Financial Crisis Meaning Explained Timeline Causes Examples

Financial Crisis Meaning

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It also entails the indebtedness of firms and customers, along with financial institutions encountering cash deficit problems. Additionally, the financial crisis inquiry commission is formed to investigate the causes of the latest economic crisis in the US.

Key Takeaways

A financial crisis infers a dramatic disruption in the financial market mostly connected with liquidation between defaulters and brokers and plummeting asset values. An inquiry commission is developed to scrutinize the global and domestic reasons for any economic crisis in the US. Its timeline follows the credit crisis (1772), the great depression (1929), the OPEC price shock (1973), the Asian crisis (1997), and the global economic crisis (2008). The economic crisis causes include liquidity, leverage, and subsidies and taxes.

Financial Crisis Explained

The financial crisis is tough to forecast because it can be triggered by a comparatively minor event or sequence of little events and thus an inquiry commission is developed for the same. Generally, distinct economic crises have different natures and degrees of seriousness but are accompanied by common conditions such as extensive credit squeezes.

It rarely occurs but with relative consistency, often leading to a critical period of complete economic downturn. Usually, an economic contraction succeeding the crisis decreases the country’s gross domestic productGross Domestic ProductGDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period.read more (GDP) more than only a recession. Although it induces great losses for investors, the economic crisis also forces regulatory authorities to introduce methods for market efficiencyMarket EfficiencyMarket efficiency refers to a market where prices represent all relevant financial information about an underlying asset or security.read more. The collateralized debt obligationsCollateralized Debt ObligationsCollateralized debt obligation (CDO) refers to a finance product offered by the banks to the institutional investors. Such tranches have a complex structure and derive their value from the various underlying assets like loans, mortgages and corporate bonds, which also serve as collaterals in case of default.read more and poor lending standards are among its major causes. Moreover, the financial crisis inquiry commission assists ordinary citizens in comprehending the economic crisis and its reasons.

Financial Crisis Timeline

To clarify, let’s go through the economic crisis timeline:

1. 1772: The Credit Crisis

Originating in London, the economic crisis instantly expanded to the remaining parts of Europe. One of the British banking house partners escaped to France to avoid the debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more settlement on 8 June 1772. So, creditors began demanding immediate cash withdrawals, allegedly leading to bank runs and Boston Tea Party protests.

2. 1929-1941: The Great Depression

This was the deepest and longest crisis in the history of the US, lasting over a decade (ended in 1941). Subsequently, industrial production and marriage rates decreased, unemployment surged, and the downturn spread worldwide. Contrary to popular belief, some US Federal policies damaged the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more, resulting in this severe downturn.

3. 1973: The Organization of The Petroleum Exporting Countries (OPEC) Oil Price Shock

The organization of Arab petroleum exporting countries (OAPEC) imposed an oil embargoEmbargoAn embargo is a political decision taken by countries where the government passes an order to restrict the free trade of goods & services between two nations for a specified period and may include restricting all types of goods & services or trading of particular interest like oil.read more on the US as a penalty for supporting Israel. In January 1974, this prevented US oil imports from partaking in OAPEC countries and almost quadrupled the rates from $2.90 to $11.65 (per barrel). It stayed the same even after the embargo was formally lifted.

4. 1997: The Asian Crisis

On 2 July 1997, Thailand experienced currency devaluationCurrency DevaluationCurrency devaluation is deliberately done in order to adjust the established exchange rates by the government and it is mostly done in the cases of fixed currencies. This mechanism is used by economies with a semi-fixed or fixed exchange rate, and it should not be confused with depreciation.read more corresponding to the US dollar. Thus, Thailand’s equity, property markets, and currency weakened, wreaking havoc through East Asia. The Philippines, Indonesia, and Malaysia also underwent a currency crisisCurrency CrisisThe term “currency crisis” refers to a situation in which a country’s domestic currency falls drastically due to several reasons such as high inflation, bank defaults, financial market fluctuations, a balance of payment deficit, war conditions, and so on.read more, with Indonesia facing an extremely dramatic political and economic crisis.

5. 2007-2009: The Global Financial Crisis

It implicates the duration of absolute distress in international banking systems and financial marketsFinancial MarketsThe term “financial market” refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more between 2007 and 2009. A contraction in the US housing industry accelerated the global financial crisis spreading from the US to other geographical locations. Resultantly, US house rates decreased, and mortgagorsMortgagorsA mortgagor is an entity that borrows money from a lender or financial institution to purchase real estate. Functionally, they are the same as the borrowers or debtors who are obliged to repay the mortgagee or lender.read more missed reimbursements.

Examples

For better understanding, here are a few examples.

Example#1

Some critical economic crises include,

The credit crisis (1772)The great depressionGreat DepressionThe Great Depression refers to the long-standing financial crisis in the history of the modern world. It began in the United States on October 29, 1929, with the Wall Street Crash and lasted till 1939.read more (1929-1941)The OPEC oil shock (October 1973-January 1974)The Asian financial crisis (July 1997-December 1998)The great financial crisis (December 2007-June, 2009)

Example#2

Contrary to the administration’s belief, Russia may encounter a financial crisis in the not-so-distant future. The headline inflationary trend is the highest in 20 years (since 2002). The month-by-month consumer price expansion has also decreased extensively by 6% from March (7.6%) to April (1.6%).

According to the statistics reported on 17 May 2022, the ruble registered an all-time reduction of 150 on March 7, trading at only over 62 to the dollar. However, economic indicators have considerably improved, and the country has managed to avert defaulting on the global currency debt, by now.

Financial Crisis Causes

That is to say, here are the major causes of a financial crisis:

1. Liquidity

Liquidity mismatches are among the crucial reasons behind downturns like the financial crisis in 2008. Through accounting gimmicks, misinterpretation among investors regarding their actual liquidity position brings about such economic contractions.

2. Leverage

Extra leverage certainly triggers an economic crisis as hazardous hidden leverage is instituted in the structured securities. It does not have any transparent accounting, and hence, its limitation is difficult and beyond the capacity of regulators and the expertise of legislators.

3. Subsidies And Taxes

Though covered by legislators, short-term speculation and the advantageous taxation of carried interest is ridiculous. Therefore, taxes like financial transaction tax are required to sustain system resiliency and facilitate actual long-term investmentInvestmentInvestments are typically assets bought at present with the expectation of higher returns in the future. Its consumption is foregone now for benefits that investors can reap from it later.read more.