Executive Summary: The 2008 Financial Crisis

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Mishkin (1991) defines a financial crisis as a disruption to financial markets in which adverse selection and moral hazard problems become much worse, so that financial markets are unable to efficiently channel funds to those who have the most productive investment opportunity. Allen (2000) states that financial crises typically have three distinct phases. First, financial liberization, expansion in credit leads to increasing asset prices and starts the inflating of an asset bubble. Secondly, the bubble bursts, meaning asset prices collapse. Thirdly, default of firms who have borrowed money to buy these assets. Asymmetric information involves knowledge of information and how much information certain parties have. It usually occurs when one party has more information about something than another, for example when the seller of a good has greater knowledge that the buyer. In this paper I will focus on adverse selection and …show more content…
It is widely accepted and believed that the beginning of the global crisis actually occurred in 2007, with the credit crunch. US investors were no longer confident about subprime mortgage values, and this resulted in a liquidity crisis. To try and fight / counter act this, the US government had to pump extremely large amounts of money into the financial markets, as there was a lot of uncertainty and doubt surrounding them. Once September 2008 came around, stock markets all over the world had crashed and become very unpredictable. They were experiencing very high levels of volatility. Consumers around the world became very nervy due to the unpredictable future, and everyone began to cut back on spending. The credit crunch that I referred to earlier, involves the inflating of the housing bubble, and then the crash after it bursts. Towards the end of my paper I will look at the subprime crisis and housing bubble, as one of the examples of how financial crises are
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