The current crisis began as a bursting of the U.S. housing market bubble and a rise in foreclosures. As it ballooned into a global financial and economic crisis, some of the largest and most venerable banks, investment houses, and insurance companies have either declared bankruptcy or have had to be rescued financially. In October 2008, after the bankruptcy of Lehman Brothers, credit flows froze, lender confidence dropped, and one after another the economies of countries around the world dipped toward recession. The crisis exposed fundamental weaknesses in financial systems worldwide, and despite coordinated easing of monetary policy by governments, trillions of dollars in intervention by central banks and governments, and large fiscal stimulus packages, recovery appears to be just beginning.
This financial crisis, which began in industrialized countries, quickly spread to emerging markets and developing economies. Investors pulled capital from countries, even those with small levels of perceived risk, and caused values of stocks and domestic currencies to plunge. Also, slumping exports and commodity prices have added to the woes and pushed economies world wide either into recession or into a period of slower economic growth.
- Dick K. Nanto, Cong. Research Serv., The Global Financial Crisis: Analysis and Policy Implications (2009).
To understand the global economic crisis, be familiar with the following financial terms:
* Systemic risk ("Too big to fail"): The risk that the failure of one or a set of market participants, such as core banks, will reverberate through a financial system and cause severe problems for participants in other sectors. . . .
* Deleveraging: The unwinding of debt. Companies borrow to buy assets that increase their growth potential or increase returns on investments. Deleveraging lowers the risk of default on debt and mitigates losses, but if it is done by selling assets at a discount, it may depress security and asset prices and lead to large losses. Hedge funds tend to be highly leveraged.
* Procyclicality: The tendency for market players to take actions over a business cycle that increase the boom-and-bust effects, e.g., borrowing extensively during upturns and deleveraging during downturns. . . .
* Collateralized debt obligations (CDOs): a type of structured asset-backed security whose value and payments are derived from a portfolio of fixed-income underlying assets. CDOs based on sub-prime mortgages have been at the heart of the global financial crisis. CDOs are assigned different risk classes or tranches, with "senior" tranches considered to be the safest. . . .
* Credit default swap (CDS): a credit derivative contract between two counterparties in which the buyer makes periodic payments to the seller and in return receives a sum of money if a certain credit event occurs (such as a default in an underlying financial instrument). Payoffs and collateral calls on CDSs issued on sub-prime mortgage CDOs have been a primary cause of the problems of AIG and other companies.
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Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376, 12 U.S.C. sec. 5301 et seq.
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"Financial Crisis for Beginners," The Baseline Scenario blog, Simon Johnson & James Kwak (last visited June 9, 2015).