Financial Crisis

1. Faizan Hassan WMBASummer 10, Reg # 09
FINANCIAL CRISIS
The financial crisis of 2007–2008, also known as the Global Financial Crisis and 2008
financial crisis, is considered by many economists to have been the worst financial crisis since
the Great Depression of the 1930s. It threatened the total collapse of large financial institutions,
which was prevented by the bailout of banks by national governments, but stock markets still
dropped worldwide. In many areas, the housing market also suffered, resulting in evictions,
foreclosures and prolonged unemployment. The crisis played a significant role in the failure of
key businesses, declines in consumer wealth estimated in trillions of U.S. dollars, and a
downturn in economic activity leading to the 2008–2012 global recession and contributing to the
European sovereign-debt crisis.
Types of financial crisis
Banking crisis
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, 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.
Currency crisis
There is no widely accepted definition of a currency crisis, which is normally considered as part
of a financial crisis. Currency crises as 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 a currency of at least 25% but it is also defined at least 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
or appreciation.
International financial crises
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 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.

2. Faizan Hassan WMBASummer 10, Reg # 09
Impact on financial markets
US stock market
The U.S. stock market peaked in October 2007, when the Dow Jones Industrial Average index
exceeded 14,000 points. It then entered a pronounced decline, which accelerated markedly in
October 2008. By March 2009, the Dow Jones average had reached a trough of around 6,600.
Four years later, it hit an all-time high. It is probable, but debated, that the Federal Reserve's
aggressive policy of quantitative easing spurred the partial recovery in the stock market.
Market strategist Phil Dow believes distinctions exist "between the current market malaise" and
the Great Depression. He says the Dow Jones average's fall of more than 50% over a period of
17 months is similar to a 54.7% fall in the Great Depression, followed by a total drop of 89%
over the following 16 months. "It's very troubling if you have a mirror image," said Dow. Floyd
Norris, the chief financial correspondent of The New York Times, wrote in a blog entry in March
2009 that the decline has not been a mirror image of the Great Depression, explaining that
although the decline amounts were nearly the same at the time, the rates of decline had started
much faster in 2007, and that the past year had only ranked eighth among the worst recorded
years of percentage drops in the Dow. The past two years ranked third, however
Financial institutions
The first notable event signaling a possible financial crisis occurred in the United Kingdom on
August 9, 2007, when BNP Paribas, citing "a complete evaporation of liquidity", blocked
withdrawals from three hedge funds. The significance of this event was not immediately
recognized but soon led to a panic as investors and savers attempted to liquidate assets deposited
in highly leveraged financial institutions.
The International Monetary Fund estimated that large U.S. and European banks lost more than
$1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These
losses are expected to top $2.8 trillion from 2007 to 2010. U.S. bank losses were forecast to hit
$1 trillion and European bank losses will reach $1.6 trillion. The International Monetary Fund
(IMF) estimated that U.S. banks were about 60% through their losses, but British and eurozone
banks only 40%.
One of the first victims was Northern Rock, a medium-sized British bank. The highly leveraged
nature of its business led the bank to request security from the Bank of England. This in turn led
to investor panic and a bank run in mid-September 2007. Calls by Liberal Democrat Treasury
Spokesman Vince Cable to nationalise the institution were initially ignored; in February 2008,
however, the British government (having failed to find a private sector buyer) relented, and the
bank was taken into public hands. Northern Rock's problems proved to be an early indication of
the troubles that would soon befall other banks and financial institutions.

3. Faizan Hassan WMBASummer 10, Reg # 09
Effects on the global economy (as of 2009)
A number of commentators have suggested that if the liquidity crisis continues, there could be an
extended recession or worse. The continuing development of the crisis has prompted in some
quarters fears of a global economic collapse although there are now many cautiously optimistic
forecasters in addition to some prominent sources who remain negative. The financial crisis is
likely to yield the biggest banking shakeout since the savings-and-loan meltdown. Investment
bank UBS stated on October 6 that 2008 would see a clear global recession, with recovery
unlikely for at least two years. Three days later UBS economists announced that the "beginning
of the end" of the crisis had begun, with the world starting to make the necessary actions to fix
the crisis: capital injection by governments; injection made systemically; interest rate cuts to help
borrowers. The United Kingdom had started systemic injection, and the world's central banks
were now cutting interest rates. UBS emphasized the United States needed to implement
systemic injection. UBS further emphasized that this fixes only the financial crisis, but that in
economic terms "the worst is still to come". UBS quantified their expected recession durations
on October 16: the Eurozone's would last two quarters, the United States' would last three
quarters, and the United Kingdom's would last four quarters. The economic crisis in Iceland
involved all three of the country's major banks. Relative to the size of its economy, Iceland’s
banking collapse is the largest suffered by any country in economic history