A financial crisis refers to a situation where the assets of financial institutions keep on reducing their value. A financial crisis may occur in banks, at the stock market, or in Mortgage firms. In 2008, the world witnessed a slowdown in economic growth that saw an upsurge in the price of essential goods and services. Further still, this slow down led to countries falling into what is termed as a recession; America is one of the greatest hits. This was attributed especially to the financial crisis that rocked the world with many financial institutions running into bankruptcy.
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Types of Financial crisis
There are various types of financial crises that might occur in a given country and may occur as a result of one given type or as a result of a combination of various types of financial crises. In the banking sector, a sudden rush for cash by depositors due to panic may result in bankruptcy with the net effect of banks becoming short of cash and lending becomes difficult. This results in low credit creation in the economy that would result in a financial crisis. In the stock market, speculation is the main cause of the financial crisis. When people involve themselves in speculative trading, the result would be a fall in prices in the long run when everyone decides to sell their shares in an anticipation of a fall in prices. This would result in the crash of stock market crash which would spiral into a financial crisis. The slow down in the economic growth as a result of a recession can also necessitate a financial crisis if the slow down is not checked or controlled in due time (Mitra 2).
Causes of the financial crisis
The major cause of the financial crisis that the world is witnessing has greatly been attributed to leverage; that is, borrowing to finance investment. This is particularly associated with the Wall Street crash of 1929 and the Wall Street crisis of 2009 where the majority of individuals borrowed cash to finance their investments in the stock market. Due to speculation, more and more people borrowed to invest and the result was bankruptcy by most leading banks which necessitated a financial crisis. Another cause can be attributed to inadequate financial control mechanism and a good case in point was the sacking of Dominique Strauss-Kahn who was accused of causing the financial crisis of 2008 due to his failure to guard against excessive risk-taking within the financial institution’s sector.
Fraud is also associated with the collapse of many financial institutions. Particularly, the Mortgage crisis of 2008 was associated with fraudulent behavior of the mortgage firms such as the Lehman brothers and Freddie Mac. Another cause of the financial crisis was Contagion which refers to a situation where a financial crisis in one sector of the economy multiplies or spirals over to other sectors of the country’s economy causing an economic crisis that is bound to bring the whole country to its knees.
Finally, a recession in the economy also contributes to the financial crisis where the slow down in economic activities would imply that velocity of money tremendously reduces and thus the capacity of the bank and other financial institutions to create credit becomes limited due to shortage of deposits were, in the long run, a financial crisis sets in (Mitra 2).
Prospects on the impact of the financial crisis
The financial crisis witnessed in early August 2008 was projected to persist till late 2009. However, with the quick response by the US government on tackling the crisis, its effects have been significantly reduced; however, the damage had already been done. With the collapse of many financial institutions, credit became inadequate and hence investments in the country reduced significantly. Consequently, production reduced and firms opted to cut their cost by reducing their employees. The result was a massive cutting down by various companies resulting in massive unemployment. The unemployment rate shot up high and with a reduction in production, the supply of essential commodities also significantly reduced raising the prices of goods and services and generally increasing the cost of living. If the financial crisis is left unchecked, the jobs of many Americans, their home values, the future of their children, and retirement plans would be greatly jeopardized. The extent of these impacts would greatly depend on the government’s response to the crisis (Cowen 1).
In conclusion, it can be asserted that the damage caused by the financial crisis would depend on the government’s intervention. So far, the government has made a significant effort in stabilizing several sectors of the economy affected by the crisis. For example, the approval of various stimulus plans such as Wall Street Bailout, Auto Bailout, and the recent Bailout on economic stabilization is a good indication of the government’s efforts to combat the crisis. However, many analysts are skeptical about the Bailout plan terming it as a short-term measure and that it would result in inflation and a further increase in prices of commodities. The results of the Bailout plan are yet to be seen and all Americans hope for the best.
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Cowen, Tyler. Three Trends and a Train Wreck. New York Times. 2008, pp p1.
Mitra, Moinak, Priyanka Sangani, Vinod Mahanta and Dibeyendu Ganguly. Financial Crisis: Are MNC Job Secure? Economic Times 2008 pp 2.