Financial Market Crises in the 20th Century - Research Paper Example

The financial crisis which began in 2007-2008 originating in the housing market is the most severe since the 1930s. After decades of rapid growth and profitability, “banks and other financial firms began to undergo marked losses on their investments in home mortgages and related securities in the second half of 2007” (Bullard, Neely and Wheelock 403). Those losses catalyzed a total financial crisis when banks and other lenders suddenly demanded much higher interest rates on loans to risky borrowers including other banks; further, there was an acute decline in trading in many financial institutions, including “Bear Stearns, IndyMac Federal Bank, the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), Lehman Brothers, American International Group (AIG), and Citigroup” (Bullard et al 403).

These made financial markets uncertain throughout much of 2008 and into 2009. The financial disorder is believed to be the main reason for the economic recession that began in late 2007. As individual firms began collapsing, there was market speculation on which firms the government would consider ‘too big’ or ‘too connected’ to be permitted to fail. Why any firm whether large or small should be protected from failure is that particularly for financial firms the key is a systemic risk.

“Systemic risk refers to the possibility that a triggering event, such as the failure of an individual firm, will seriously impair other firms or market and harm the broader economy” (Bullard et al 403). Systemic risk was the reason for the Federal Reserve’s decision to facilitate the acquisition of Bear Stearns by JP Morgan Chase in March 2008 and the U.S. Department of the Treasury’s decision to place Fannie Mae and Freddie Mac into conservatorship or a legal arrangement in which control over the companies’ financial affairs was given to another party; the Federal Housing Finance Agency is appointed conservator; and for the Treasury to assume control of the American International Group (AIG) in September 2008.