FINANCIAL CRISES

Financial Crises



Financial Crises

Introduction

Financial crisis is a situation in which the supply of money is outpaced by the demand for money. This means that liquidity is quickly evaporated because available money is withdrawn from banks (called a run), forcing banks either to sell other investments to make up for the shortfall or to collapse. (KAUFMAN 1999 123)

Financial crisis is a situation precipitated by a general lack of confidence in a countries financial system (Aizenman, 2007). The financial intercessors in many advanced countries are the banks and stock markets. A country may suffer from a financial crisis when investors seek to liquidate their holdings (usually financial instruments) to run away from some perceived risk, both real and imagined, and seek soft landing in other safer assets like foreign currency or bonds in laissez faire economies and government bonds and commodities such as gold in closed economies. What follows a financial crisis is the collapse of a country's currency (Hausmann, 2004). The collapse is brought about by diminished demand for it and converse preference for hard currency. The laws of demand and supply also apply to the monetary system, and the result is that the local currency depreciates at a unusually high rate. From that perspective, it is thus easier to see that the recent "subprime" mortgages crisis experienced in US does not qualify as a financial crisis, but was only a market turbulenc. (AIZENMAN 2007 10)

Discussion

It became apparent in August 2007 that the financial market could not solve the subprime crisis on its own and the problems spread beyond the United State's borders. The interbank market froze completely, largely due to prevailing fear of the unknown amidst banks. Northern Rock, a British bank, had to approach the Bank of England for emergency funding due to a liquidity problem. By that time, central banks and governments around the world had started coming together to prevent further financial catastrophe. The financial crisis of 2007-08 has taught us that the confidence of the financial market, once shattered, can't be quickly restored. In an interconnected world, a seeming liquidity crisis can very quickly turn into a solvency crisis for financial institutions, a balance of payment crisis for sovereign countries and a full-blown crisis of confidence for the entire world. But the silver lining is that, after every crisis in the past, markets have come out strong to forge new beginnings. (HALDANE 2004 14)

It became apparent in August 2007 that the financial market could not solve the subprime crisis on its own and the problems spread beyond the United State's borders. The interbank market froze completely, largely due to prevailing fear of the unknown amidst banks. Northern Rock, a British bank, had to approach the Bank of England for emergency funding due to a liquidity problem. By that time, central banks and governments around the world had started coming together to prevent further financial catastrophe. (KAUFMAN 1999 123)

The crisis started in the summer of 2007 and was initially referred to in the media as the "credit ...