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 the financial crisis of 2008 on 'regulatory failure to guard against excessive risk-taking in the financial system, especially in the us'. 28 likewise, the new York times singled out the deregulation of credit default swaps as a cause of the crisis. 29 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 best to decrease lending precisely when capital is scarce, potentially aggravating a financial crisis. 30 International regulatory convergence has been interpreted in terms of regulatory herding, deepening market herding (discussed above) and so increasing systemic risk. 31 32 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 the resulting income.
27 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 the innovation (in our example, as others learn about the potential of the Internet then still more. 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 the spiral may go into reverse, with price decreases causing a rush of sales, reinforcing the decrease in prices. Regulatory failures edit main articles: Financial regulation and Bank regulation 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 is making sure institutions have sufficient assets to meet their contractual obligations, through reserve requirements, capital requirements, and other limits on leverage.
This generates a mismatch between the currency denomination of their liabilities (their bonds) and their assets (their local tax revenues so that they run a risk of sovereign default due to fluctuations in exchange rates. 21 Uncertainty and herd behavior edit main articles: Economic psychology and Herd behavior 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 liazon has also analyzed failures of economic reasoning in his concept of 'œcopathy'. 22 Historians, notably Charles. 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. 23 24 Early examples include 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, 25 and the Crash of 1929, which followed the introduction of new electrical and. 26 More recently, many financial crises followed changes in the investment environment brought about by financial deregulation, and the crash of the dot com bubble in 2001 arguably began with "irrational exuberance" about Internet technology.
Freedom from fear: The American people
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 marketing all its promised payments to other firms, it may spread financial troubles from one firm to another (see 'contagion' below). The average degree of leverage in the economy often rises prior to a financial crisis. Citation needed for example, borrowing to finance investment in the stock market thesis margin buying became increasingly common prior to the wall Street Crash of 1929.
In addition, some scholars have argued that financial institutions can contribute to fragility by hiding leverage, and thereby contributing to underpricing of risk. 16 Asset-liability mismatch edit main article: Asset-liability mismatch 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 which can be withdrawn at any time and they use 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. 19 likewise, bear Stearns failed in 200708 because it 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.
14 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. 15 Circularity and self-fulfilling prophecies may be exaggerated when reliable information is not available because of opaque disclosures or a lack of disclosure. 16 Furthermore, in many cases investors have incentives to coordinate their choices. For example, someone who thinks other investors want to buy lots of Japanese yen may expect 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. 17 It has been argued that if people or firms have a sufficiently strong incentive to do the same thing they expect others to do, then self-fulfilling prophecies may occur. 18 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. 19 Therefore, financial crises are sometimes viewed as a vicious circle in which investors shun some institution or asset because they expect others to. 20 leverage edit main article: leverage (finance) leverage, which means borrowing to finance investments, is frequently cited as a contributor to financial crises. 16 When a financial institution (or an individual) only invests its own money, it can, in the very worst case, lose its own money.
List of recessions in the United States, wikipedia
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 good Great Depression, which was preceded in many countries by bank runs and stock market crashes. The subprime mortgage crisis and the bursting of other real estate bubbles around the world also led to recession in the. And a number of other countries in late 20Some 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. In particular, milton Friedman and Anna Schwartz argued that 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. 13 causes and consequences edit Strategic complementarities in financial markets edit main articles: Strategic complementarity mom and Self-fulfilling prophecy It is often observed that successful investment requires each investor in a financial market to guess what other investors will. George soros has called this need to guess the intentions of others ' reflexivity '.
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, had 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 the european Exchange rate mechanism suffered crises in 199293 and were forced to devalue or withdraw from the mechanism. Another round of currency crises took place in Asia in 199798. 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. Wider economic crisis edit main articles: Recession and Depression (economics) Negative gdp growth lasting two or more quarters is called a recession.
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. 6 Speculative bubbles and crashes edit main articles: Stock market crash and Bubble (economics) A speculative bubble exists in the event of large, sustained overpricing of some class of assets. 7 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 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. 8 Well-known examples of bubbles (or purported bubbles) and crashes in stock prices and other asset prices include 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, the crash. 5 9 s sparked a real estate bubble where housing prices were increasing significantly as an asset good. 11 International financial crisis edit main articles: Currency crisis and sovereign default 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 is called a currency crisis or balance.
Contents, banking crisis edit, main article: Bank run, 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 a run renders the bank insolvent, causing customers to lose their deposits,. An event in which bank runs are widespread is called a systemic banking crisis or banking panic. 3, examples of bank runs include the run on the bank of the United States in 1931 and the run. Northern Rock in 2007. 4, banking crises generally occur after periods of risky lending and resulting loan defaults. 5, currency the crisis edit, there is no widely accepted definition of a currency crisis, also called a devaluation crisis, 6 is normally considered as part of a financial crisis. (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.
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A financial crisis is any of essay 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 the bursting of other financial bubbles, currency crises, and sovereign defaults. 1 2, financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy (e.g. 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 is no consensus, however, and financial crises continue to occur from time to time.