What Caused the Financial Crisis

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Starting with a look at how companies pay for investment, Mr Minsky described three kinds of financing. The first, which he called hedge financing, is the safest: companies can repay debts with their earnings. They have limited borrowings and good profits.

What Caused Global Financial Crisis

The second, speculative financing, is a little riskier: companies can cover their interest payments but must roll over their principal. This works fine normally but not in downturns. The third, Ponzi financing, is the most dangerous. Earnings cover neither principal nor interest; firms are betting that their assets will appreciate. If not, they are in trouble. Economies dominated by hedge financing—those with strong cashflows and low debt levels—are stable.

When speculative and, especially, Ponzi financing become popular, economies are vulnerable. If asset values fall, overstretched investors must sell their positions. Investors would have done better to stick to hedge financing. But over time, particularly when the economy is healthy, debt is irresistible. When growth seems guaranteed, why not borrow more? Banks add to the dynamic, lowering their standards the longer booms last.

Edited by Jeffrey Friedman. Afterword by Richard A. Posner

If defaults are minimal, why not lend more? That is a powerful insight, but quite what to do with it is another matter. Over the years mathematics has become the language of economics. Since academics have, with varying degrees of success, tried to bring more quantitative rigour to his instability hypothesis. They have shown how long stretches of low volatility and high debt-to-cashflow ratios are indeed predictors of trouble. For policymakers, the main takeaway from Mr Minsky is that constant vigilance is required, especially when the going is good. But Mr Minsky might also have predicted that, as more time passes without a crisis, we grow more likely to forget his warnings.

What Caused the Financial Crisis of 2008?

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    New to The Economist? Sign up now Activate your digital subscription Manage your subscription Renew your subscription. Topics up icon. Thanks to this insurance, investors snapped up the derivatives. As the demand for these derivatives grew, so did the banks' demand for more and more mortgages to back the securities.

    To meet this demand, banks and mortgage brokers offered home loans to just about anyone.

    What caused the banking crisis?

    Banks offered subprime mortgages because they made so much money from the derivatives, rather than the loans themselves. Banks hit hard by the recession welcomed the new derivative products. The payments were cheaper because their interest rates were based on short-term Treasury bill yields, which are based on the fed funds rate.

    However, that lowered banks' incomes, which are based on loan interest rates. With such cheap loans, many people bought homes as investments to sell as prices kept rising. Many of those with adjustable-rate loans didn't realize the rates would reset in three to five years. In , the Fed started raising rates. By the end of the year, the fed funds rate was 2. By the end of , it was 4. By June , the rate was 5. Homeowners were hit with payments they couldn't afford. Housing prices started falling after they reached a peak in October By July , they were down 4 percent.

    That was enough to prevent mortgage-holders from selling homes they could no longer make payments on.

    Here's Who Really Caused the Great Recession

    The Fed's rate increase couldn't have come at a worse time for these new homeowners. The Balance uses cookies to provide you with a great user experience. By using The Balance, you accept our.

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    Global Financial Crisis – What caused it and how the world responded

    Markets Stock Market. By Kimberly Amadeo. Continue Reading.

    What Caused the Financial Crisis What Caused the Financial Crisis
    What Caused the Financial Crisis What Caused the Financial Crisis
    What Caused the Financial Crisis What Caused the Financial Crisis
    What Caused the Financial Crisis What Caused the Financial Crisis
    What Caused the Financial Crisis What Caused the Financial Crisis
    What Caused the Financial Crisis What Caused the Financial Crisis
    What Caused the Financial Crisis What Caused the Financial Crisis
    What Caused the Financial Crisis What Caused the Financial Crisis
    What Caused the Financial Crisis

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