Financial Crisis of 2007–2008

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The Financial crisis of 2007–2008 initially referred to in the media as a "credit crunch" or "credit crisis", began in August 2007, when a loss of confidence by investors in the value of securitized mortgages in the United States resulted in a liquidity crisis which prompted a substantial injection of capital into financial markets by the United States Federal Reserve and the European Central Bank.[1][2] The TED spread, an indicator of perceived credit risk in the general economy, spiked up in August 2007, remained volatile for a year, then spiked even higher in September 2008.[3]

Although America's housing collapse is often cited as having caused the crisis, the financial system was vulnerable because of intricate and overleveraged financial contracts and operations, a US monetary policy making the cost of credit negligible therefore encouraging such overleverage, and generally an hypertrophy of the financial sphere (financialization).

One example was credit derivatives - Credit Default Swaps (CDS), which insure debt holders against default. They are fashioned privately, traded over the counter outside the purview of regulators. The U.S. government's seizure of the mortgage companies prompted an auction of their debt so that traders who bought and sold default protection (CDS) could settle contracts. The auctions are used to set a price by which investors can settle the contracts with cash rather than having to physically deliver a bond to their counterparties. Sellers of protection pay the face value of the contracts minus the recovery value set on the bonds.

Source : Wikipedia

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