A financial crisis occurs when asset prices drop steeply, businesses and consumers can’t pay their debts, and financial institutions experience liquidity shortages. Many factors contribute to financial crises, including systemic failures, unanticipated or uncontrollable human behavior, incentives to take excessive risks, regulatory absence or failures, and natural disasters. Financial crises are often accompanied by panics and recessions. Examples of such crises include the Tulip Mania of the 17th century, the Stock Crash of 1929, the 1973 OPEC Oil Crisis, the Asian Crisis of 1997-1998, and the 2008 Global Financial Crisis.
The 2007-2008 Global Financial Crisis (GFC) began with a subprime mortgage lending problem and quickly grew to encompass the entire world economy, driven by a massive devaluation of mortgage-backed assets such as bundled loan portfolios and credit default swaps. This devaluation was exacerbated by the bankruptcy of investment bank Lehman Brothers in September 2008. The failure of Lehman and the threat of further collapses prompted investors to pull their money out of banks and financial firms around the world. This “financial panic” paralyzed the financial markets and led to a global economic slowdown.
The GFC ended when governments around the world increased spending to support demand and employment, guaranteed deposits and bank bonds, purchased ownership stakes in banks and other financial firms to prevent them from going bankrupt, and loosened regulations on the over-the-counter trading of financial derivatives such as credit default swaps. These measures helped to stabilize the financial system and prevent a global depression, but they also delayed the recovery of the real economy for years.