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What Are the Causes of Financial Crisis?

There are many different causes of financial crisis.
John Maynard Keynes.
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  • Written By: Jessica Ellis
  • Edited By: Bronwyn Harris
  • Last Modified Date: 08 October 2014
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A financial crisis occurs when a household, business, industry, or country, can no longer afford to cover its debts. Some people think of the Great Depression, or the 2007-2008 financial disaster when they think of a “financial crisis,” but the term can apply to a family or individual who finds himself out of funds when a medical or family emergency hits. There are many different causes of financial crisis; often, a situation that has taken a while to build is thrown into crisis by a dramatic event. In other cases, an unforeseen risk or problem coming to fruition can leave a formerly successful enterprise in danger of insolvency.

A major economic crash, such as the financial crisis of 2007-2008, is often caused by a combination of issues. Many economic analysts attribute the causes of financial crisis in this instance to a deregulation trend that allowed home mortgage lenders to reduce lending standards and offer more and more risky loans, including the famed sub-prime mortgages. Since the amount of people who can buy homes isn't infinite, eventually the market reached a tipping point where the amount of people applying for loans could no longer sustain the rates offered. Construction tapered off, and many lenders started to raise mortgage rates, quickly leading to panic across the financial marketplace. As interest rates soared, people foreclosed, depriving major financial companies of the income they relied upon, which in turn led to company bankruptcies, a flourishing unemployment rate, and severe economic depression.

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Causes of financial crisis situations of this size can be traced back decades, even to the original financial philosophies of economic giants such as John Maynard Keynes. Unfortunately, a lack of prudence and desire for immediate profit can drive large industries further and further into risky lending and investment, driven on by the momentum of the market. Some economists go so far as to say that fear and panic, rather than realistic circumstance, can drive a macroeconomic market into financial crisis.

In a business, there can be many isolated or interdependent causes of financial crisis. Embezzlement, bad public relations, a high-profile product recall, or simple poor performance can drive a business into insurmountable debt. A macroeconomic crisis, such as a recession, can hurt many businesses, as rising unemployment translates to lower consumer spending, which can destroy many small businesses. Businesses can attempt to manage risk by paying off debts, such as start-up loans, and increasing their monthly cash flow to keep all accounts current, but many do remain fearfully dependent on the whims of the market.

In a household, the causes of financial crisis often include poor budgeting or high costs of living. With many essential items from health care to college tuition increasing in price since the mid-20th century, even families that carefully budget expenses may find it difficult to save for a rainy day. As a result, financial crisis can occur when a household functioning on a month-to-month survival level faces a sudden crisis, such as a medical emergency.

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