Financial Crises: New Insights

Financial crises, like disease outbreaks, are recurring events with devastating consequences.  Contagious and difficult to control, crises trigger steep declines in asset prices, disrupt credit intermediation, and precipitate waves of business failures, unemployment, and other economic dislocations. The experience of living through a crisis can have lasting impacts, even shaping individuals’ beliefs and preferences decades later. Crises can also have significant political repercussions. For example, the Great Depression contributed to the rise of fascism in Europe, and to an unprecedented reconfiguration of American institutions—President Franklin Delano Roosevelt’s New Deal.

The Global Financial Crisis of 2008 and the incipient financial panic at the outset of the Covid pandemic remind us that financial crises are likely to recur, and that understanding financial crises remains as important as ever. In recent years scholars have assembled new sources of data and utilized novel empirical designs to analyze financial crises, shedding light on old questions and producing new insights.  In what follows, I highlight some of those insights, as discussed in Hilt (2026).

Over the past two centuries, as financial markets and institutions evolved, the character and frequency of financial crises evolved as well. From the early 19th century until the mid-20th century, crises occurred with some regularity. Particularly in the United States, the most acute phases of those crises often began with the outbreak of banking panics—widespread runs on financial institutions, leading to a broad scramble for liquidity. Then in the period from the 1940s to the 1970s, a time of rigid financial regulations and strong public roles in the allocation of credit, there were essentially no financial crises at all. Finally, beginning in the 1970s, many countries implemented financial liberalizations, and financial crises began to recur, but in variants that differed somewhat from their historical antecedents. Deposit insurance schemes generally ended major panics within the commercial banking systems of high-income countries; many crises occurred without panics.  Panics reemerged in some financial crises, but broke out among the holders of short-term financial liabilities outside the purview of deposit insurance systems, such as international lenders, or, more recently, depositors in shadow banking systems.

In spite of this pattern of change over time, some elements of financial crises have remained quite consistent since the late nineteenth century. Financial crises tend to be preceded by lending booms, or periods in which the volume of bank lending increases substantially. These lending booms have been associated with rising asset values, and in extreme cases, asset price bubbles. They have also been associated with declining risk premia and weakening lending standards. Financial crises have occurred when these booms have gone bust, a pattern which has held consistently from the nineteenth century to the present (Schularick and Taylor, 2012).

By contrast, the role of panics in financial crises has changed considerably over time. From the early 19th century through the mid-20th century, the United States led the world in the frequency with which it experienced banking panics. Some of those panics may not, in fact, have been associated with full-blown financial crises, which are defined by significant financial distress in the banking system, and a disruption of financial intermediation.  To be sure, panics occurred in the most significant financial crises, including the Great Depression, the Global Financial Crisis, and the crises of 1873, 1893, and 1907. Yet panics also developed in 1884, 1890 and 1914, and those events may have been brought under control before significant damage was done to the banking system.

Outside the U.S., panics were far less common, which suggests that the unique structure of the American banking system contributed to its vulnerability to panics. The banking system in the U.S. was populated by tens of thousands of relatively small banks, and, prior to 1914, no central bank. In the U.K., in the years following the Overend & Gurney panic in 1866, the aggressive actions of the Bank of England helped prevent the outbreak of panics. The banking system of Canada, which lacked a central bank until 1936, was dominated by a relatively small number of large banks with extensive branch networks, which were more robust and better able to coordinate in response to shocks.  Even before the introduction of deposit insurance, those countries experienced financial crises without panics.

The distinction between panics and crises is also important for understanding the economic consequences of financial crises (Baron et al., 2021).  There are many distinct channels through which financial crises may impact economic activity.  Some of these relate directly or indirectly to panics. The outbreak of a panic induces a scramble for liquidity, leading banks to withdraw their deposits from other banks to raise cash, and to liquidate assets, sometimes at fire sale prices. This transmits the shock to banks not initially impacted by the panic, as they experience declines in the values of their assets, while also facing the loss of the deposits of other banks. In this environment, banks will shift their balance sheets away from loans and toward safe securities, excluding riskier borrowers from access to credit. Banks may also be reluctant to lend if they fear that borrowers’ prospects are worsening, or that other banks will restrict their own lending, which would indirectly harm their borrowers (Bebchuk and Goldstein, 2011). An extensive literature effects of these mechanisms in the context of the Great Depression (see Bernanake, 2025).

Yet crises can disrupt financial intermediation even in the absence of a panic, through their effects on bank balance sheets.  When lending booms go bust, banks suffer losses on loans or other investments, which reduces their capital and impairs their ability to lend. This mechanism seems likely to have been important in the Japanese financial crisis of the 1990s, in which financial institutions suffered very significant losses on loans made in the ‘bubble economy’ of 1980s Japan. Deposit insurance protected Japanese banks from panics, but the banking system nonetheless suffered substantial damage.  Also consistent with the importance of this channel, Correia et al. (2024) found that most failed banks in the U.S. since the 1870s were fundamentally insolvent, which implies that it is unlikely that panic-driven liquidity pressures were responsible for their failures.

The impact of the financial crisis of 2008 was likely driven in part by panics, and in part by balance-sheet effects. Panics within the shadow banking system caused some credit markets to freeze up, and negatively impacted financial institutions that financed their operations through the issuance of uninsured short-term liabilities. Yet the decline in the values of mortgage-backed securities contracted the balance sheets of many different types of financial intermediaries, impairing their ability to lend.  Controlling the damage from financial crises means not only bringing panics under control, but also finding ways to ensure that balance sheet impairments of lenders do not cause credit markets to dry up.