Why do banking crisis and financial crisis happen

  The US subprime lending crisis erupted in 2007 has been involved as the global financial crisis in 21 century, which not only lead to the economic depression in USA, but also result in tough time in economy during many countries. The US subprime lending crisis influenced from investment banks to commercial banks gradually. Up to year 2009, there were fifteen banks went bankrupt. The biggest bank among them is IndyMac bank, which was one of the largest mortgage lenders in USA. An analyst at RBC capital market in San Francisco said “IndyMac still has a sizable book of poorly performing loans. That’s its biggest problem. Our best guess is that IndyMac winds up in receivership.” According to the international monetary fund, global financial lost 1.4 trillion dollars due to this subprime lending crisis. There are many factors cause such crises. Overall, there are three aspects to analysis. First of all is from financial market and institution side. In short, subprime mortgage is to mortgage the houses to the people who in fact have no ability to pay back the money in a very low price. Such subprime mortgage was based on the low interest rate and increasing property price. However, the higher interest rate increases borrowers’ cost and the real estate market met recession in year2004, which shake the existence and development of subprime mortgage. And this situation led to higher rate of liquidated damages. Quite a lot of mortgage enterprise went out of business. Then, from investors’ side, many investors have no ability to identify the value or risk of derivative which may make mistake. Finally, from the regulation side, the irresponsible rating agency made incorrect strategy due to lack of good regulation. For example, many Chinese banks hold bond of Lehman Brothers, and along with subprime lending crisis, the Chinese financial institution lost 4.9 billion in Chinese currency.  The Chinese commercial banks appear toxic assets at present.

   Many theories explain why banking crisis happen. In Macroscopic view, Irving Fisher believed that there’s close relationship between banking crisis and bad economic cycle. Hyman P. Minsky suggested “financial instability hypothesis”, which showed that economy boom may cause the financial turbulence in the future. Friedman concluded that “the wrong monetary policy brought about the banking crisis” by researching banking behavior during the great depression from 1929 to 1933. From microcosmic, such as asymmetrical information, adverse selection by borrowers, the moral hazard behavior, the banking behavior itself, all of these factors would cause the banking crisis. Overall, it is impossible to understand how banking crisis exist. We need more and more theory and case study to conclude it.

   Subprime lending crisis impact banks most. The following week I will discuss how does it influence the banks, and banks' response to it. (In week 2, I discuss the reason of banking crisis and financial crisis in general according to my own point of view and research.)