Financial Crises: Causes, Theories and Types

happen with no warnings; one of these financial crises is the subprime mortgage crises that took place at August 2007 in the United States as a result of striking rise in the financial negligence and wrong doing. Moreover, many other financial crises have occurred as a result of the U.S crises which affected the globe. Asian countries including Hong Kong, Singapore, South Korea, and Taiwan known as the “Dragons” in addition to Indonesia, Malaysia, Philippine and Thailand known as the “Tigers” has also faced financial crises. Asian financial crises have started to occur in the year 1997-1998 after they were a great example of the financial and economical success and development at high rates. The financial crises started to occur in Asia in the year 1997 after the Baht which was the currency of Thailand was out under pressure and the government didn’t support and defend it anymore in July 2, 1997 leading to a 14% decrease of the currency on the local, on ground market and decreased up to 19% in the close lands I.e. the offshore of the market (Franck and Fourcan, 2003) . These crises have continued and extended with the problems that have faced the currencies of Philippine and Malaysian which were the peso and ringgit respectively. The government tried to defend these currencies but they had failed to do so and the loses increased which pushed the central bank of Malaysia to stop defending the ringgit in July 11 and the central bank of Indonesia to stop supporting the rupee on the 14th of August. These crises have continued to reach the Asian countries known as “Dragons” that stopped defending their currencies after their decrease. The financial crises have also attacked the “European Monetary System” in 1992-1993, the Mexican crises in the year 1994-1995. As a result of the financial crises at the United States have affected the global markets not only the local markets. In general financial crises are used to describe all the bad monetary situations that lead to sudden unexpected losses in the assets and money value of a certain country, the financial crises are always associated with panics in the markets and great loses. Beside what is mentioned above, there are several types of financial crises that have different causes and different effects globally and locally. Moreover, there are several theories that discussed the issues of financial crises from different angles and different points of views.

The above map shows the growth in the GDP all around the world in the year 2007, it shows improvement in the production of goods and services as well as improvement in the value of the assets and the profits.

Literature Review:

Continuing financial crises and depressions of the economical world quickly during the last 50 years, this fact has gave curiosity to the scientists in order to explore the world of economy and find solutions for the financial problems starting with Jean Charles Leonard de Sismondi, who was followed by several scientists that established different theories from different angles and different points of views, aiming to reach equilibrium between the supply and the demand to decrease the financial risks. Some of those are Karl Marx, Hyman Minisky as well as the “coordination games”, and “Herding and Learning Models “.

Marxist Theory:

The central theme of Karl Marx was to develop an economical theory; Marx’s theory was based on materialism, and a materialistic analysis of the case aiming to centralize the profits. From Marx perception successful working industries pay for the employees less than the profits which mean that in this case wages and salaries of employees are less that the gains of the company, where the company uses the profits in order to cover the money paid in the business investments, this action in the long run leads to great loses because as the population will not be able to pay the costs of the products since the wages are lower. In addition to that, when the businesses want to expand their business the prices directly fall.

This theory and its concepts are only valid under three conditions:

  1. The taxes placed by the government and returned to the population including families, welfare, benefits…
  2. Portion of the people who are employed compared to the business man and the investors.
  3. The huge amount of money and capital needed to start big businesses such as military industry, airline transportation, the production of chemicals …

Beside what is mentioned above, the empirical and econometrics researches continued to study and explore the “world systems theory” and studying the economical cycle especially after the oil crises.

Minisky’s Theory:

Hyman Minisky planned a “post-Keynesian” which a school of economic thought. Minisky was concerned about the domestic market the universal expansion of monetary weakness; the movement to the threshold of monetary disaster; the disturbance of steadiness by unusual and surprising events, and “debt-deflation”, including the skills to stop the “debt-deflation” procedure. As the development and growth extends, confidence enlarges, and meetings about the appropriate height of balance due and danger start s to alter. Prices of monetary possessions increase and the universal altitude of assumptions rises. Speculation is in use to be the effort to bet on the upcoming way and type of the marketplace. In addition to that, with respect to Minisky fragile economics is the path to the financial crises, Minisky made his analysis easier by developing three ways a firm can follow, “hedge finance, speculative finance, and Ponzi finance”. First, hedge finance, profits movements should meet up with the economical responsibilities all the time taking into consideration the principal and the significance on mortgages, second speculative finance means that the organization has to evolve over the liabilities because revenues are meant to cover the interest costs without covering any of the principal costs, third for Ponzi finance, is the most dangerous and fragile one because the income flows don’t neither cover the interest cost nor the principal cost and in this case the company is obliged to borrow money to minimize the liabilities. In this case the only solution is to increase the market value in order to be able to pay off interest and principle costs.

According to Minisky, fragile finance is directly related to the business cycle and they move together in the same dimensions, for example after the recession the best approach is the hedge since it’s the easier and the most economical and secured one, whereas when the profits are increasing and they are enough to cover all the interest speculative financing is the best approach. After the financial crises, refinancing will be difficult to obtain for many reasons especially if there is no new money entries which will lead to serious economical crises, and during recessions the business cycle will be closed.

Coordination Games:

Coordination games are related to studying the financial crises from a mathematical approach which has showed the “positive feedback” which reflects the presence of great dramatic changes in the financial situations, and that that we can have more than one stability point.

Herding Models and Learning Models:

A variety of forms have been established in which benefit standards may twist extremely positively or negatively as shareholders and sponsors find out new things and learn from each other. In the herding models, profits acquired by a small number of managers promote others to purchase also, because investors believe that the profits increases and their value becomes high when they figure out that other investors are purchasing , and not because many people buy as the “strategic complementarily “states.

The “herding” representation, assumed that financiers are fully reasonable and logical, and have incomplete knowledge and data about the economy. “Herding models”, states that, when only some shareholders obtain certain types of assets, means that the shareholders have good information about that assets giving them a high value. Although it is a logical and rational decision sometimes using this methods wrong decisions are taken because maybe the first investor took the wrong choice and he/she is mistaken.

In “adaptive learning” or “adaptive expectations” models, shareholders make their decisions based on the newest incidents. In these forms, if the value of a given capital increases for a certain period of time then the investors starts to believe that the price is going to increase constantly and that’s why shareholders will buy increasingly. As well as studying some decreases in the prices may lead to a few price decreases in a descending charge twisting, thus in forms of “this type large fluctuations” in property costs can take place.


Financial crises are different; there are mainly four types of financial crises which are: banking crises, rough bubbles and crashes, international financial crises, wider economic crises.

  • First, Banking crises, are mainly caused by “bank runs” which means the sudden extraction of money from the bank by a large number of people that think that the bank is going to become bankrupt and broken which means that the bank will not be able to pay people’s debt anymore. Insolvency occurs in two forms which are:”Cash flow insolvency” I.e. failing in paying the debts at the stated dates, the 2nd time is “balance sheet insolvency” which means that the liabilities are more than the assts. here also the positive feedback applies in which people imitate each other and the number of people who takes their money deposits increases when people notices that others are going this, leading to the absence of stability and moves to bankruptcy.

Complete banking catastrophes are connected with considerable monetary expenses and huge yield sufferers. Usually, “crisis liquidity” sustains and covers certifications that have been used to hold these financial disasters, but they are not successful all the time. Even though financial reductions may help in having market demands and difficulties if crises are caused by weak economical strategies, “expansionary fiscal policies” are usually used. In financial crisis of “liquidity and solvency”, central banks can offer “liquidity” to hold up “illiquid” banks. Shareholders security may help in re-establishing assurance, even if it have a tendency to be expensive and its doesn’t recover the loses for sure. Involvement is frequently postponed hoping that improvement will take place, and this holdup enlarges the pressure on the financial system.

“Silent run” takes place when the hidden financial shortage starting from the supervisors defeat revelation to “zombie banks” which is a financial organization that has a net profit less than zero but it continues to work and operate. This back is important and powerful enough to put off depositors of these stores. When the number of shareholders and depositors who doubt the ability of the government to sustain and support the banking systems at the country increase the costs of the “zombie banks funding” increase due to the gathering of the “silent run” condensation. reparing the damages of the crisis is very costly , for example in systemically significant “banking crises” .

  • Second, the Speculative bubbles and crashes states that according to economists fiscal benefits such as stocks demonstrate a “bubble” if the price of the financial asset surpasses the current charge of the upcoming wages including interests and dividends that might be established through holding it to its ripeness i.e maturity. In case that participants but the stocks and plans to sell it later on at higher prices rather than buying it due to the incomes generates a “bubble “will occur. In addition to that the presence of “bubble” leads to . when a bubble exist a higher risk of crashes in property’s costs occur in which contestants at the market buys only if they find out that others are buying , while if they stop selling the prices will go down. Nevertheless, knowing if the prices of assets are equivalent to their basic value thus detecting bubbles consistency is a complicated issue, and this fact pushes some economists to believe that bubbles never occur. The Wall Street Crash of 1929, Dutch tulip mania , Japanese property bubble of 1980s… are all good examples of famous bubbles.
  • Third, the international financial crises some countries sustain an unchanged trading chargesƒ¨ fixed exchange rates which causes unexpected diminishing and decrease in the currency due to rough attacks such phenomena is known as ” currency crisis “or as “balance of payment crises” . Sovereign default occurs if the state don’t succeed in returning that debts which are guaranteed by the government.

Whereas depression and failure to pay might both be: intentional and controlled choice made by the government, or spontaneous unintentional consequences caused by changes in the results of depositor responses and opinions leading to either unexpected stop in assets “inflows” or a hasty boost in investment departure.

There are several currency crises that occurred in different areas such as Europe in which several currencies that were part of the “European Exchange Rate Mechanism” experienced crises in the years 1992 and 1993, in which they were strained to bring down or leave from the system. Asia also faced currency crises in the year 1997-1998 , in addition to a lot of Latin American countries that failed to pay on their liabilities in the early 1980s, as well as 1998 Russian financial crisis which caused the depreciation of the ruble and evasion of the connections at the Russian government.

  • The fourth and the final type of financial crises is the wider economic crises, this includes the recession which is the negative move of the GDP which lasts for a period of time. Depression is recession that last for a longer period of time, with a time consuming process, if but during depression the GDP is moving slowly but not in a negative way it is called “economic stagnation”.

Furthermore, there are several causes of the financial crises such as:

1- “Strategic complementarities in financial markets”; in general the success of a certain investment can be estimated by predicting the behaviors of others and trying to guess how they are going to work and invest. Investors need to analyze and observe the reasons that make other investors successful; according to the economist George Soros, the purpose of supposition and estimation of others action is called “reflexivity” which is a social theory that states that this issue is like and endless, continuous circular relationship between causes and effects in which one of them leads to the other in a bidirectional motion moreover in this theory, sociology interferes directly. Beside Soros, “John Maynar Keynes” contrasted the economical markets with beauty contests in which all those who are sharing try to guess which one will be picked as the best and the more beautiful.

In addition to that, sometimes the choice of some investors can affect the choice of other investors because they might link the number of buyers to the success of their business choice for example if a lot of investors buy American dollar other shareholders might think that this means that the American dollar is very strong and encourage them to buy this currency. One of the argues about the issue of studying others actions and doing like they do was that self-fulfilling divination will occur.

2-Leverage, that is having access to fund savings, is regularly referred to as a supplier to fiscal crises. This happens when a monetary organization or even a person empower its own currency only, because in some cases the funds will be gone. On the other hand if the organization wants to borrow some more money so that it can share in more investments, it may sometimes gain from such type of investments but sometimes the organization may lose all what it has. Thus, the” leverage” increases the probable profits from assets, as well as the possibility of liquidation, I.e. bankruptcy. This phenomena leads to problems that spread from one company to another. In addition to that, the normal amount of control in the financial area increases before the financial crisis like what happened in the Wall Street crash of 1929.

3-Asset-liability mismatch is another cause of financial crises which is a condition where the hazards linked with an organization’s sum unpaid and possessions are not suitably and properly associated. As an example we can talk about profitable banks present financial records that can be reserved during anytime and they are used to continue to create “long-term” mortgages to commerce’s and “homeowners”. The difference between the bank’s deposits which are short-term liabilities and the loans which are long-term assets is recognized to be one of the causes of “bank runs” which is caused as a result of find withdrawing from banks by the depositors. Bear Stearns is an example about bank runs as a result of failure due to the disability of matching between the deposits and the assets in financial securities.

In global circumstances, several up-and-coming market governments are not allowed to sell “bonds “in the country’s currency , leading to denominated bond selling in the US dollars instead of the national currency .This creates a difference between the money value of the assets and the liabilities.

4-Hesitation and group performance, a large number of financial crisis studies spot the lights on the task of speculation errors caused by the need of facts, information, and the deficiencies of individual’s way of thinking. “Behavioral finance” revise mistakes in financial and quantitative analysis.

Some economists have argued that most of the very dangerous and major financial crises have been caused due to changes in the financial opportunities and the wrong decisions done by the investors due to mistaken expectations. For example, there are crashes that occurred due to new and strange investments such as the South Sea Bubble and Mississippi, as well as the Crash of 1929 which occurred directly after new transport and electric improvements. Moreover, the new financial crises pursued modifications and transformations in the savings settings due to removing the governmental power and giving freedom to the market share. as an example about this issue was he dot com bubble crash in the year 2001 which started as a result of the absurd energy about Internet know-how machinery and tools. Being unfamiliar with the modern technological and financial improvements can aid in explaining how depositors from time to time disgustingly overvalue and misjudge the asset standards. As well, in case the opening shareholders in a innovative and fresh set of properties and resources, profits will remain the same and don’t raise until the investors get to the innovations more, then at rest additional people might go behind their model and illustration, where the prices of the inventions rise since investors will rush to buy as they hope to gain the same profits. The official name of the rush behavior is the “herd behavior” which causes the costs to coiled in a positive direction by having values that are even higher than the real values of the assets and in this case financial crisis should be expected. Beside what is mentioned above, if for any cause the value for a short time fall, the sponsors are going to understand that additional achievements are not guaranteed, afterward the twisting may move in the opposite direction I.e. in a negative sense causing loses as the charges will reduce leading to selling in low prices.

5-Regulatory failures, in which the governments have tried to reduce or lessen the number of economical crisis via flexible and adaptable financial segment. One of the main goals of instructions is simplicity and clearance: making organizations financial conditions recognized and indentified by involving ordinary treatments under consistent office measures and dealings. One more objective of rules is to make sure that the organizations have enough belongings to meet up their contractual requirements, all the way through set aside necessities, assets supplies, and other restrictions on leverage.

Various fiscal crises have been held responsible on inadequate rules and regulation, and have led to modifications in rule so that they circumvent a replicate. On the other hand, extreme laws and instructions have also been referred to as a probable origin of fiscal crisis. To be more precise, banks should be not allowed to increase their capital when risks arise because they will pass though financial crisis as a result.

The financial crises have great impacts and effects including, on the market and on the investors some of the effects of the financial crises are: “contagion, recessionary effects, as well as some effects on the developing countries. Contagion is related to the thought that fiscal crisis may extend from one organization to another ,for example, once a bank run extends from a small number of caches to many others, or from a state to another, as when currency crises, self-governing evasion, or stores marketplace break downs extend along nations. When the crash of one exacting monetary associations intimidate the steadiness and consistency of a lot of other organizations, this is known as the “systemic risk”.

One of the very important examples about contagion is the widen of the Thai crisis in 1997 to reach additional nation such as South Korea. Nevertheless, economists regularly discuss whether examining crisis in numerous states approximately at the same time is truly caused by contagion from one market to another, or in case it is as an alternative causes by related fundamental troubles that might influence each state independently even in the lack of global connections and associations .

The second affect of financial crisis is the recessionary effects, in which a number of monetary crisis encompass small effect exterior of the fiscal segment, similar to the Wall Street crash of 1987, except that supplementary crisis are supposed to play an important part in diminishing development in the remaining of the financial system. There are several theories that discuss the reasons of having recessionary effects that after the financial crises effect on the rest of the economy. Some of these theories are: ‘financial accelerator’, ‘flight to quality’ and ‘flight to liquidity’, and the “Kiyotaki-Moore model.

Although financial crises are not expected yet countries should always have backup plans to fix the situation and stand on their feet again. Some of the responses last for a long period of time while some lasts for a short period. for example the United States have followed the three solutions below:

First, centralized stores that is the “Federal Reserve” and the inner most banks that are found all over the world, these central banks usually take actions to increase their gains and the supply of money in order to stay away from depression and depreciation twisting, so that lesser salaries and higher number of people who don’t have jobs directs to a positive feedback decrease in the international use. Moreover, governments perform huge financial encouragement correspondences, through having access to and using up to balance the drop in confidential subdivision needs and obligations caused by the crisis. The U.S. implemented two incentive correspondences, adding together almost one trillion dollars throughout the years 2008 and 2009. This recognition congeals conveys the universal fiscal methods and systems to the edge of falling down. In addition to that, the reaction of the U.S. “Federal Reserve, the European Central Bank”, and additional different central banks was direct, urgent, and striking. For example, through the final quarter of 2008, the fundamental banks bought around two trillion American dollar and a half of the government’s liabilities as well as the disturbed and uneasy confidential properties and resources from the banks. This action was the biggest and the major action for the transformation of assets into cash as well as financial strategies in globe record. Beside what is mentioned above, the governments of European states and the USA also lift up the assets of their nationalized banking systems by around one million and five hundred trillion American dollars, as they bought new “Preferred stock” in their central banks. Furthermore, governments also “bailed out” a number of organization, acquires big and great fiscal compulsions. Till now, different governmental organizations in the United States have dedicated trillions of dollars in debts, purchasing assets, agreements, and straight costs.

A second response is the long term and authoritarian proposals, Obama the president of U.S along with the main consultants brought in a sequence of dictatorial suggestions in June of the year 2009. The suggestions concentrated on customers and buyers defense, managerial compensation, stock monetary reduce as well as assets supplies, prolonged instructions of the new and copied banking systems , and improved power for the “Federal Reserve” to securely move in a system way in well-known and famous organizations among other organizations.

Furthermore, an array of additional narrow modifications that have been planned and projected by the economists, the politicians, the media, and commerce privileges in order to diminish the crash of the present economical tragedies and avoid repetitions, but none of the projected clarifications is applied yet.

The third response used by the United States is the community offends that is the “public outrage”. This states that, economical crises have forced an outburst of critiques and manuscripts exterior of the academic and fiscal journalists.

The above solutions were suggested by the government for the United States to solve the financial crises issues of the between the years 2007-2010. Yet, there are many other solutions that are followed by different countries such as :

  1. Reduce the percentage of taxes.
  2. Increase the number of services offered by the government.
  3. Prevent the nearing retirement fund disasters.
  4. Enjoy the elevated non-refundable wages, or else spend less time at work.
  5. Segment exposed state liabilities.
  6. Decrease the commercial and customer debts.

Crises of UAE and Greece:

The two recent crises that have shocked the whole world are the crises that occurred in UAE and Greece. The economy of Greece was very strong in which it was considered to be in the twenty-seventh largest economy in the world by studying it based on the GDP and it was the main thirty-third largest country of the purchasing power according to the “International Monetary Fund” thus the economy of Greece was really a strong and it was known with its high incomes and profits. Moreover, the Greek economy have evolved during the period of the industrial revolution here is a graph that compares the financial situation in Greece between the year 1996 and 2006 based on the increase and the decrease of the GDP .

The economy of Greece has moved down word during the year 2010, at the beginning of the year 2010 and the early weeks of this year the government of Greece started to worry about the economical situation since the debts were increasing, the Canadian European Economic Crisis, stated that the mess in the economy of some European countries including Greece if due to inflation of the euro zone, tax shirking, and the mixture between the Keynesian theory which believe that the actions of the private sectors some times, lead to insufficient and ineffective macro economical outcomes which forces the sponsors that belong to the public sector such as the government, central banks… to interfere in solving this problem. Of course the government proposed some of the long term solutions and to prevent the spread of the crises in the surrounding countries.

The graph below demonstrate the government surplus or deficient in the percentage of GDP in some of the European countries against the Euro zone. The

The long term solutions that were suggested by the government were mainly two including:

  1. Generating of common finances which aims to giving capital of the organizations which are going to bankruptcy, insolvency and liquidation.
  2. Fiscal policies that organizes on portfolio investment.

The Dubai economical situations were flying high, in which it was build in the oil industry and petroleum. Possessions marketplace experienced great economical loses between the years 2008 and 2009 , at the beginning of the year 2009 the financial situation stared to getting even worst along with the “global economical crisis”. In Februarys of the year 2009 the debts has increased to reach 80 billion dollar. Tourism and trading industry are two major sectors of the economical and financial those shops and investments along with the support of the near countries helped to make the financial situation in UAE better after it was a worst one in which a lot of organizations were bankrupted and a lot of employees lost their work with lower incomes and high prices.


In conclusion, the worldwide fiscal crisis have by now extended from corner to corner across the earth, financial disasters that come into sight in residential areas and developed countries has been spreading recently and reached the developing countries leading to high risks and dangers on the economy and standing up again after beating the financial crises and finding solutions for them. In addition to that, predictions of enlargement and improvement in the rising countries have been demoted and reduced considerably in a great way, even lately there were several questions that economists highlighted and tried to find answers to, such as how profound, for how much time will these complexities and difficulties will last and how much will it extend? Which of the states will be inflated and affected more than the rest of the countries? What are the guides and controls throughout which this may toil? Will these methods that are used to solve the problem have a positive effect? How long will it last and be affected? Are these methods effective in supporting the poor and developing countries that are affected by the financial crises? What are the proper responses for these problems? And what are appropriate responses for policy makers and development officials?

In addition to that, a lot of the shortage and deficiencies in the globe is caused by the planned systems used by the banks in a large number of countries in most which allows, such a policy allows the gain of the government to be only three percent where as the banks make ninety seven percent of the money profits by the banks. Never the less, funds shaped by the depository’s profits the banks; whereas the wealth and capitals produced by the government reimbursement everybody. Moreover, economists have always tried to find the reasons of the financial crises; some have stated that the main reason of financial crises is political by nature, although it explodes from economical and financial crisis, yet it might be related to political reasons in which the losses will be distributed in an extremely subjective and continuous manner. Eventually, most if not all the financial crises are due to power, control, and influence. In addition to that, financial crises throughout history have proved to be economical production can reach an everlasting success and continuity.

In addition to that, a lot of the shortage and deficiencies in the globe is caused by the planned systems used by the banks in a large number of countries

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