US managed to achieve partial restoration of its financial structure, but at the same time the chain reaction because of lack of external financing caused the downturn of economies worldwide, which still returned to the USA in the form of international trade decline (Nanto 2).

Consumption market in the USA could not help affecting the overall state of the economy, and added to the aggravating effect of the crisis. The reason for this is the direct relationship of consumption habits and the borrowing possibilities of US citizens. As Baily and Elliott note, the US took the first step of tightening the bank lending standards, with the total freeze of loans shortly after that (Baily & Elliott 8). What was seen as an urgent rescue measure for the financial market in the US, turned out to be the total drama for the US consumers. At the background of massive lays off, as estimated by Nanto at the level of 111,182 in May 2009, people were left without the prime source of income, without health insurance, and with huge mortgage debts they had to pay off to remain with a dwelling (Nanto 82).

Therefore, consumers left without financial sources cut their expenditures dramatically, which was the start of the commodity market collapse. Later on, with the cuts of external financing for the developing countries, the US was left without a significant share of import reported to decline by 34% (Baily & Elliott 16). This tendency appeared to aggravate the state of the US domestic market seriously, and revealed the heavy dependence of the USA on the capital flows from the rest of the world (Baily & Elliott 20).

Global Crisis

As it has already become evident from the information above, the US financial and economic crisis produced the disastrous effect on all economies of the world. The reason for such vast effect of financial problems in one country is the close relationship between economies in the international trade and financing nowadays. Each country depends on the set of others in terms of securitization of the financial market and the globalization of the stock exchange, the internalization of business due to the increase in emergence of multinational corporations tying the international business into a unified biological organism. Thus, problems in one organ of the body inevitably cause the infection of all organs and systems of organs, which actually took place with the global economy. The Asian market that thought to be shielded by the sound banking system and corporate balance sheets witnessed a decline from 10% to 25%, mainly in new industrialized economies such as Singapore, Korea, Taiwan, and SAR (IMF 711). The main reason for such a dramatic downturn was the quick fall in demand for consumer durable goods in the USA and other countries impacted by the recession (IMF 71).

Europe appeared vulnerable to the turbulence in the US economy as well. The main causes for the plunge in the US markets were the lower expectations about the future income European households had, which resulted in the decrease of the international trade (IMF 75). The crisis in Europe had begun earlier than the US financial collapse manifested itself because of the increase in oil prices (IMF 75). However, the countries hit the most by the recession were the CIS countries that represent the emerging European economies, and developing countries depending heavily on FDI. The CIS economies are thought to have experienced the triple blow of the crisis, including the effect of financial turbulence, the slumping demand in terms of export to advanced economies, and the fall in commodity prices, namely the prices for energy (IMF 84).

As one can see from the present research paper, the US financial crisis started as a problem of financing the growing consumption demands of the US citizens, and the crisis of lending practices. Further on, the inter-relation of the global community in terms of finance, trade, and economy revealed itself in the systemic risk; the initial efforts taken by the US policymakers caused the unrivaled economic downturn all over the world, with the most distant and independent economies affected. The main consequences for the advanced economies included the collapse of financial and security markets, freezes in the domestic housing and commodity markets, and huge job losses. The developing economies were troubled much more as they appeared paralyzed in their development and advancement because of the lack of external financing from the US and other advanced countries. Being the bystanders of the crash in the most developed and prosperous markets of the world, developing countries became the innocent victims of the downturn, so they need urgent help as well, being unable to cope with the crisis only due to their internal resources.

Generally speaking, it is clear that only a comprehensive effort of the US financial legislators and the cooperative measures from other countries can help the contemporary world get out of the deep slump of the economy, consumption, and securities market. To outline the major perspectives of coping with the crisis for the near future, one should turn to Nanto’s consideration of the solutions proposed by the US Congress. They include:

• Introducing strong financial regulations to detect threatening institutions and economically unstable enterprises
• Establishing comprehensive supervision of financial markets
• Protecting consumers and investors from financial abuse
• Providing the government with tools to manage increased international regulatory standards (Nanto 6-7).

It is clear that the whole world, the US included, will need several decades to cope with the crisis and its consequences. The destructive ideas on self-reliance hinder the international trade, so a new level of mutual trust should be established for countries to regain confidence in each other. Households will need more financial guarantees and time to accumulate capital for securing themselves from another turn of the crisis. Therefore, coping with the crisis and restoring the trusting and deeply interconnected international trade space is a long-term perspective that should be given a number one priority alongside with domestic restoration and recovery.

Works Cited

Baily, Neil Martin, and Elliott, J. Douglas. “The US Financial and Economic Crisis: Where Does It Stand and Where Do We Go From Here?” Initiative on Business and Public Policy at Brookings . 2009. Web. 30 November 2010.

Brandon, E. Denby, and H. Oliver Welch. The History of Financial Planning: The Transformation of Financial Services . San Francisco, CA: John Wiley and Sons, 2009.

IMF. “World Economic Outlook: Crisis and Recovery”. World Economic and Financial Surveys . April 2009. Web. 30 November 2010.

Nanto, K. Dick. Global Financial Crisis: Analysis and Policy Implications . Washington, DC: DIANE Publishing, 2010. Print.

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Financial Crisis

Any situation where significant financial assets – such as stocks or real estate – suddenly experience a sharp decline in value

What is a Financial Crisis?

A financial crisis is defined as any situation where one or more significant financial assets – such as stocks, real estate , or oil – suddenly (and usually unexpectedly) loses a substantial amount of their nominal value.

Common examples of a financial crisis include financial market crashes – either widespread or within specific industries – housing market crashes and bank runs. A bank run happens when large numbers of bank depositors panic and seek to withdraw, all at once, all their funds on deposit with their bank.

In the United States, over the past couple of centuries, financial crises of one sort or another occur roughly every 25-30 years. Recent examples include the Global Financial Crisis of 2008 and the dot-com speculative bubble bursting around the turn of the century.

• A financial crisis is generally defined as any situation where significant financial assets – such as stocks or real estate – suddenly experience a sharp decline in value.
• They are often preceded by periods of economic boom and overextension of credit to borrowers.
• Economic recessions that follow a financial crisis are usually significantly more severe than recessions that are not preceded by a specific financial crisis.

Understanding Financial Crises

While various financial crises differ in both their nature and their severity, there are some common conditions that typically accompany such crises.

One is that a financial crisis is often preceded by, accompanied by, or followed by periods where there are widespread credit problems. The 2008 Global Financial Crisis was no exception. It was largely precipitated by a massive boom in subprime mortgage lending, which created a large stack of mortgage loans that were virtually doomed from the start to end up in default.

Subprime mortgage loans are loans granted to homebuyers with relatively lower credit scores – in short, large loans given to people who are likely to encounter difficulty making the loan payments.

According to several studies of financial crises, the rapid expansion of available credit, followed by a shorter period of sharp credit tightening, frequently provides an early warning indication of a coming financial crisis. Financial crises are nearly invariably followed by a period of severe credit tightening, where lenders seek to curb their risk exposure by only extending credit to borrowers with stellar credit ratings.

Another fact about financial crises is that although they don’t happen very frequently, they do seem to occur with relative regularity. Over the past century and a half or so, the United States has experienced on average, some type of financial crisis about once every 25 to 30 years.

However, the most recent history shows financial crises arising a bit more often. The U.S., for example, suffered a major stock market meltdown in 1987, then the dot-com bubble in the early 2000s, and then the 2008 Global Financial Crisis.

Financial crises are often difficult to foresee, and one reason is the fact that the triggering cause may be a relatively small event or series of events. For example, the dot-com bubble that happened around 2000-2002, while it was cataclysmic for many investors in the rapidly growing tech industry, initially involved a relatively small proportion of the overall stock market. Despite the failure of numerous companies, several dot-com companies, such as Amazon and Google, enjoyed massive growth in the ensuing years.

Finally, a financial crisis commonly leads to a notably severe period of overall economic recession. An economy’s gross domestic product (GDP) typically declines by up to 50% more during a recession that follows a financial crisis, compared to a “normal” recession that is not preceded or ushered in by a particular crisis.

The Next Financial Crisis?

The world may be on the verge of another major, global financial crisis in the wake of the Covid-19 pandemic (if we’re not already in one). However, it’s difficult to see, as of mid-2020, what the ultimate economic consequences of the virus and the widespread quarantine lockdowns may be. It is, in part, because many lenders are currently practicing credit forbearance – that is, not pressing debtors who are falling behind in making their loan payments.

Therefore, the true level of financial distress experienced by many companies and individuals may not have reached its full effect. Many market analysts warn that, thus far, we’ve only seen the tip of the iceberg in terms of both corporate and personal bankruptcies – that there are likely many more to come.

Secondly, governments are doing everything they can think of to prop up their economies. However, while most governments are pledging to do “whatever it takes,” their extraordinary efforts cannot be sustained forever. Although interest rates remain, for the moment, at record-low levels, there are already signs of lenders in the U.S. beginning to tighten up on credit. A severe credit crunch in the not-too-distant future is certainly not out of the question.

Related Readings

Thank you for reading CFI’s guide to Financial Crisis. To keep advancing your career, the additional CFI resources below will be useful:

• Economic Collapse
• Dotcom Bubble
• The Economic Crash of 2020
• See all economics resources

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• DOI: 10.2139/ssrn.1008311
• Corpus ID: 14552641

An Introduction to Financial Crises

• Franklin Allen , Douglas Gale
• Published 14 August 2007
• Capital Markets: Asset Pricing & Valuation

45 Citations

Theories about the financial crises, theories of financial crises, financial globalization and crisis: the role of local financial markets, do institutions and culture matter for business cycles, the role of uncertainty in liquidity breakdown working paper # bsp / 2008 / 098, incentives to innovate and financial crises, financial crisis and innovation in banking business model: are we minding the gap with the reform agenda, do we need new modelling approaches in macroeconomics, bank-specific shocks and the real economy, financial systems: introduction and summary, 81 references, history of crises under the national banking system, the microeconomics of banking, contemporary banking theory, a model of financial crises in emerging markets, models of currency crises with self-fulfilling features, the interbank market during a crisis.

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The Global Financial Crisis

• Category: Government
• Topic: Crisis , Financial Crisis

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Introduction

Causes and triggers, lessons learned, global cooperation and recovery.

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