Facing Crises[/b]
The term financial crisis is applied broadly to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. The crisis often occurs after a long period of economic growth, high employment and high activity.
The situation for companies and individuals are typically as follows:
The economic activity in the whole society is very high after a long period of growth, but is beginning to decline.
Stocks are traded for historically high quotes after a long period of rise of 300% or more, they have reached an all time high level, but they are beginning to decline again.
The prizes of real estate properties are also high after a long period of growth, 300% or more, but they also are beginning to decline after an all time high level.
Companies are often over-established after aggressive investments for borrowed money. The investments have not yet shown profitable, but the companies estimate great profits from the investments because they think the general growth will continue uninterruptedly.
Also the average individuals have high debts after having invested massively in their homes and in luxury objects. They have some beginning problems with payment on their debts, but think these problems soon will go away with an anticipated further rises of personal income.
The crisis usually has a slowly developing initial face. During this face the situation can reverse and the economy recover without great damages. In this initial period one can observe the following process:
Steadily more companies realize that their massive investments do not pay back with the expected revenues and they have problems paying on their loans. They abruptly reduce further investments and begin selling off assets.
Steadily more individuals also realize they have a too great debt to handle with their private income. They reduce their consumption and sell off properties and luxury objects.
Companies are getting steadily less orders, are selling less and have less to do because of reduced consume and investments.
Earnings of companies and individuals are declining and many are downright losing money.
The stock market values are sharply declining, often 20-30%.
The property prizes are sharply declining, often 20-30%.
Ultimately, all financial crises are crisis of governance. Financial crises prove that financial engineering cannot create perpetual prosperity. It takes good governance, at the corporate, financial and social level, to generate long-run sustainable stability. All crises have to be solved by governments, and if not satisfactorily, by the next government.
In one sense, I am hopeful. The present financial crisis has creatively destroyed many myths and out-dated theories. Free-market fundamentalism has truly been marked-to-market.