Global financial crisis – definition and meaning

A global financial crisis is a financial crisis that affects many countries at the same time. It is a period of severe difficulties which financial institutions, markets, companies, and consumers experience simultaneously. During a global financial crisis, financial institutions lose faith and stop lending to each other and traders stop buying financial instruments. Eventually, most lending stops and businesses suffer significantly.

In most global financial crises, parties to financial contracts in many countries fear that their counterparties will not honor them.

They also conclude that the financial assets they own will be worth less than they had previously thought.

Eventually, banks stop lending and demand early settlement of loans and other financial instruments. Banks also start selling all the financial assets that they can.

According to ft/com/lexicon, the Financial Times’ glossary of terms:

“The result is what is often referred to as “frozen” financial markets, where trading volumes fall considerably and parties often cannot be induced to trade financial instruments no matter what prices are offered.”

Global Financial Crisis - definition and illustrations
When there is a global financial crisis, everybody suffers, including banks, companies, workers, consumers, and borrowers.

Financial crisis – features

Financial crises come in many forms. However, they have common elements. The information below comes from an IMF Working Paper, written by Stijn Claessens and M. Ayhan Kose.

The authors say that at least one the following phenomena are present during a global financial crisis:

  • Credit volumes change significantly.
  • Asset prices decline considerably.
  • There are serious disruptions in financial intermediation.
  • There is a severe disruption in the supply of external financing to many players in the economy.
  • Households, companies, financial intermediaries, and sovereigns experience large scale-balance sheet problems.
  • There is large scale government support, i.e., bailouts.

The authors add:

“As such, financial crises are typically multidimensional events and can be hard to characterize using a single indicator.”

If a financial crisis spreads, it becomes an economic crisis. An economic crisis occurs when the whole economy is in trouble, not just the banking and finance sectors.

The 2007/8 global financial crisis

When talking about the financial crisis of 2007/8, people often say the ‘Global Financial Crisis’ or the ‘2008 Financial Crisis.’ It was the worst global crisis since the Wall Street Crash and the subsequent Great Depression in the 1930s.

The 2007/8 financial crisis was followed by the Great Recession, which lasted until 2012. It was a period of general economic decline in most countries’ economies and global markets. If there are two successive quarters of economic contraction, there is a recession.

When a recession lasts a long time it becomes a depression. Depressions last more than three years and reduce GDP by at least ten percent.

In September 2008, Lehman Brothers, a sprawling global bank, collapsed. This collapse subsequently brought down the global financial system.

Taxpayers in North America, Europe, and elsewhere spent hundreds of billions of dollars on bailouts.

Despite the massive financial help, the ensuing credit crunch exacerbated what was already a severe downturn. In fact, what followed was the worst recession in eighty years.

Even after 2012, when the Global Financial Crisis was over, there was a very weak and fragile recovery. Workers have had to suffer almost a decade of below-inflation wage increases.

Causes of the 2007/8 global financial crisis

The Economist magazine says that the crisis had multiple causes. The most obvious culprits were the financiers. Especially those financiers who claimed to have found a way to banish risk. In fact, what they had done was to lose track of risk.

Regulators and central bankers were also to blame because they were the ones ‘who tolerated this folly.’

The Economist adds:

“The “Great Moderation”—years of low inflation and stable growth—fostered complacency and risk-taking. A “savings glut” in Asia pushed down global interest rates.”

“Some research also implicates European banks, which borrowed greedily in American money markets before the crisis and used the funds to buy dodgy securities. All these factors came together to foster a surge of debt in what seemed to have become a less risky world.”

Video – The Global Financial Crisis

In this TedX talks video, Brian Wesbury, Chief Economist at First Trust Advisors L.P., talks about the 2008 Global Financial Crisis. He explains what really happened.