The Financial Crisis of 2007–9 and the British Experience

Abstract

Abstract.This paper traces the course of the international financial crisis from its outbreak in mid 2007 to the easing of financial turmoil in May 2009, based on the British experience. The crisis resulted from excessive risk‐taking following a prolonged period of macroeconomic stability, combined with financial innovation. Problems arose initially with rising defaults in the US market for subprime mortgages, which induced a breakdown in the market for asset backed securities in mid‐2007. The drying up of the money market threatened the liquidity of several UK banks, notably Northern Rock, while falling asset prices undermined their solvency. A critical point was reached when Lehman Brothers failed in September 2008. This event confirmed that the world faced a systemic financial crisis. Fortunately monetary and fiscal authorities took vigorous action to stem the crisis and as a result some confidence has been restored in ailing banks. This has not prevented a sharp decline in economic activity and a persistent shortage of credit.