Credit Crisis

At the very core, a credit crisis is when a number of financial institutions see the loans they have issued start to default. As this phenomenon occurs, the financial institutions’ balance sheets are shrunk significantly. Their assets, the loans, become non-performing assets and do not provide them with any income or payments; this results in financial institutions not issuing further loans, which, in turn, leads to lower funding ability and higher interest rates. The credit crisis then moves into a liquidity crisis, as the borrower can’t pay the higher rates and is unable to fund daily operations. A credit crisis could then lead to insolvency and bankruptcy.

Between 2007 and 2009, the U.S. economy witnessed a credit crisis that was initiated by massive downturn in the housing market. As the value of home prices declined, those who had mortgages started to default; banks, in return, saw their balance sheets shrink immensely. The banks essentially stopped lending to consumers and each other. Less credit in the market took the U.S. economy towards a downturn, resulting in lower consumption and business investments.

To fight all this, the Federal Reserve and the U.S. government had to intervene, bailing out banks that were facing severe liquidity crisis. Many banks were closed by the government, investment banks like Lehman Brothers filed for bankruptcy, and others were sold.


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