A financial crisis is a severe disruption of the world’s financial markets and resulting in a drop in asset prices, businesses being unable to pay their debts and liquidity shortages in financial institutions. The cause may be due to unanticipated or uncontrollable human behavior, incentives to take excessive risk, regulatory failures and natural disasters. Examples of these crises include Tulip Mania, the stock market crash of 1929 and the 2008 Global Financial Crisis (GFC).
The GFC was triggered by the failure or near-failure of a number of major US financial institutions including the investment bank Lehman Brothers and mortgage-backed securities providers Bear Stearns and AIG. This prompted a panic in the financial markets with investors pulling money out of banks and other financial firms as they became worried about potential losses on mortgage assets. This led to a decline in the value of trillions of dollars of mortgage-backed securities. This triggered a chain reaction of write-downs on mortgage assets and subsequent losses for the overleveraged financial institutions, which led to bankruptcies and forced the sale of many assets at fire-sale prices. Under mark-to-market accounting rules, these sales also reduced the value of these institutions’ holdings and further drained their liquidity.
The GFC triggered a worldwide economic slowdown and deep recession and wiped out wealth for millions of people. In the wake of it, new policies have been put in place to try to avoid future financial crises and ensure that if a crisis does occur, it is contained quickly. These measures include: