Analysis of a Monetary or Financial Issue

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2007 Financial Crisis
A financial crisis happens with no prior warnings or signs that it would ever pass. Few notice its imminence, but no one can explicitly point to the time a crisis starts or when it ends. For example, the 2007 financial crisis came as a surprise but soon, the entire world found itself trying to prevent the impending danger of economies succumbing to the spiraling effect. Also, it is challenging to pinpoint the reasons for the same, considering what was thought of as issues or challenges in the subprime mortgage market soon became a financial issue that brought the entire world to its knees. Banks scampered to cover loopholes that exposed them to the crisis, but a few casualties were expected. The Lehman Brothers, for example, was a big company and one of the largest financial services companies in the world. However, the financial crisis of 2008 swallowed it whole, and it soon collapsed. Provided herein is a discussion of the crisis by assessing the events leading to the situation, effects of the crisis, how the crisis was addressed.
Events leading to the Crisis and Explanation of the Crisis Using Fisher's Debt-Deflation Theory
The 2007 crisis was induced by several factors that can be traced as far back as the technology bubble. During the collapse of the technology bubble, the Federal Reserve opted to introduce a low-interest rate policy, which inspired central banks in the U.S. to follow suit. With such an approach, subprime lending was bound to arise at some point, with banks taking the same approach as their central banks and the Federal Reserve. The effect of such policies led to what was considered a real estate boom, but unknowingly to many, the boom was 'manufactured' and was bound to bust once people started defaulting on the low-interest loans. Since more people could have access to loans, house prices skyrocketed, but in 2006, these prices started to drop.
This paper employs Irving Fisher's debt-deflation theory to explain best the drop and why there was a ripple effect. Fisher's debt-deflation theory mainly posits that the downfall of an economy can be instigated by a rise in the number of loan defaults coupled with bank insolvencies. He explained that as the value of debt rose due to the value of currency also rising, the chances are high that people will not be able to service their loans. In an economy where prices are falling, like in the real estate market during the 2007 financial crisis, the chances are high that more people will find it difficult to service their loans.
In the 2007 financial crisis, the U.S. economy was in a state of over-indebtedness, meaning an imbalance between the assets available and what could be liquidated (Quiviger, 1). While in a state of over-indebtedness, people try to liquidate as many assets as possible in what Quigiver calls 'distress selling' (1). However, since people have no money to spend, the chances are high that these assets are not being sold at a high rate, and this further pushes the prices down, the same thing that was happening when the real estate market busted in the U.S. Banks also found themselves at a disadvantage as more people were withdrawing their monies to try and stay liquid. As this was happening and others were defaulting on their loans, banks found themselves with decreasing levels of liquidity. Furthermore, the debts being defaulted value increased, heaping more pressure on banks to liquidate.
The fall in the prices of houses greatly affected the economy. As prices were falling, profits on loans and investments were being eradicated, which means that wages or incomes were also hampered. As such, debt-repayment was dwindling, and more defaults followed. As Assous (312) indicates, the more banks, people, and financial institutions try to remove themselves from the over-indebtedness issue, the more they sink. He notes that "as bank loans are paid off, the deposit volume is reduced," which means that banks' liquidity was dealt a heavy blow. The effects of the crisis were intensely felt and grew to other sectors of the American economy and the world. The Department of the Treasury 2012 (3) report revealed that about $19.2 trillion household wealth was erased. Swagel (14) notes that the stock holdings were also erased, with the U.S. losing more than $7.4 trillion. These resulted from the ripple effects of the sinking economy and the spiraling effect, as explained by Fisher's debt-deflation theory.
The Relevance of the Keynesian Theory
The application of Keynesian economics was critical in dealing with the crisis. Keynesian economics was developed to address the Great Depression during the 1930s (Calomiris and Khan 64). The theory advocated for increased government expenditures and a reduction in taxes to stimulate demand and enable the economy to pull out of depression. It focused on the ability of the government to manage aggregate demand to prevent economic recessions actively. The theory was successful in dealing with the Great Depression of the 1930s.