Background of Financial Crisis of 2007–2009

This article is about the series of financial market events, starting in July 2007, which were the proximate cause of a weakening of the global economy. For details on the stock market crashes and bank bailouts of late 2008, see Global financial crisis of 2008–2009. For economic issues beyond the financial markets, see Late 2000s recession. For discussions of major aspects of the policy response to the crisis, see The Keynesian Resurgence of 2008 / 2009 and 2009 G-20 London summit.

The previous major financial crisis occurred in 1928 to 1933. A financial crisis occurs when there is a disorderly contraction in money supply and wealth in an economy. It is also known as a credit crunch. It occurs when participants in an economy lose confidence in having loans repaid by debtors. This causes lenders to limit further loans as well as recall existing loans.
The financial/banking system relies on credit creation as a result of debtors spending the money which in turn is 'banked' and loaned to other debtors. As a result a relative small contraction in lending can lead to a dramatic contraction in money supply. The Great Depression occurred after a dramatic expansion in debt and money supply in the roaring twenties. Total US private credit market debt as a percentage of GDP reached 250% in 1929. The next time debt exceeded this level in the USA was in 1999 reaching a peak of 350% prior to the bubble bursting.

A dramatic contraction then occurred between 1929 and 1933 as debt was defaulted upon and resulted in a 'contraction' in money and wealth. The debt deflation theory coined by Irving Fisher formed the basis of the regulation subsequently introduced by Congress.

The Glass-Steagall Act was passed by Congress in order to prevent this occurring again. It was found that financial firms encouraged debt to be invested in the stockmarket which then overheated the stockmarket. The act was designed to prevent this by separating the advising from the lending role of financial institutions. Following its repeal by Congress in 1999, institutions could advise and lend setting up a direct conflict of interest in many 'deals'.
The framework which created the great depression from a regulatory point of view were 're-created' by the repeal of this act. Financial firms could profit in the short term by simply setting up and lending on deals using others money.
A sequence of rapid debt expansion occurred including a dot-com bubble, which was followed by an equity and housing bubble and then a commodity bubble. Without the debt expansion which measured $14 Trillion USD some analysts have argued that there would have been no economic growth in the USA between 1996 and 2006.

The Global financial crisis is the unwinding of the debt bubbles between 2007-2009.