A financial crisis is a severe contraction of liquidity in global financial markets that threatens the stability of the international banking system and brings with it a worldwide economic downturn. It may be triggered by a wide variety of events, including the bursting of asset bubbles, stock market crashes, sovereign debt crises, and currency crises. These events exacerbate real economic effects through the transmission of their underlying dynamics and via adverse balance-sheet adjustments in other sectors.
The 2007-09 global financial crisis has been a wrenching and costly experience. Its causes are still being debated, but it is clear that systemic risk was a significant factor. The collapse of Lehman Brothers, in particular, was a watershed moment. The subsequent bailout of financial institutions by the US government and by private investors shook investor confidence and triggered a global panic. The crisis also led to the collapse of credit markets and a sharp contraction of economic activity.
A central lesson of the crisis is that it is dangerous to assume that financial instability will not happen again. A long period of rapid economic growth and financial stability lulled banks, investors, and regulators into believing that extreme economic volatility was a thing of the past. This mindset, along with an ideological climate of deregulation and the assumption that financial firms could police themselves, enabled them to ignore clear warning signs and continue their reckless lending, borrowing, and securitization practices. Moreover, the political pressures on public authorities to be seen as promoting growth and creating jobs made it difficult for them to curb these behaviors.