CRS Report: Averting Financial Crisis

by Sabrina I. Pacifici on March 30, 2008

Averting Financial Crisis, Updated March 21, 2008, Mark Jickling, Specialist in Financial Economics, Government and Finance Division.

“There is no precise definition of “financial crisis,” but a common view is that disruptions in financial markets rise to the level of a crisis when the flow of credit to households and businesses is constrained and the real economy of goods and services is adversely affected. Since mid-2007, central bankers — including the Federal
Reserve — have labored to keep the downturn in U.S. subprime housing from developing into such a crisis.

While subprime problems were widely anticipated, the subsequent spread of turmoil into many seemingly unrelated parts of the global financial system was not. Many losses occurring in diverse firms and markets — often quite severe — have features in common: the use of complex, hard-to-value financial instruments; large speculative positions underwritten by borrowed funds, or leverage; and the use of
off-the-books entities to remove risky trading activities from the balance sheets of major financial institutions.”

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