Explain the Different Stages of a Financial Crisis and...

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†¦show more content†¦The debt burden thus increases as debt levels are typically fixed and not indexed to asset values. Individuals stop repaying their loan in such cases leading to an increase in adverse selection and moral hazard, which is followed by a decrease in lending. * The Great Depression One financial crisis which has largely affected the United States is the Great Depression. It was the longest and most severe economic downturn in American history. The Great Depression began in October 1929.No one really knows what caused the Great Depression. It was triggered with the crash of the stock market in the United States in 1929. During the 1920s, lots of Americans invested in stock market. This led to stock prices to rise as more people were buying and selling shares to become rich. As long as the stock prices kept going up, the system worked. However, during 1928 and 1929, the prices of many stocks were higher than the companies’ net worth stock they represented. Thus investors started selling their stock leading to stock price to fall. Many investors in the stock market had bought stock on margin. Brokers seeing this new situation started asking investors to pay their debts which forced investors to sell their stock when they couldnt repay. This resulted in stock prices to fall even more. Stock prices plummeted because no one wanted to buy stock from the desperate sellers. The stock market then crashed which led directly to the start of the GreatShow MoreRelatedEurope Economic Crisis55278 Words   |  222 PagesISSN 0379-0991 Economic Crisis in Europe: Causes, Consequences and Responses EUROPEAN ECONOMY 7|2009 EUROPEAN COMMISSION The European Economy series contains important reports and communications from the Commission to the Council and the Parliament on the economic situation and developments, such as the Economic forecasts, the annual EU economy review and the Public ï ¬ nances in EMU report. 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