Anatomy of a Financial Crisis

Financial crises often follow a familiar pattern. A new opportunity or easy credit fuels rising asset prices; rising prices attract more borrowing and speculation, and optimism detaches from fundamentals. Economist Hyman Minsky argued that stable periods encourage ever riskier borrowing, so stability itself breeds instability. Eventually a shock or loss of confidence causes prices to fall, borrowers cannot repay, and lenders pull back.

Because banks fund long-term loans with short-term deposits, fear can trigger a bank run, as depositors rush to withdraw before others, making the bank fail even if it was solvent. Historian Charles Kindleberger traced this cycle of mania, panic and crash through centuries, from the South Sea Bubble of 1720 onward. In 1873 Walter Bagehot advised central banks to act as 'lender of last resort', lending freely against good collateral during panics.

Modern deposit insurance and regulation aim to break the cycle, though they can encourage risk-taking if banks expect rescue.