A financial crisis is a period of general market instability that leads to a major drop in asset prices, liquidity shortages in banks and other financial institutions, and the inability of businesses and consumers to meet their debt obligations. These crises can be caused by a variety of factors, including systemic failures, unanticipated or uncontrollable human behavior, incentives to take too much risk, regulatory absence or failures, and contagions that spread problems from one institution to the next.

In the run-up to the crisis, banks and investors in the United States and around the world borrowed large amounts of money to expand their lending and purchase mortgage-backed securities (MBS). This borrowing, known as leverage, magnified potential profits but also increased losses should the price of these assets decline. Moreover, the financial system became increasingly interconnected as many of these investments were backed by a common pool of mortgages.

The collapse of Lehman Brothers and the near-collapse or bailout of a number of other large financial firms triggered a global panic. As a result, investors began pulling their money out of banks and investment funds. This exacerbated the crisis as these entities could not easily get new funding to replace their short-term deposits and long-term loans.

The financial crisis was a catalyst for significant reforms to the banking and financial systems. These include the creation of a consumer protection bureau and a regulatory agency, increases in the required capital for traditional banks and larger increases for so-called “systemically important” institutions, and new liquidity standards that limit how quickly banks can convert short-term investments to longer-term assets.