Causes of Financial Crises

    Mankind has been facing financial crises for a long time and, apparently, will be facing for a long time. Each crisis is investigated retrospectively, as a result of which the reasons that entailed it are identified. Most of the reasons are described qualitatively, without quantitative parameters or indicators, which often leaves room for debate about the degree of significance of a particular cause. In the context of such a polemic, acquaintance with the most popular reasons seems at least interesting.

    Causes of Financial Crises

    Recall that a financial crisis is considered a situation in which financial institutions or assets (for example, stocks or bonds) dramatically lose a significant part of their value. The causes of crises include the following events:

    Similarity of strategies and self-fulfilling forecasts

    Many scientists note: the psychology of most investors is designed so that in the absence of quality information about the future, they have a tendency to imitate other investors.

    Such imitation leads to banking crises. Having no reliable information about the state of a particular bank, depositors can begin to urgently withdraw deposits, based only on rumors of possible problems of the bank or simply by seeing the line of lined depositors. It is interesting that such an avalanche-like influx of depositors becomes the reason why the bank is not able to pay all at once. In other words, this is a self-fulfilling forecast: rumors and assumptions about the bank's problems alone lead to very real difficulties.

    Mimicking actions can lead to banking and currency crises, speculative bubbles, as well as liquidity crises.

    Leverage or leverage

    Financial leverage means financing investments through loans. This is a situation when investors use not only their funds, but also borrowed funds for investments. It is clear that in case of success, income using leverage increases, but if the investments do not meet expectations, then the losses will be higher: the bankrupt investor will lose not only his funds, but will also remain to the creditors, which will jeopardize the creditors themselves.

    Leverage alone is not the cause of financial crises, but it increases risk, and therefore aggravates the situation in case of problems. Some economists have noted that leverage is increasing in the face of crises. Thus, the number of loans to finance investments increased before the collapse of the Wall Street bubble in 1929.

    New technologies, uncertainty and herd behavior

    Many crisis researchers have noted that an important cause of financial turmoil is people's erroneous behavior when dealing with new, untested phenomena. Historian Charles Kindleberger noted that many financial crises arise soon after the advent of new technologies or new financial instruments (for example, new types of bonds).

    While the prospects for new technologies or financial instruments can only be estimated theoretically, future earnings from these technologies or instruments can be overly optimistic. Mass optimism leads to higher prices, but when reality does not live up to expectations, prices are sharply adjusted downward, that is, a financial crisis occurs.

    It is believed that errors in assessing the prospects of new technologies caused the dot-com crisis in 2001, and an incorrect assessment of the risks of financial instruments related to mortgage loans became one of the causes of the 2008 global financial crisis.

    Regulation Errors

    It is believed that inadequate regulation of the activities of financial organizations leads to the fact that these organizations can take excessive risks, which then can not justify. The absence of laws restricting such behavior can simultaneously cause difficulties for many companies, which can cause a financial crisis.

    It is curious - some economists believe that excessive regulation can also be the cause of crises: recently, US legislation has been criticized, according to which banks should increase their equity while taking greater risk, which in a crisis can aggravate the situation due to the contraction of lending volumes.

    Fraud and dishonesty

    Many financial institutions may themselves be on the verge of bankruptcy and endanger partners due to fraud. So, in addition to financial pyramids or Ponzi games, in which a financial company simply finances some debts with new loans, there are situations when it may be beneficial for company management to hide the true state of affairs. Such “secrets” temporarily delay bankruptcy, but often exacerbate it.

    History offers many examples of such fraud. Let us recall the well-known scandal with the oil company Shell, when in 2004 it turned out that the company's proven oil reserves were exaggerated - and this reporting error was a consequence of the dishonesty of the management. As a result of the scandal, the shares of the company, which was considered one of the most reliable in the world, sharply lost in value.

    Financial infection

    The concept of infection in the world of investment and finance describes phenomena when a financial crisis can be transferred from one organization to another or even from one country to another. So, when an influx of depositors into one bank leads to distrust in relation to other banks (or a currency crisis or a state default leads to other crises within the country and even abroad) - they say that financial infection is spreading.

    The financial infection phenomenon arises from the close financial interconnection of companies in a developed economy: for example, companies lend to each other, and these loans, in turn, become collateral for new ones. When someone in the system suddenly turns out to be unable to pay - all the participants, as in a chain, begin to have problems.

    It is clear that financial infection in itself is more likely a mechanism by which the problems of individual organizations turn into financial crises that already affect the entire economy.

    Causes and causes

    Considering the concept of crisis in the economy, we compared the crisis with the exacerbation of the illness of the economic system. You can search for the causes of the exacerbation - along with the causes of the disease. Some will be prerequisites for others, and vice versa. Among the reasons listed above are both the causes of the disease (imitation of strategies, fraud, new technologies and uncertainty, regulatory errors and non-compliance of assets with obligations), and the causes of exacerbations (leverage, financial infection).


    Economists name the various causes of a financial crisis. Often, the reasons are described on a qualitative level, and each of them is credited with several of them at once. Among the most common causes of financial crises are imitation of strategies, financial leverage, new technologies and uncertainty, regulatory errors, fraud and dishonesty, and financial infection.

    For a snack: the financial crisis in Russia in 1998

    In Russia, in 1998, as a result of low prices on commodity markets and a shortage of funds from tax revenues, the state budget deficit was financed by bonds (T-bills - government short-term bonds). In anticipation of rising prices for resources, the state was paying off on old T-bills due to the issue of new ones, which eventually began to resemble a financial pyramid.

    Due to the high interest rates on T-bills and the fact that no additional budget revenues were found, the GKO financial pyramid ended on August 17, 1998 with a state default (recognition by the state of its inability to pay off debts).

    It turns out that due to the presence of the financial pyramid, we can talk about "fraud and dishonesty." However, not everything is so simple: if in the case of a separate company the pyramid could be hidden, then in the situation with GKOs it was known that payments were made by issuing new GKOs. This indicates that investors, when buying GKOs, believed that additional means of financing the Russian budget would be found. Thus, imitation in strategies and herd behavior were no less important causes of the 1998 crisis.

    It is curious that a sovereign default on August 17, 1998 through the mechanism of the spread of financial infection led to increased pressure on the exchange rate, which in turn ended in a currency crisis: the ruble exchange rate dropped by 3 times in just 3 weeks.

    A source

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