There have been countless theories and speculations regarding whether the next financial crisis will occur or not. And the answer is a big ‘YES’, according to me.
What is a Financial Crisis?
A financial crisis can be defined as a collapse in the financial system; a situation in which the supply of money is outpaced by the demand for money, hence giving rise to a liquidity crunch.
Initiators of a Financial Crisis
A financial crisis is primarily caused by deregulation in the financial industry that permits banks to engage in hedge fund trading with derivatives. Banks then demand more mortgages to support the profitable sale of these derivatives. Other situations that may be labelled as “financial crises” include the bursting of a speculative financial bubble, a stock market crash, a sovereign default or a currency crisis. A financial crisis may be limited to banks or spread throughout a single economy, the economy of a region, or economies worldwide.
There have been several instances of financial crisis all over the globe since the medieval times, but we shall focus on some of the major ones.
- Credit Crisis of 1772. After a period of rapidly expanding credit, this crisis started in March/April in London. Alexander Fordyce, a partner in a large bank, lost a huge sum shorting shares of the East India Company and fled to France to avoid repayment. Panic instigated a run on English banks that led to more than 20 large banking houses either becoming bankrupt or stopping payments to depositors and creditors. The crisis quickly spread to much of Europe. Historians draw a line from this crisis to the cause of the Boston Tea Party — the infamous tax legislation in the 13 colonies — and the resulting unrest that gave birth to the American Revolution.
- The Stock Crash of 1929. This crash, starting on October 24, 1929, saw share prices collapse after a period of wild speculation and borrowing to buy shares. It led to the Great Depression which was felt worldwide for over a dozen years. Its social impact lasted far longer. One trigger of the crash was a drastic oversupply of commodity crops which led to a steep decline in prices. A wide range of regulations and market-managing tools were introduced as a result of this crash.
- The 2007-2008 Global Financial Crisis. This financial crisis was the worst economic disaster since the Stock Market Crash of 1929. It started with a subprime mortgage-lending crisis in 2007 and expanded into a global banking crisis with the failure of the investment bank Lehman Brothers in September 2008. Huge bailouts and other measures meant to limit the spread of the damage failed and the global economy fell into recession.
Intuitions for the next Financial Crisis
The probability for the next financial crisis is quite reasonable and high and is based on the following speculations : (www.investopedia.com)
Reduced Bank Capital
An independent research arm of the U.S. Treasury Department has found that the financial system would be in great peril if one or more big banks fail, despite reforms enacted after the 2008 crisis. Similarly, Economics Professor Kenneth Rogoff of Harvard University believes that leading central banks around the world are unprepared to deal with a new banking crisis.
Soaring Private Debt
The credit card debt, subprime auto loans, loans that finance corporate leveraged buyouts, and general corporate debt — any type of secured lending backed by an asset that is overvalued — should be a concern.
The student debt is at a staggering $1.3 trillion which is parallel to 2008. There are massive amounts of unaffordable loans being made to people who can’t pay them, and the easy availability of these loans is leading to asset inflation.
Therefore, considering the above factors, a financial crisis can occur in the coming decades. The JPMorgan model calculates outcomes based on the length of the economic expansion, the potential duration of the next recession, the degree of leverage, asset-price valuations and the level of deregulation and financial innovation before the crisis. According to them, the year may be 2020.
Content: Kaif Ahmed
Graphics: Pradatta Nigamanshu
Editor: Prachi Prafull