Explain the Different Stages of a Financial Crisis and Compare the Financial Crisis 2007-2010 with That of the Great Depression 1929.
Explain the different stages of a financial crisis and compare the financial crisis 2007-2010 with that of the Great Depression 1929.
* What is a financial crisis?
There is no precise definition of a financial crisis. It can be explained as a situation where disruption in financial markets leads to adverse selection and moral hazard problems to worsen, thus preventing financial markets to efficiently direct funds. A financial crisis thus results to a sharp contraction in the economy and may leads to collapse of large financial institutions, bank runs and downturn in stock market. In order to better understand how financial crisis arises, Misklin and other economists in the US developed a framework where they have identified three main stages that could lead to a financial crisis.
* Stages of a financial crisis
The first stage is initiation of financial crises .Financial crisis as we have seen from past crises, can arise due to mismanagement of financial liberalization or innovation, asset-price bubble, increase in interest rates, and an increase in uncertainty.
With the removal of certain regulations and new advances in technology, financial institutions have usually taken unnecessary risk. They introduce new lines of business that is new types of loans and other financial products which automatically lead to more people taking credit where proper monitoring of the risk involved in lending were lacking. In addition to this, government safety net further worsens the problem of lack of risk management leading to increase in potential moral hazard. Depositors, unaware of their bank risk taking activities, do not feel that they should check how their money is being handled. With time, such activities lead to loan losses and defaults causing a decrease in the value of bank assets which have direct impact on bank net worth. Financial institutions, dealing with these problems, stop lending money.
Moreover financial crisis can also be triggered by an asset price
* What is a financial crisis?
There is no precise definition of a financial crisis. It can be explained as a situation where disruption in financial markets leads to adverse selection and moral hazard problems to worsen, thus preventing financial markets to efficiently direct funds. A financial crisis thus results to a sharp contraction in the economy and may leads to collapse of large financial institutions, bank runs and downturn in stock market. In order to better understand how financial crisis arises, Misklin and other economists in the US developed a framework where they have identified three main stages that could lead to a financial crisis.
* Stages of a financial crisis
The first stage is initiation of financial crises .Financial crisis as we have seen from past crises, can arise due to mismanagement of financial liberalization or innovation, asset-price bubble, increase in interest rates, and an increase in uncertainty.
With the removal of certain regulations and new advances in technology, financial institutions have usually taken unnecessary risk. They introduce new lines of business that is new types of loans and other financial products which automatically lead to more people taking credit where proper monitoring of the risk involved in lending were lacking. In addition to this, government safety net further worsens the problem of lack of risk management leading to increase in potential moral hazard. Depositors, unaware of their bank risk taking activities, do not feel that they should check how their money is being handled. With time, such activities lead to loan losses and defaults causing a decrease in the value of bank assets which have direct impact on bank net worth. Financial institutions, dealing with these problems, stop lending money.
Moreover financial crisis can also be triggered by an asset price