Financial Crisis


The World has been marked by the most major financial crisis over the past century with the last one being the 2007-2009 financial crisis which has been a painful reminder of the multifaceted nature of crises, namely:
  1) Financial crises occur in all market economies, in small and large countries as well as poor and rich ones.
  2) Economies can experience long crisis-free periods
  3) Financial crises are sudden and always involve private money markets

  4) Crises are typically preceded by credit booms.

  5) Crises occur at or near business cycle peaks, when the macroeconomy weakens.

  6) Recoveries are prolonged following a financial crisis.

  7) Financial crises are costly.

The extensive impact of a crisis warrants a solid understanding of this topical matter.   We approach this question by first providing a brief literature on financial crises before proceeding with two historical examples of financial crisis

Review of Literature

Over the years, there have been exhaustive studies on financial crisis.     Eichengreen and Portes (1986) define a financial crisis as a disturbance to financial markets, associated typically with falling asset prices and insolvency among debtors and intermediaries, which ramifies through the financial system, disrupting the market’s capacity to allocate capital within the economy.   In an international financial crisis, disturbances spill over national borders, disrupting the market’s capacity to allocate capital internationally.

According to Gorton (2012), a financial crisis occurs when bank debt holders run on all or many banks demanding that banks convert their (short-term) debt claims into cash to such an extent that this demand for cash cannot be met. The banking system must then be saved by the central bank or the government. Or, if there is no run on banks—or no observed run- then a financial crisis is a situation where there is significant impairment to the...