Effects of Financial Panics on Economy - Essay Example

The statement by Bernanke talks about financial crisis in the market and the prospective causes (Bernanke 1). The statement prospects that the financial crisis resulted from significant losses from residential mortgage loans given to subprime borrowers. The potential for losses are large especially with outstanding funds in the subprime mortgages (Bernanke 2). However, apart from mortgage loans, lack of government’s crisis-response plans can result to severe financial crises, which adversely affect the broader economy. When banks run short of funds, depositors in the bank, and lenders in the commercial market, place the highest value on safety and liquidity (Bernanke, 2). According to Gary Gorton, when banks find funding costly and difficult, investors pull back funding and affect the country’s economy. For example, a medium-sized German bank announced to receive extraordinary support from the government and German banks association to meet its obligations. This resulted from inability of its Rhineland off-balance sheet to roll over the asset-backed commercial paper it issued in U.S market to fund its asset-backed securities (Bernanke 2). Commercial paper investors became concerned about the bank’s ability to meet its obligation and withdrew their investments. The financial panics the investors experience makes them withdraw their investments from the bank, affecting the economy. Shortfalls in the private sector amplify effects of financial panics on the economy. Bernanke’s