In the summer of 2007, millions of homeowners in the United States discovered that the terms on their mortgage loans had worsened at the same time that the market values of their homes were declining. The squeeze quickly led to a sharp rise in foreclosures, and many families lost their homes. Within weeks, the turmoil spread to other advanced economies with complex financial systems, where businesses and individuals found that loans were harder to obtain and were unexpectedly expensive. Suddenly, the solvency of major banks and other financial institutions was being questioned.
What is surprising about this episode is that most people seem to have thought that advanced financial systems were sophisticated enough to absorb risks and to spread them widely enough to prevent a sudden drying up of liquidity. Bank runs happened in the 1930s. They were not supposed to happen in the 21st century. What is not so surprising is that once the problem began, it spread around the world before any one country could resolve the matter or protect itself from contagion. What began as a banking crisis spilled over into equity markets, destabilizing stock markets in industrial countries and raising fears that emerging markets could also be at risk.
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