A financial crisis occurs when the economy is in turmoil and people are unable to pay their debts. It usually results from a domino effect, as one firm defaults and others follow suit. This leads to panic, which causes investors to withdraw their money from banks. The crisis is often accompanied by a recession and lower economic activity.
The financial crisis was caused by a variety of factors, including the bountiful issuance of subprime mortgages and their sale on the secondary market; the deregulation of over-the-counter derivatives; the failures of credit rating agencies to adequately price risk; and a combination of excessive borrowing and lending by households and businesses, as well as ill-prepared actions by government and key policy makers who did not fully understand the complex and interconnected financial system they oversaw. The collapse of the US investment bank Lehman Brothers in September 2008 and the failure or near-failure of a range of other financial institutions triggered global panic.
In response, central banks lowered interest rates to very low levels and bought large quantities of government and mortgage-backed securities (known as quantitative easing). These measures slowed the downturn in global economies, but did not prevent it. The crisis was a major cause of the Great Recession, a global bear market in stocks and a slowdown in economic growth. It also contributed to the collapse of the housing bubble in the United States and several other countries. Michael Lewis authored a book about the financial crisis, The Big Short, which was made into an Academy Award-winning film in 2015. Several followers of heterodox economics – such as Dean Baker, Wynne Godley and Fred Harrison – predicted the crisis.