There have been many debt crises in the history of the world.
Some were limited to a single country, but some spread to others too. The ones that spread to others were particularly originated in some big economy that had trade relations with many other economies. But wherever might the crisis happen, what matters most are the effects that they create. The financial crisis happening anywhere in the world create almost the same kinds of situation and imbalances. Some common consequences of the debt crisis are massive unemployment, reduction in aggregate demand, fall in the consumer demand, reduction in business investment, fall in government revenue due to low tax payments, etc.
Many small financial crises have taken place in various countries. There was two major crisis that affected almost the whole world. One in the 20th century and another at the start of 21st century. Both were originated in the US. The one that took place in the 1930s was named the Great Depression and the one in 2007-08 was called the Great Recession. The great depression happened because of the stock market crash of October 1929 and the agriculture sector failures. The stock makes market crash took place as many of the investors sold their shares valuing millions on a single day. This created a panic among the general public and more shares got started selling. Banks faced quite a lot of problems as they were unable to heed to the needs of deposit withdrawals. They did not have enough money to pay back all the people at once as a result of his many banks faced the issue of insolvency. A number of loans given by the banks reduced. This negatively impacted the investment done by the business firms. Agriculture too suffered a lot. Farmers were harmed by the reduction in prices all over the country. Their crops were unable to be sold at such low prices. The remuneration they got was too low thus they demanded special tariffs from the government. These tariffs hampered the international trade as the US is one of the largest economies of the world. Other countries too started to safe ground their domestic industries from foreign competition.
The financial crisis of 2007-08 was preceded by housing industry bubble burst. The prices of houses went high in the initial years of the 2000s. Many people started to buy the houses. They needed loans for the same therefore they approached the banks. Initially, everything was going as usual.
But the banks started trading these mortgages to financial institutions. These financial institutions seeing the houses were a good place to invest started making mortgage-based securities.
They further sold these mortgage-based securities to investors in smaller shares. Investment banks also got involved in the same. Insurance companies came up with the credit default swaps. These CDS were offered to the public to safeguard themselves from the failure of collateralized debt obligations.
Until and unless the prices of houses were high everyone profited. Soon the prices of houses came down and everyone started to face losses. The people who owned CDS asked insurance companies for payment. Insurance companies were incapable of making such large payments. Thus many financial institutions failed at that time. The government had to bail out many institutions. Banks runs became a common scenario. The houses the banks took from the subprime borrowers could not be sold due to no demand for houses and low value. Thus banks too failed. Unemployment rose in the country to really high levels. The effects of the debt crisis spread to other countries as well. Europe banks also invested in mortgage-based securities. They also faced huge loss after the crisis.
These two examples of crisis show a lot of effects and consequences of the failure of financial institutions in a country.
These have internal as well as external effects. International trade balances are also hampered by such crisis. But the historical studies of debt crisis help economies in many ways.
They tell the circumstances that led to such situations and also a way to prevent them to happen again. Many lessons are learnt and situations are overcome with the study of such debt crisis.
Would you like to read more about this topic? This book might interest you: Big Debt Crisis.