CHAPTER ONE
1.0 INTRODUCTION
As the International Monetary Fund, IMF observed, the extent and severity of the crisis that began with the bursting of the housing bubble in the United States in August 2007 reflects the confluence of myriad of factors some of which are familiar from previous crises, while others are new. As in previous times of financial turmoil, the pre-crisis period was characterized by:
(i) Surging asset prices that proved unsustainable;
(ii) A prolonged credit expansion leading to accumulation of debt;
(iii) The emergence of new types of synthetic financial instruments;
(iv) Regulatory failure.
This time around the rapid expansion of securitization (not itself a new phenomenon), which changed incentives for lenders and lowered credit standards caused the crisis. Systems became fragile because balance sheets became increasingly complex (further complicated by increased use of off- balance-sheet instruments). Financial market players were highly leveraged and relied on wholesale funding and external risk assessments. Cross-border spillovers intensified after the crisis started because financial institutions and markets across borders were closely linked and risks highly correlated.
No doubt, the world is inextricably linked by globalization. Thus, the economic and financial crisis, which started in the United States, destabilized markets and economies (developed, developing and underdeveloped) around the globe and has continued to dominate discussions on the global economy. These days one would hardly watch the television or browse through national and international newspapers, magazines and journals without stumbling upon headline news of how political leaders are scrambling for strategies to mitigate the impact of the financial crisis on the domestic and global economy.
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