A financial crisis occurs when a country’s or world’s economic system suffers from severe disruption. This can be caused by a variety of factors, including the burst of financial bubbles and stock market crashes, bank failures and nationalizations, currency crises, and sovereign defaults. Financial crises can affect the whole economy by causing investments and assets to lose value and eroding consumer confidence.
The Global Financial Crisis of 2007-2009 was the result of the bountiful issuance of risky mortgages to subprime borrowers and other speculative investors, resulting in a large increase in bad debt. As these debts were sold on the secondary market, investment firms, insurance companies, and banks that guaranteed mortgages (Fannie Mae and Freddie Mac) began to suffer massive losses. As a result, their credit ratings plummeted and they lost access to short-term wholesale funding. These losses sparked panic and fear, and credit markets froze.
Ultimately, the government stepped in to rescue investment banks and large insurers. This included the US government bailing out Lehman Brothers in September of 2008 and rescuing AIG a day later. Other bailouts followed as the markets became increasingly unstable. These events led to the worst economic downturn since the Great Depression, and many countries experienced unemployment and other economic woes. This led to calls for reforms in banking and financial regulation.
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