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145-396: Heterodox A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with banking panics , and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and

290-415: A bubble in housing", and also said in the wake of the subprime mortgage and credit crisis in 2007, "I really didn't get it until very late in 2005 and 2006.". The mortgage and credit crisis was caused by the inability of a large number of home owners to pay their mortgages as their low introductory-rate mortgages reverted to regular interest rates. Freddie Mac CEO Richard Syron concluded, "We had

435-451: A self-fulfilling prophecy . Indeed, Robert K. Merton , who coined the term self-fulfilling prophecy , mentioned bank runs as a prime example of the concept in his book Social Theory and Social Structure . Mervyn King , governor of the Bank of England, once noted that it may not be rational to start a bank run, but it is rational to participate in one once it had started. A bank run is

580-534: A 2012 report from the University of Michigan analyzed data from the Panel Study of Income Dynamics (PSID), which surveyed roughly 9,000 representative households in 2009 and 2011. The data seems to indicate that, while conditions are still difficult, in some ways the crisis is easing: Over the period studied, the percentage of families behind on mortgage payments fell from 2.2 to 1.9; homeowners who thought it

725-531: A bank reorganization. Bank runs first appeared as a part of cycles of credit expansion and its subsequent contraction. From the 16th century onwards, English goldsmiths issuing promissory notes suffered severe failures due to bad harvests, plummeting parts of the country into famine and unrest. Other examples are the Dutch tulip manias (1634–37), the British South Sea Bubble (1717–19),

870-523: A bubble", and concurred with Yale economist Robert Shiller 's warning that home prices appear overvalued and that the correction could last years, with trillions of dollars of home value being lost. Greenspan warned of "large double digit declines" in home values "larger than most people expect". Problems for home owners with good credit surfaced in mid-2007, causing the United States' largest mortgage lender, Countrywide Financial , to warn that

1015-587: A catastrophe? ... Their true weakness will finally reveal the abyss into which the housing market is about to plummet." The New York Times report connects the hedge fund crisis with lax lending standards: "The crisis this week from the near collapse of two hedge funds managed by Bear Stearns stems directly from the slumping housing market and the fallout from loose lending practices that showered money on people with weak, or subprime, credit, leaving many of them struggling to stay in their homes." On August 9, 2007, BNP Paribas announced that it could not fairly value

1160-512: A challenge to the epistemic norms typically assumed within financial economics and all of empirical finance. The possibility of financial crises being beyond the predictive reach of causality is discussed further within Epistemology of finance . Leverage , which means borrowing to finance investments, is frequently cited as a contributor to financial crises. When a financial institution (or an individual) only invests its own money, it can, in

1305-545: A country is wiped out. The resulting chain of bankruptcies can cause a long economic recession as domestic businesses and consumers are starved of capital as the domestic banking system shuts down. According to former U.S. Federal Reserve chairman Ben Bernanke , the Great Depression was caused by the failure of the Federal Reserve System to prevent deflation, and much of the economic damage

1450-431: A crisis is triggered by unsustainable fiscal policies, expansionary fiscal policies are typically used. In crises of liquidity and solvency, central banks can provide liquidity to support illiquid banks. Depositor protection can help restore confidence, although it tends to be costly and does not necessarily speed up economic recovery. Intervention is often delayed in the hope that recovery will occur, and this delay increases

1595-402: A currency of at least 25% but it is also defined as at least a 10% increase in the rate of depreciation. In general, a currency crisis can be defined as a situation when the participants in an exchange market come to recognize that a pegged exchange rate is about to fail, causing speculation against the peg that hastens the failure and forces a devaluation . A speculative bubble (also called

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1740-418: A devaluation crisis, is normally considered as part of a financial crisis. Kaminsky et al. (1998), for instance, define currency crises as occurring when a weighted average of monthly percentage depreciations in the exchange rate and monthly percentage declines in exchange reserves exceeds its mean by more than three standard deviations. Frankel and Rose (1996) define a currency crisis as a nominal depreciation of

1885-399: A few agents encourage others to buy too, not because the true value of the asset increases when many buy (which is called "strategic complementarity"), but because investors come to believe the true asset value is high when they observe others buying. In "herding" models, it is assumed that investors are fully rational, but only have partial information about the economy. In these models, when

2030-516: A few cities in Florida and California, where home prices soared to nose-bleed heights, could have 'hard landings'." National home sales and prices both fell dramatically in March 2007 — the steepest plunge since the 1989 Savings and Loan crisis . According to NAR data, sales were down 13% to 482,000 from the peak of 554,000 in March 2006, and the national median price fell nearly 6% to $ 217,000 from

2175-441: A few investors buy some type of asset, this reveals that they have some positive information about that asset, which increases the rational incentive of others to buy the asset too. Even though this is a fully rational decision, it may sometimes lead to mistakenly high asset values (implying, eventually, a crash) since the first investors may, by chance, have been mistaken. Herding models, based on Complexity Science , indicate that it

2320-406: A few percentage points to 50% or more from peak values in some markets, and although this cooling had not yet affected all areas of the U.S., some warned that it still could, and that the correction would be "nasty" and "severe". Chief economist Mark Zandi of the economic research firm Moody's Economy.com predicted a "crash" of double-digit depreciation in some U.S. cities by 2007–2009. In

2465-401: A financial bubble or an economic bubble) exists in the event of large, sustained overpricing of some class of assets. One factor that frequently contributes to a bubble is the presence of buyers who purchase an asset based solely on the expectation that they can later resell it at a higher price, rather than calculating the income it will generate in the future. If there is a bubble, there is also

2610-404: A financial crisis. To facilitate his analysis, Minsky defines three approaches that financing firms may choose, according to their tolerance of risk. They are hedge finance, speculative finance, and Ponzi finance. Ponzi finance leads to the most fragility. Financial fragility levels move together with the business cycle . After a recession , firms have lost much financing and choose only hedge,

2755-473: A fixed exchange rate may be stable for a long period of time, but will collapse suddenly in an avalanche of currency sales in response to a sufficient deterioration of government finances or underlying economic conditions. According to some theories, positive feedback implies that the economy can have more than one equilibrium . There may be an equilibrium in which market participants invest heavily in asset markets because they expect assets to be valuable. This

2900-713: A handful of political and economic analysts, such as Jeffery Robert Hunn in a March 3, 2003, editorial. Hunn wrote: [W]e can profit from the collapse of the credit bubble and the subsequent stock market divestment [(decline)]. However, real estate has not yet joined in a decline of prices fed by selling (and foreclosing). Unless you have a very specific reason to believe that real estate will outperform all other investments for several years, you may deem this prime time to liquidate investment property (for use in more lucrative markets). An August 2008 article in The New York Times r eported that in mid-2004 Richard F. Syron ,

3045-450: A housing bubble, particularly at its peak from 2004 to 2006, with some rejecting the "house bubble" label in 2008. The chief economist of Freddie Mac and the director of Joint Center for Housing Studies (JCHS) disputed the existence of a national housing bubble and expressed doubt that any significant decline in home prices was possible, citing consistently rising prices since the Great Depression , an anticipated increased demand from

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3190-406: A larger fraction of unbooked losses; if it rolls over its liabilities at increased interest rates, it squeezes its profits along with the profits of healthier competitors. The longer the silent run goes on, the more benefits are transferred from healthy banks and taxpayers to the zombie banks. The term is also used when many depositors in countries with deposit insurance draw down their balances below

3335-652: A lengthy article in The Washington Post titled, "What Went Wrong". In their investigation, the authors claim that Greenspan vehemently opposed any regulation of financial instruments known as derivatives . They further claim that Greenspan actively sought to undermine the office of the Commodity Futures Trading Commission , specifically under the leadership of Brooksley E. Born , when the Commission sought to initiate

3480-456: A paper he presented to a Federal Reserve Board economic symposium in August 2007, Yale University economist Robert Shiller warned, "The examples we have of past cycles indicate that major declines in real home prices—even 50 percent declines in some places—are entirely possible going forward from today or from the not-too-distant future." To better understand how the mortgage crisis played out,

3625-504: A peak of $ 230,200 in July 2006. John A. Kilpatrick from Greenfield Advisors was cited by Bloomberg News on June 14, 2007, on the linkage between increased foreclosures and localized housing price declines: "Living in an area with multiple foreclosures can result in a 10 percent to 20 percent decrease in property values". He went on to say, "In some cases that can wipe out the equity of homeowners or leave them owing more on their mortgage than

3770-408: A position of negative equity —a mortgage debt higher than the value of the property. The underlying causes of the housing bubble are complex. Factors include tax policy (exemption of housing from capital gains), historically low interest rates, lax lending standards, failure of regulators to intervene, and speculative fever . This bubble may be related to the stock market or dot-com bubble of

3915-491: A potentially fatal run on a fictitious US bank. A run on a bank is one of the many causes of the characters' suffering in Upton Sinclair's The Jungle . In The Simpsons season 6 episode 21 The PTA Disbands has Bart Simpson starting a hush whisper campaign at the Bank of Springfield as a prank to instigate a bank run. The bank run is not shown, instead the bank manager, who bears resemblance to Jimmy Stewart, says

4060-406: A proposal asserted that a government bailout of subprime borrowers was not in the best interests of the U.S. economy because it would simply set a bad precedent, create a moral hazard , and worsen the speculation problem in the housing market. Lou Ranieri of Salomon Brothers , creator of the mortgage-backed securities market in the 1970s, warned of the future impact of mortgage defaults: "This

4205-579: A recovery in the housing sector was not expected to occur at least until 2009 because home prices were falling "almost like never before, with the exception of the Great Depression ". The impact of booming home valuations on the U.S. economy since the 2001–2002 recession was an important factor in the recovery, because a large component of consumer spending was fueled by the related refinancing boom, which allowed people to both reduce their monthly mortgage payments with lower interest rates and withdraw equity from their homes as their value increased. During

4350-697: A risk of sovereign default due to fluctuations in exchange rates. Many analyses of financial crises emphasize the role of investment mistakes caused by lack of knowledge or the imperfections of human reasoning. Behavioural finance studies errors in economic and quantitative reasoning. Psychologist Torbjorn K A Eliazon has also analyzed failures of economic reasoning in his concept of 'œcopathy'. Historians, notably Charles P. Kindleberger , have pointed out that crises often follow soon after major financial or technical innovations that present investors with new types of financial opportunities, which he called "displacements" of investors' expectations. Early examples include

4495-489: A risk of a crash in asset prices: market participants will go on buying only as long as they expect others to buy, and when many decide to sell the price will fall. However, it is difficult to predict whether an asset's price actually equals its fundamental value, so it is hard to detect bubbles reliably. Some economists insist that bubbles never or almost never occur. Well-known examples of bubbles (or purported bubbles) and crashes in stock prices and other asset prices include

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4640-616: A run on the banks under the rallying cry "Stop the Duke, go for gold!". Many of the recessions in the United States were caused by banking panics. The Great Depression contained several banking crises consisting of runs on multiple banks from 1929 to 1933; some of these were specific to regions of the U.S. Bank runs were most common in states whose laws allowed banks to operate only a single branch, dramatically increasing risk compared to banks with multiple branches particularly when single-branch banks were located in areas economically dependent on

4785-485: A run renders the bank insolvent, causing customers to lose their deposits, to the extent that they are not covered by deposit insurance. An event in which bank runs are widespread is called a systemic banking crisis or banking panic . Examples of bank runs include the run on the Bank of the United States in 1931 and the run on Northern Rock in 2007. Banking crises generally occur after periods of risky lending and resulting loan defaults. A currency crisis, also called

4930-542: A scale matching or exceeding the bank's geographical area of operation, depositors' unpredictable needs for cash are unlikely to occur at the same time; that is, by the law of large numbers , banks can expect only a small percentage of accounts withdrawn on any one day because individual expenditure needs are largely uncorrelated . A bank can make loans over a long horizon, while keeping only relatively small amounts of cash on hand to pay any depositors who may demand withdrawals. However, if many depositors withdraw all at once,

5075-687: A single industry. Banking panics began in the Southern United States in November 1930, one year after the stock market crash, triggered by the collapse of a string of banks in Tennessee and Kentucky , which brought down their correspondent networks. In December, New York City experienced massive bank runs that were contained to the many branches of a single bank. Philadelphia was hit a week later by bank runs that affected several banks, but were successfully contained by quick action by

5220-427: A small profit could be made with little or no capital. However, when interest rates changed and the incentive for the flow was removed or reversed sudden changes in capital flows could occur. The subjects of investment might be starved of cash possibly becoming insolvent and creating a credit crunch and the loaning banks would be left with defaulting investors leading to a banking crisis. As Charles Read has pointed out,

5365-431: A valuable service by aggregating funds from many individual deposits, portioning them into loans for borrowers, and spreading the risks both of default and sudden demands for cash. Banks can charge much higher interest on their long-term loans than they pay out on demand deposits, allowing them to earn a profit. If only a few depositors withdraw at any given time, this arrangement works well. Barring some major emergency on

5510-613: Is based on the work of Thomas Tooke , Thomas Attwood , Henry Thornton , William Jevons and a number of bankers opposed to the Bank Charter Act 1844 . Starting at a time when short-term interest rates are low, frustration builds up among investors who search for a better yield in countries and locations with higher rates, leading to increased capital flows to countries with higher rates. Internally, short-term rates rise above long-term rates causing failures where borrowing at short term rates has been used to invest long-term where

5655-459: Is called a currency crisis or balance of payments crisis . When a country fails to pay back its sovereign debt , this is called a sovereign default . While devaluation and default could both be voluntary decisions of the government, they are often perceived to be the involuntary results of a change in investor sentiment that leads to a sudden stop in capital inflows or a sudden increase in capital flight . Several currencies that formed part of

5800-462: Is called a recession . An especially prolonged or severe recession may be called a depression , while a long period of slow but not necessarily negative growth is sometimes called economic stagnation . Some economists argue that many recessions have been caused in large part by financial crises. One important example is the Great Depression , which was preceded in many countries by bank runs and stock market crashes. The subprime mortgage crisis and

5945-425: Is little consensus and financial crises continue to occur from time to time. It is apparent however that a consistent feature of both economic (and other applied finance disciplines) is the obvious inability to predict and avert financial crises. This realization raises the question as to what is known and also capable of being known (i.e. the epistemology ) within economics and applied finance. It has been argued that

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6090-509: Is making sure institutions have sufficient assets to meet their contractual obligations, through reserve requirements , capital requirements , and other limits on leverage . Some financial crises have been blamed on insufficient regulation, and have led to changes in regulation in order to avoid a repeat. For example, the former Managing Director of the International Monetary Fund , Dominique Strauss-Kahn , has blamed

6235-540: Is often delayed in the hope that insolvent banks will recover if given liquidity support and relaxation of regulations, and in the end this delay increases stress on the economy. Programs that are targeted, that specify clear quantifiable rules that limit access to preferred assistance, and that contain meaningful standards for capital regulation, appear to be more successful. According to IMF, government-owned asset management companies ( bad banks ) are largely ineffective due to political constraints. A silent run occurs when

6380-498: Is scarce, potentially aggravating a financial crisis. International regulatory convergence has been interpreted in terms of regulatory herding, deepening market herding (discussed above) and so increasing systemic risk. From this perspective, maintaining diverse regulatory regimes would be a safeguard. Fraud has played a role in the collapse of some financial institutions, when companies have attracted depositors with misleading claims about their investment strategies, or have embezzled

6525-571: Is taxed by government and returned to the mass of people in the form of welfare, family benefits and health and education spending; and secondly, the proportion of the population who are workers rather than investors/business owners. Given the extraordinary capital expenditure required to enter modern economic sectors like airline transport, the military industry, or chemical production, these sectors are extremely difficult for new businesses to enter and are being concentrated in fewer and fewer hands. Empirical and econometric research continues especially in

6670-460: Is the internal structure of the market, not external influences, which is primarily responsible for crashes. In "adaptive learning" or "adaptive expectations" models, investors are assumed to be imperfectly rational, basing their reasoning only on recent experience. In such models, if the price of a given asset rises for some period of time, investors may begin to believe that its price always rises, which increases their tendency to buy and thus drives

6815-403: Is the leading edge of the storm ... If you think this is bad, imagine what it's going to be like in the middle of the crisis." In his opinion, more than $ 100 billion of home loans were likely to default when the problems seen in the subprime industry also emerge in the prime mortgage markets. Former Federal Reserve Chairman Alan Greenspan had praised the rise of the subprime mortgage industry and

6960-656: Is the type of argument underlying Diamond and Dybvig's model of bank runs , in which savers withdraw their assets from the bank because they expect others to withdraw too. Likewise, in Obstfeld's model of currency crises , when economic conditions are neither too bad nor too good, there are two possible outcomes: speculators may or may not decide to attack the currency depending on what they expect other speculators to do. A variety of models have been developed in which asset values may spiral excessively up or down as investors learn from each other. In these models, asset purchases by

7105-484: Is wiped out. Furthermore, the holders of the mortgage debt will also have a loss." Reuters reported in October 2007 that a Merrill Lynch analyst too had warned in 2006 that companies could suffer from their subprime investments . The Economist magazine stated, "The worldwide rise in house prices is the biggest bubble in history", so any explanation needs to consider its global causes as well as those specific to

7250-639: The Baby Boom generation, and healthy levels of employment. David Lereah , former chief economist of the National Association of Realtors (NAR), distributed "Anti-Bubble Reports" in August 2005 to "respond to the irresponsible bubble accusations made by your local media and local academics". On the basis of 2006 market data that were indicating a marked decline, including lower sales, rising inventories, falling median prices and increased foreclosure rates, some economists have concluded that

7395-555: The Banking Committee held hearings and asked executives from the top five subprime mortgage companies to testify and explain their lending practices. Dodd said that "predatory lending" had endangered home ownership for millions of people. In addition, Democratic senators such as Senator Charles Schumer of New York were already proposing a federal government bailout of subprime borrowers in order to save homeowners from losing their residences. Economists have debated whether

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7540-608: The Case–Shiller home price index reported the largest price drop in its history. The credit crisis resulting from the bursting of the housing bubble is an important cause of the Great Recession in the United States . Increased foreclosure rates in 2006–2007 among U.S. homeowners led to a crisis in August 2008 for the subprime , Alt-A , collateralized debt obligation (CDO), mortgage , credit , hedge fund , and foreign bank markets. In October 2007, Henry Paulson ,

7685-626: The European Exchange Rate Mechanism suffered crises in 1992–93 and were forced to devalue or withdraw from the mechanism. Another round of currency crises took place in Asia in 1997–98 . Many Latin American countries defaulted on their debt in the early 1980s. The 1998 Russian financial crisis resulted in a devaluation of the ruble and default on Russian government bonds. Negative GDP growth lasting two or more quarters

7830-517: The South Sea Bubble and Mississippi Bubble of 1720, which occurred when the notion of investment in shares of company stock was itself new and unfamiliar, and the Crash of 1929 , which followed the introduction of new electrical and transportation technologies. More recently, many financial crises followed changes in the investment environment brought about by financial deregulation , and

7975-476: The U.S. Secretary of the Treasury , called the bursting housing bubble "the most significant risk to our economy". A bubble had the potential to affect not only on home valuations, but also mortgage markets, home builders, real estate , home supply retail outlets, Wall Street hedge funds held by large institutional investors, and foreign banks, increasing the risk of a nationwide recession. Concerns about

8120-431: The bursting of other financial bubbles , currency crises , and sovereign defaults . Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy (for example, the crisis resulting from the famous tulip mania bubble in the 17th century). Many economists have offered theories about how financial crises develop and how they could be prevented. There

8265-510: The discount window rate, which is the lending rate between banks and the Federal Reserve Bank, by 50 basis points to 5.75% from 6.25%. The Federal Reserve Bank stated that the recent turmoil in the U.S. financial markets had raised the risk of an economic downturn. In the wake of the mortgage industry meltdown, Senator Chris Dodd , chairman of the Banking Committee , held hearings in March 2007 in which he asked executives from

8410-710: The financial crisis of 2007–2008 on 'regulatory failure to guard against excessive risk-taking in the financial system, especially in the US'. Likewise, the New York Times singled out the deregulation of credit default swaps as a cause of the crisis. However, excessive regulation has also been cited as a possible cause of financial crises. In particular, the Basel II Accord has been criticized for requiring banks to increase their capital when risks rise, which might cause them to decrease lending precisely when capital

8555-478: The stock market (" margin buying ") became increasingly common prior to the Wall Street Crash of 1929 . Another factor believed to contribute to financial crises is asset-liability mismatch , a situation in which the risks associated with an institution's debts and assets are not appropriately aligned. For example, commercial banks offer deposit accounts that can be withdrawn at any time, and they use

8700-596: The warnings . Other cautions came as early as 2001, when the late Federal Reserve governor Edward Gramlich warned of the risks posed by subprime mortgages. In September 2003, at a hearing of the House Financial Services Committee , Congressman Ron Paul identified the housing bubble and foretold the difficulties it would cause: "Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity

8845-421: The world systems theory and in the debate about Nikolai Kondratiev and the so-called 50-years Kondratiev waves . Major figures of world systems theory, like Andre Gunder Frank and Immanuel Wallerstein , consistently warned about the crash that the world economy is now facing. World systems scholars and Kondratiev cycle researchers always implied that Washington Consensus oriented economists never understood

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8990-611: The 17th century Dutch tulip mania , the 18th century South Sea Bubble , the Wall Street Crash of 1929 , the Japanese property bubble of the 1980s, and the crash of the United States housing bubble during 2006–2008. The 2000s sparked a real estate bubble where housing prices were increasing significantly as an asset good. When a country that maintains a fixed exchange rate is suddenly forced to devalue its currency due to accruing an unsustainable current account deficit, this

9135-571: The 1930s, even under conditions such as the U.S. savings and loan crisis of the 1980s and 1990s . The 2007–2008 financial crisis was centered around market-liquidity failures that were comparable to a bank run. The crisis contained a wave of bank nationalizations, including those associated with Northern Rock of the UK and IndyMac of the U.S. This crisis was caused by low real interest rates stimulating an asset price bubble fuelled by new financial products that were not stress tested and that failed in

9280-485: The 1990s. This bubble roughly coincides with the real-estate bubbles of the United Kingdom, Hong Kong, Spain, Poland, Hungary and South Korea. While bubbles may be identifiable in progress, bubbles can be definitively measured only in hindsight after a market correction, which began in 2005–2006 for the U.S. housing market. Former U.S. Federal Reserve Board Chairman Alan Greenspan said "We had

9425-488: The 2008 subprime mortgage crisis ; government officials stated on 23 September 2008 that the FBI was looking into possible fraud by mortgage financing companies Fannie Mae and Freddie Mac , Lehman Brothers , and insurer American International Group . Likewise it has been argued that many financial companies failed in the recent crisis because their managers failed to carry out their fiduciary duties. Contagion refers to

9570-536: The CEO of Freddie Mac , received a memo from David Andrukonis, the company's former chief risk officer , warning him that Freddie Mac was financing risk-laden loans that threatened Freddie Mac's financial stability. In his memo, Mr. Andrukonis wrote that these loans "would likely pose an enormous financial and reputational risk to the company and the country". The article revealed that more than two-dozen high-ranking executives said that Mr. Syron had simply decided to ignore

9715-622: The French Mississippi Company (1717–20), the post-Napoleonic depression (1815–30), and the Great Depression (1929–39). Bank runs have also been used to blackmail individuals and governments. In 1832, for example, the British government under the Duke of Wellington overturned a majority government on the orders of the king, William IV , to prevent reform (the later Reform Act 1832 ( 2 & 3 Will. 4 . c. 45)). Wellington's actions angered reformers, and they threatened

9860-511: The U.S. Federal Reserve Bank conducted an " open market operation " to inject U.S. $ 38 billion in temporary reserves into the system to help overcome the ill effects of a spreading credit crunch, on top of a similar move the previous day. In order to further ease the credit crunch in the U.S. credit market, at 8:15 a.m. on August 17, 2007, the chairman of the Federal Reserve Bank Ben Bernanke decided to lower

10005-697: The U.S. housing bubble. This was shared between the public sector and the private sector . Because of the large market share of Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (both of which are government-sponsored enterprises ) as well as the Federal Housing Administration , they received a substantial share of government support, even though their mortgages were more conservatively underwritten and actually performed better than those of

10150-549: The United States' subprime mortgage industry collapsed due to higher-than-expected home foreclosure rates (no verifying source), with more than 25 subprime lenders declaring bankruptcy, announcing significant losses, or putting themselves up for sale. The stock of the country's largest subprime lender, New Century Financial , plunged 84% amid Justice Department investigations, before ultimately filing for Chapter 11 bankruptcy on April 2, 2007, with liabilities exceeding $ 100 million (~$ 142 million in 2023). The manager of

10295-504: The United States. The then Federal Reserve Board Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market) ... it's hard not to see that there are a lot of local bubbles"; Greenspan admitted in 2007 that froth "was a euphemism for a bubble". In early 2006, President Bush said of the U.S. housing boom: "If houses get too expensive, people will stop buying them ... Economies should cycle". Many contested any suggestion that there could be

10440-415: The actual risks in the economy and stop giving credit so easily. Refinancing becomes impossible for many, and more firms default. If no new money comes into the economy to allow the refinancing process, a real economic crisis begins. During the recession, firms start to hedge again, and the cycle is closed. The Banking School theory of crises describes a continuous cycle driven by varying interest rates. It

10585-475: The assumptions of unique, well-defined causal chains being present in economic thinking, models and data, could, in part, explain why financial crises are often inherent and unavoidable. When a bank suffers a sudden rush of withdrawals by depositors, this is called a bank run . Since banks lend out most of the cash they receive in deposits (see fractional-reserve banking ), it is difficult for them to quickly pay back all deposits if these are suddenly demanded, so

10730-420: The bank itself (as opposed to individual investors) may run short of liquidity, and depositors will rush to withdraw their money, forcing the bank to liquidate many of its assets at a loss, and eventually to fail. If such a bank were to attempt to call in its loans early, businesses might be forced to disrupt their production while individuals might need to sell their homes and/or vehicles, causing further losses to

10875-675: The benefits of collective prevention are commonly believed to outweigh the costs of excessive risk-taking. Techniques to deal with a banking panic when prevention have failed: The bank panic of 1933 is the setting of Archibald MacLeish 's 1935 play, Panic . Other fictional depictions of bank runs include those in American Madness (1932), It's a Wonderful Life (1946, set in 1932 U.S.), Silver River (1948), Mary Poppins (1964, set in 1910 London), Rollover (1981), Noble House (1988) and The Pope Must Die (1991). Arthur Hailey 's novel The Moneychangers includes

11020-468: The bursting of other real estate bubbles around the world also led to recession in the U.S. and a number of other countries in late 2008 and 2009. Some economists argue that financial crises are caused by recessions instead of the other way around, and that even where a financial crisis is the initial shock that sets off a recession, other factors may be more important in prolonging the recession. In particular, Milton Friedman and Anna Schwartz argued that

11165-625: The circular relationships often evident in social systems between cause and effect – and relates to the property of self-referencing in financial markets. George Soros has been a proponent of the reflexivity paradigm surrounding financial crises. Similarly, John Maynard Keynes compared financial markets to a beauty contest game in which each participant tries to predict which model other participants will consider most beautiful. Furthermore, in many cases, investors have incentives to coordinate their choices. For example, someone who thinks other investors want to heavily buy Japanese yen may expect

11310-413: The correction in the U.S. housing market began in 2006. A May 2006 Fortune magazine report on the US housing bubble states: "The great housing bubble has finally started to deflate ... In many once-sizzling markets around the country, accounts of dropping list prices have replaced tales of waiting lists for unbuilt condos and bidding wars over humdrum three-bedroom colonials." Among other statements,

11455-601: The country saw very little price appreciation during the "bubble period". Out of 20 largest metropolitan areas tracked by the S&;P/Case-Shiller house price index , six (Dallas, Cleveland, Detroit, Denver, Atlanta, and Charlotte) saw less than 10% price growth in inflation-adjusted terms in 2001–2006. During the same period, seven metropolitan areas (Tampa, Miami, San Diego, Los Angeles, Las Vegas, Phoenix, and Washington, D.C.) appreciated by more than 80%. However, housing bubbles did not manifest themselves in each of these areas at

11600-415: The crash of the dot com bubble in 2001 arguably began with "irrational exuberance" about Internet technology. Unfamiliarity with recent technical and financial innovations may help explain how investors sometimes grossly overestimate asset values. Also, if the first investors in a new class of assets (for example, stock in "dot com" companies) profit from rising asset values as other investors learn about

11745-410: The current financial system . Bank run#Systemic banking crises A banking panic or bank panic is a financial crisis that occurs when many banks suffer runs at the same time, as people suddenly try to convert their threatened deposits into cash or try to get out of their domestic banking system altogether. A systemic banking crisis is one where all or almost all of the banking capital in

11890-445: The cycle restarts from the beginning. Mathematical approaches to modeling financial crises have emphasized that there is often positive feedback between market participants' decisions (see strategic complementarity ). Positive feedback implies that there may be dramatic changes in asset values in response to small changes in economic fundamentals. For example, some models of currency crises (including that of Paul Krugman ) imply that

12035-413: The dangers and perils, which leading industrial nations will be facing and are now facing at the end of the long economic cycle which began after the oil crisis of 1973. Hyman Minsky has proposed a post-Keynesian explanation that is most applicable to a closed economy. He theorized that financial fragility is a typical feature of any capitalist economy . High fragility leads to a higher risk of

12180-598: The downturn. Under fractional-reserve banking , the type of banking currently used in most developed countries , banks retain only a fraction of their demand deposits as cash. The remainder is invested in securities and loans , whose terms are typically longer than the demand deposits, resulting in an asset–liability mismatch . No bank has enough reserves on hand to cope with all deposits being taken out at once. Diamond and Dybvig developed an influential model to explain why bank runs occur and why banks issue deposits that are more liquid than their assets. According to

12325-499: The early 2000s house price boom involved nationwide or local bubbles. As early as 2005, because of non-uniform price appreciation, some economists, including former Fed Chairman Alan Greenspan , argued that United States was not experiencing a nationwide housing bubble per se , but a number of local bubbles. In 2007, however, Greenspan stated that "all the froth bubbles add up to an aggregate bubble". Despite greatly relaxed lending standards and low interest rates, many regions of

12470-399: The economy of the United States. These trends were reversed during the real estate market correction of 2006–2007. As of August 2007, D.R. Horton's and Pulte Corp's shares had fallen to 1/3 of their respective peak levels as new residential home sales fell. Some of the cities and regions that had experienced the fastest growth during 2000–2005 began to experience high foreclosure rates. It

12615-551: The economy. These theoretical ideas include the ' financial accelerator ', ' flight to quality ' and ' flight to liquidity ', and the Kiyotaki-Moore model . Some 'third generation' models of currency crises explore how currency crises and banking crises together can cause recessions. Austrian School economists Ludwig von Mises and Friedrich Hayek discussed the business cycle starting with Mises' Theory of Money and Credit , published in 1912. Recurrent major depressions in

12760-522: The fall 1930 bank runs and forced banks to liquidate loans, which directly caused a decrease in the money supply , shrinking the economy. Bank runs continued to plague the United States for the next several years. Citywide runs hit Boston (December 1931), Chicago (June 1931 and June 1932), Toledo (June 1931), and St. Louis (January 1933), among others. Institutions put into place during the Depression have prevented runs on U.S. commercial banks since

12905-547: The first four years of the crisis. Several techniques have been used to help prevent or mitigate bank runs. Some prevention techniques apply to individual banks, independently of the rest of the economy. Some prevention techniques apply across the whole economy, though they may still allow individual institutions to fail. The role of the lender of last resort, and the existence of deposit insurance, both create moral hazard , since they reduce banks' incentive to avoid making risky loans. They are nonetheless standard practice, as

13050-455: The first place and therefore did not appear to be contributing to the national bubble. This was also true of some cities in the Rust Belt such as Detroit and Cleveland , where weak local economies had produced little house price appreciation early in the decade but still saw declining values and increased foreclosures in 2007. As of January 2009 California, Michigan, Ohio and Florida were

13195-408: The form of wages) than the value of the goods produced by those workers (i.e. the amount of money the products are sold for). This profit first goes towards covering the initial investment in the business. In the long-run, however, when one considers the combined economic activity of all successfully-operating business, it is clear that less money (in the form of wages) is being returned to the mass of

13340-417: The funds and three other banks closed out their positions with them. The Bear Stearns funds once had over $ 20 billion of assets, but lost billions of dollars on securities backed by subprime mortgages. H&R Block reported that it had made a quarterly loss of $ 677 million on discontinued operations, which included the subprime lender Option One, as well as writedowns, loss provisions for mortgage loans and

13485-459: The funds cannot be liquidated quickly (a similar mechanism was implicated in the March 2023 failure of SVB Bank ). Internationally, arbitrage and the need to stop capital flows, which caused bullion drains in the gold standard of the nineteenth century and drains of foreign capital later, bring interest rates in the low-rate country up to equal those in the country which is the subject of investment. The capital flows reverse or cease suddenly causing

13630-530: The house is worth. The innocent houses that just happen to be sitting next to those properties are going to take a hit." The US Senate Banking Committee held hearings on the housing bubble and related loan practices in 2006, titled "The Housing Bubble and its Implications for the Economy" and "Calculated Risk: Assessing Non-Traditional Mortgage Products". Following the collapse of the subprime mortgage industry in March 2007, Senator Chris Dodd , Chairman of

13775-441: The idea that financial crises may spread from one institution to another, as when a bank run spreads from a few banks to many others, or from one country to another, as when currency crises, sovereign defaults, or stock market crashes spread across countries. When the failure of one particular financial institution threatens the stability of many other institutions, this is called systemic risk . One widely cited example of contagion

13920-574: The impact of the collapsing housing and credit markets on the larger U.S. economy caused President George W. Bush and the Chairman of the Federal Reserve Ben Bernanke to announce a limited bailout of the U.S. housing market for homeowners who were unable to pay their mortgage debts. In 2008 alone, the United States government allocated over $ 900 billion (~$ 1.25 trillion in 2023) to special loans and rescues related to

14065-431: The implicit fiscal deficit from a government's unbooked loss exposure to zombie banks is large enough to deter depositors of those banks. As more depositors and investors begin to doubt whether a government can support a country's banking system, the silent run on the system can gather steam, causing the zombie banks' funding costs to increase. If a zombie bank sells some assets at market value, its remaining assets contain

14210-504: The initial economic decline associated with the crash of 1929 and the bank panics of the 1930s would not have turned into a prolonged depression if it had not been reinforced by monetary policy mistakes on the part of the Federal Reserve, a position supported by Ben Bernanke . It is often observed that successful investment requires each investor in a financial market to guess what other investors will do. Reflexivity refers to

14355-504: The innovation (in our example, as others learn about the potential of the Internet), then still more others may follow their example, driving the price even higher as they rush to buy in hopes of similar profits. If such " herd behaviour " causes prices to spiral up far above the true value of the assets, a crash may become inevitable. If for any reason the price briefly falls, so that investors realize that further gains are not assured, then

14500-416: The larger economy. Even so, many, if not most, debtors would be unable to pay the bank in full on demand and would be forced to declare bankruptcy , possibly affecting other creditors in the process. A bank run can occur even when started by a false story. Even depositors who know the story is false will have an incentive to withdraw, if they suspect other depositors will believe the story. The story becomes

14645-679: The leading city banks and the Federal Reserve Bank . Withdrawals became worse after financial conglomerates in New York and Los Angeles failed in prominently-covered scandals. Much of the US Depression's economic damage was caused directly by bank runs, though Canada had no bank runs during this same era due to different banking regulations. Milton Friedman and Anna Schwartz argued that steady withdrawals from banks by nervous depositors ("hoarding") were inspired by news of

14790-575: The lender. The same principle applies to individuals and households seeking financing to purchase large-ticket items such as housing or automobiles . The households and firms who have the money to lend to these businesses may have sudden, unpredictable needs for cash, so they are often willing to lend only on the condition of being guaranteed immediate access to their money in the form of liquid demand deposit accounts , that is, accounts with shortest possible maturity. Since borrowers need money and depositors fear to make these loans individually, banks provide

14935-408: The limit for deposit insurance. The cost of cleaning up after a crisis can be huge. In systemically important banking crises in the world from 1970 to 2007, the average net recapitalization cost to the government was 6% of GDP , fiscal costs associated with crisis management averaged 13% of GDP (16% of GDP if expense recoveries are ignored), and economic output losses averaged about 20% of GDP during

15080-625: The losses on their $ 5 (~$ 6.95 trillion in 2023) trillion portfolio of loans and loan guarantees. On June 16, 2010, it was announced that Fannie Mae and Freddie Mac would be delisted from the New York Stock Exchange; shares now trade on the over-the-counter market. NAR chief economist David Lereah's explanation, "What Happened", from the 2006 NAR Leadership Conference Basing their statements on historic U.S. housing valuation trends, in 2005 and 2006 many economists and business writers predicted market corrections ranging from

15225-448: The lower prices achievable for mortgages in the secondary market. The unit's net asset value had fallen 21% to $ 1.1 billion as of April 30, 2007. The head of the mortgage industry consulting firm Wakefield Co. warned, "This is going to be a meltdown of unparalleled proportions. Billions will be lost." Bear Stearns pledged up to U.S. $ 3.2 billion (~$ 4.53 billion in 2023) in loans on June 22, 2007, to bail out one of its hedge funds that

15370-471: The makeup, those six-inch hooker heels, and a " tramp stamp ." Many of these good-looking girls are not high-class assets worth 100 cents on the dollar ... [T]he point is that there are hundreds of billions of dollars of this toxic waste ... This problem [ultimately] resides in America's heartland, with millions and millions of overpriced homes. Business Week has featured predictions by financial analysts that

15515-427: The model, business investment requires expenditures in the present to obtain returns that take time in coming, for example, spending on machines and buildings now for production in future years. A business or entrepreneur that needs to borrow to finance investment will want to give their investments a long time to generate returns before full repayment, and will prefer long maturity loans, which offer little liquidity to

15660-408: The model, the bank acts as an intermediary between borrowers who prefer long-maturity loans and depositors who prefer liquid accounts. The Diamond–Dybvig model provides an example of an economic game with more than one Nash equilibrium , where it is logical for individual depositors to engage in a bank run once they suspect one might start, even though that run will cause the bank to collapse. In

15805-517: The modern equivalent of this process involves the Carry Trade, see Carry (investment) . Some financial crises have little effect outside of the financial sector, like the Wall Street crash of 1987 , but other crises are believed to have played a role in decreasing growth in the rest of the economy. There are many theories why a financial crisis could have a recessionary effect on the rest of

15950-428: The money they lend. Therefore, they are ready to lend to firms without full guarantees of success. Lenders know that such firms will have problems repaying. Still, they believe these firms will refinance from elsewhere as their expected profits rise. This is Ponzi financing. In this way, the economy has taken on much risky credit. Now it is only a question of time before some big firm actually defaults. Lenders understand

16095-422: The organization of central banks that act as a lender of last resort , the protection of deposit insurance systems such as the U.S. Federal Deposit Insurance Corporation , and after a run has started, a temporary suspension of withdrawals. These techniques do not always work: for example, even with deposit insurance, depositors may still be motivated by beliefs they may lack immediate access to deposits during

16240-400: The political reasons it was being ignored. Prior to that, Robert Prechter wrote about it extensively as did Professor Shiller in his original publication of Irrational Exuberance in the year 2000. Peter Schiff also called the bubble early on and was vocal about it on television and wrote a book detailing his predictions of the fallout. The burst of the housing bubble was predicted by

16385-410: The population (the workers) than is available to them to buy all of these goods being produced. Furthermore, the expansion of businesses in the process of competing for markets leads to an abundance of goods and a general fall in their prices, further exacerbating the tendency for the rate of profit to fall . The viability of this theory depends upon two main factors: firstly, the degree to which profit

16530-549: The price up further. Likewise, observing a few price decreases may give rise to a downward price spiral, so in models of this type, large fluctuations in asset prices may occur. Agent-based models of financial markets often assume investors act on the basis of adaptive learning or adaptive expectations. As the most recent and most damaging financial crisis event, the Global financial crisis, deserves special attention, as its causes, effects, response, and lessons are most applicable to

16675-474: The private sector. Land prices contributed much more to the price increases than did structures. This can be seen in the building cost index in Fig. 1. An estimate of land value for a house can be derived by subtracting the replacement value of the structure, adjusted for depreciation, from the home price. Using this methodology, Davis and Palumbo calculated land values for 46 U.S. metro areas, which can be found at

16820-401: The proceeds to make long-term loans to businesses and homeowners. The mismatch between the banks' short-term liabilities (its deposits) and its long-term assets (its loans) is seen as one of the reasons bank runs occur (when depositors panic and decide to withdraw their funds more quickly than the bank can get back the proceeds of its loans). Likewise, Bear Stearns failed in 2007–08 because it

16965-503: The regulation of derivatives. Ultimately, it was the collapse of a specific kind of derivative, the mortgage-backed security , that triggered the economic crisis of 2008. Concerning the subprime mortgage mess, Greenspan later admitted that "I really didn't get it until very late in 2005 and 2006." On September 13, 2007, the British bank Northern Rock applied to the Bank of England for emergency funds because of liquidity problems related to

17110-654: The reports stated that people "should [not] be concerned that home prices are rising faster than family income", that "there is virtually no risk of a national housing price bubble based on the fundamental demand for housing and predictable economic factors", and that "a general slowing in the rate of price growth can be expected, but in many areas inventory shortages will persist and home prices are likely to continue to rise above historic norms". Following reports of rapid sales declines and price depreciation in August 2006, Lereah admitted that he expected "home prices to come down 5% nationally, more in some markets, less in others. And

17255-678: The resulting income. Examples include Charles Ponzi 's scam in early 20th century Boston, the collapse of the MMM investment fund in Russia in 1994, the scams that led to the Albanian Lottery Uprising of 1997, and the collapse of Madoff Investment Securities in 2008. Many rogue traders that have caused large losses at financial institutions have been accused of acting fraudulently in order to hide their trades. Fraud in mortgage financing has also been cited as one possible cause of

17400-484: The run up in asset prices and before the Great Recession, various parties described the housing market as a bubble or contested that designation. Especially in late 2004 and early 2005, numerous economic and cultural factors led several economists to argue that a housing bubble existed in the U.S. Dean Baker identified the bubble in August 2002, thereafter repeatedly warning of its nature and depth, and

17545-471: The safest. As the economy grows and expected profits rise, firms tend to believe that they can allow themselves to take on speculative financing. In this case, they know that profits will not cover all the interest all the time. Firms, however, believe that profits will rise and the loans will eventually be repaid without much trouble. More loans lead to more investment, and the economy grows further. Then lenders also start believing that they will get back all

17690-422: The same thing they expect others to do, then self-fulfilling prophecies may occur. For example, if investors expect the value of the yen to rise, this may cause its value to rise; if depositors expect a bank to fail this may cause it to fail. Therefore, financial crises are sometimes viewed as a vicious circle in which investors shun some institution or asset because they expect others to do so. Reflexivity poses

17835-653: The same time. San Diego and Los Angeles had maintained consistently high appreciation rates since late 1990s, whereas the Las Vegas and Phoenix bubbles did not develop until 2003 and 2004 respectively. It was in the East Coast, the more populated part of the country where the economic real estate turmoil was the worst. Somewhat paradoxically, as the housing bubble deflates some metropolitan areas (such as Denver and Atlanta) have been experiencing high foreclosure rates, even though they did not see much house appreciation in

17980-538: The savings are in other people's houses, spoofing It's a Wonderful Life . United States housing bubble The 2000s United States housing bubble or house price boom or 2000s housing cycle was a sharp run up and subsequent collapse of house asset prices affecting over half of the U.S. states . In many regions a real estate bubble , it was the impetus for the subprime mortgage crisis . Housing prices peaked in early 2006, started to decline in 2006 and 2007, and reached new lows in 2011. On December 30, 2008,

18125-425: The spiral may go into reverse, with price decreases causing a rush of sales, reinforcing the decrease in prices. Governments have attempted to eliminate or mitigate financial crises by regulating the financial sector. One major goal of regulation is transparency : making institutions' financial situations publicly known by requiring regular reporting under standardized accounting procedures. Another goal of regulation

18270-462: The states with the highest foreclosure rates. By July 2008, year-to-date prices had declined in 24 of 25 U.S. metropolitan areas, with California and the southwest experiencing the greatest price falls. According to the reports, only Milwaukee had seen an increase in house prices after July 2007. Prior to the real estate market correction of 2006–2007, the unprecedented increase in house prices starting in 1997 produced numerous wide-ranging effects in

18415-425: The stress on the economy. Some measures are more effective than others in containing economic fallout and restoring the banking system after a systemic crisis. These include establishing the scale of the problem, targeted debt relief programs to distressed borrowers, corporate restructuring programs, recognizing bank losses, and adequately capitalizing banks. Speed of intervention appears to be crucial; intervention

18560-456: The subject of investment to be starved of funds and the remaining investors (often those who are least knowledgeable) to be left with devalued assets. Bankruptcies, defaults and bank failures follow as rates are pushed high. After the crisis governments push short-term interest rates low again to diminish the cost of servicing government borrowing which has been used to overcome the crisis. Funds build up again looking for investment opportunities and

18705-455: The subprime mortgage market meltdown would result in earnings reductions for large Wall Street investment banks trading in mortgage-backed securities , especially Bear Stearns , Lehman Brothers , Goldman Sachs , Merrill Lynch , and Morgan Stanley . The solvency of two troubled hedge funds managed by Bear Stearns was imperiled in June 2007 after Merrill Lynch sold off assets seized from

18850-663: The sudden withdrawal of deposits of just one bank. A banking panic or bank panic is a financial crisis that occurs when many banks suffer runs at the same time, as a cascading failure . In a systemic banking crisis , all or almost all of the banking capital in a country is wiped out; this can result when regulators ignore systemic risks and spillover effects . Systemic banking crises are associated with substantial fiscal costs and large output losses. Frequently, emergency liquidity support and blanket guarantees have been used to contain these crises, not always successfully. Although fiscal tightening may help contain market pressures if

18995-575: The tendency for the rate of profit to fall borrowed many features of the presentation of John Stuart Mill 's discussion Of the Tendency of Profits to a Minimum (Principles of Political Economy Book IV Chapter IV). The theory is a corollary of the Tendency towards the Centralization of Profits . In a capitalist system, successfully-operating businesses return less money to their workers (in

19140-424: The tools which it uses to assess credit-worthiness in an April 2005 speech. Because of these remarks, as well as his encouragement of the use of adjustable-rate mortgages, Greenspan has been criticized for his role in the rise of the housing bubble and the subsequent problems in the mortgage industry that triggered the economic crisis of 2008 . On October 15, 2008, Anthony Faiola, Ellen Nakashima and Jill Drew wrote

19285-473: The top five subprime mortgage companies to testify and explain their lending practices. Dodd said that "predatory lending practices" were endangering home ownership for millions of people. In addition, Democratic senators such as Senator Charles Schumer of New York were already proposing a federal government bailout of subprime borrowers like the bailout made in the savings and loan crisis, in order to save homeowners from losing their residences. Opponents of such

19430-485: The underlying assets in three funds because of its exposure to U.S. subprime mortgage lending markets. Faced with potentially massive (though unquantifiable) exposure, the European Central Bank (ECB) immediately stepped in to ease market worries by opening lines of €96.8 billion (U.S. $ 130 billion) of low-interest credit. One day after the financial panic about a credit crunch had swept through Europe,

19575-515: The very worst case, lose its own money. But when it borrows in order to invest more, it can potentially earn more from its investment, but it can also lose more than all it has. Therefore, leverage magnifies the potential returns from investment, but also creates a risk of bankruptcy . Since bankruptcy means that a firm fails to honor all its promised payments to other firms, it may spread financial troubles from one firm to another (see 'Contagion' below). For example, borrowing to finance investment in

19720-534: The website for the Lincoln Institute for Land Policy. Housing bubbles may occur in local or global real estate markets. In their late stages, they are typically characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios , and other economic indicators of affordability. This may be followed by decreases in home prices that result in many owners finding themselves in

19865-399: The world economy at the pace of 20 and 50 years have been the subject of studies since Jean Charles Léonard de Sismondi (1773–1842) provided the first theory of crisis in a critique of classical political economy's assumption of equilibrium between supply and demand. Developing an economic crisis theory became the central recurring concept throughout Karl Marx 's mature work. Marx's law of

20010-453: The world's largest bond fund, PIMCO , warned in June 2007 that the subprime mortgage crisis was not an isolated event and would eventually take a toll on the economy and ultimately have an impact in the form of impaired home prices. Bill Gross , a "most reputable financial guru", sarcastically and ominously criticized the credit ratings of the mortgage-based CDOs now facing collapse: AAA? You were wooed, Mr. Moody's and Mr. Poor's , by

20155-484: The yen to rise in value, and therefore has an incentive to buy yen, too. Likewise, a depositor in IndyMac Bank who expects other depositors to withdraw their funds may expect the bank to fail, and therefore has an incentive to withdraw, too. Economists call an incentive to mimic the strategies of others strategic complementarity . It has been argued that if people or firms have a sufficiently strong incentive to do

20300-456: Was "very likely or somewhat likely" that they would fall behind on payments fell from 6% to 4.6% of families. On the other hand, family's financial liquidity has decreased: "As of 2009, 18.5% of families had no liquid assets, and by 2011 this had grown to 23.4% of families." By mid-2016, the national housing price index was "about 1 percent shy of that 2006 bubble peak" in nominal terms but 20% below in inflation adjusted terms. In March 2007,

20445-508: Was caused directly by bank runs. The cost of cleaning up a systemic banking crisis can be huge, with fiscal costs averaging 13% of GDP and economic output losses averaging 20% of GDP for important crises from 1970 to 2007. Several techniques have been used to try to prevent bank runs or mitigate their effects. They have included a higher reserve requirement (requiring banks to keep more of their reserves as cash), government bailouts of banks, supervision and regulation of commercial banks,

20590-480: Was collapsing because of bad bets on subprime mortgages. Peter Schiff , president of Euro Pacific Capital, argued that if the bonds in the Bear Stearns funds were auctioned on the open market, much weaker values would be plainly revealed. Schiff added, "This would force other hedge funds to similarly mark down the value of their holdings. Is it any wonder that Wall street is pulling out the stops to avoid such

20735-570: Was suggested that the weakness of the housing industry and the loss of the consumption that had been driven by the withdrawal of mortgage equity could lead to a recession, but as of mid-2007 the existence of this recession had not yet been ascertained. In March 2008, Thomson Financial reported that the " Chicago Federal Reserve Bank 's National Activity Index for February sent a signal that a recession [had] probably begun". The share prices of Fannie Mae and Freddie Mac plummeted in 2008 as investors worried that they lacked sufficient capital to cover

20880-734: Was the spread of the Thai crisis in 1997 to other countries like South Korea . However, economists often debate whether observing crises in many countries around the same time is truly caused by contagion from one market to another, or whether it is instead caused by similar underlying problems that would have affected each country individually even in the absence of international linkages. The nineteenth century Banking School theory of crises suggested that crises were caused by flows of investment capital between areas with different rates of interest. Capital could be borrowed in areas with low interest rates and invested in areas of high interest. Using this method

21025-449: Was unable to renew the short-term debt it used to finance long-term investments in mortgage securities. In an international context, many emerging market governments are unable to sell bonds denominated in their own currencies, and therefore sell bonds denominated in US dollars instead. This generates a mismatch between the currency denomination of their liabilities (their bonds) and their assets (their local tax revenues), so that they run

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