Growth in economic value slows down drastically sometimes. The immediate cause for this disruption is a drop in investment/ money-lending due to varied reasons.
1929: great depression
Importance
A transformative event in world (especially US) history: disagreement about the goodness of new deal set lasted throughout the following century as rivalry between Democrats and Republicans in politics.
Boom + bubbles
In the 1920’s, there was over-investment and under-consumption - there was a boom and a bubble. The bubble burst.
Bust, credit crisis
There was over-indebtedness. Some banks crashed. Depositors withdrew money from other banks. So, remaining banks became reluctant to lend money. On Oct 29 1929, Stock market crashed.
Deflationary cycle
In response to rising unemployment and falling income, businesses - in order to sell goods - had to reduce prices. The reduced prices led to further decrease in wages; which in turn led to reduced prices and reduced profits, which in-turn fed the credit crisis. Thus vicious cycles were formed
Commodity prices, especially food (and therefore farmland) fell; and farmers got much poorer. Disparity in wealth between the rich and the poor had grown.
Hoarding savings
Some banks refused to accept new deposits, because they were unable to find satisfactory investments. So, people, for psychological reason, wanted to convert their currency to gold instead - which was possible because the currency was exchangeable for gold on surrender to the government.
Wrong fixes
To discourage hoarding of savings in the form of gold and to encourage investments, the inexperienced Fed tightened credit - this raised interest rates both for savings accounts and for loans - even though the opposite was required to encourage banks to lend money. Thus, the status quo continued.
International trade broke down: tariffs were increased in order to protect the profitability of local industry.
Ditching gold standard
UK, USA ditched the gold-standard - to discourage gold hoarding and perhaps because of the inadequacy of the gold reserve. This allowed currency to be printed to encourage banks to lend. Also, as a way of injecting money into the economy, the government started buying back gold at higher prices with newly printed money.
This was critical. Countries which ditched the gold standard later got out of the depression later.
New deal 1
FD Roosevelt took over from Hoover, promised vigorous experimentation to find some way out. He kept citizens informed through a radio show, stopped prohibition of liquor and was popular.
Farmers were paid not to grow crops - to raise food prices. Working hours and conditions favorable to workers was encouraged: growth which was favorable for the rich was slowed down. The huge unemployed population was employed by the government to build infrastructure. Banks, with government aid, were set to operate soundly; and small deposits were guaranteed by the government .
2008: sub-prime mortgages
Bad credit
At the most basic level, a lot of bad loans were made to consumers: not just in buying homes, but also in general.
Eager investors
In 2000, US federal bank indicated that government bonds will continue to offer low interest rates - at 1%; so investors managing global savings - which had recently grown due to rapid economic growth - eager to get profit despite risk sought investment avenues.
Bad mortgage-backed securities
At this time, people in the US financial industry invented mortgage-backed securities, by which investors could buy a share of ownership in loans. There was so much supply of investor money and such short supply of worthy investments, that people started making bad loans to people incapable of paying back in order to sell shares in these loans and make profit in the short term. Borrowers lied about their incomes - often encouraged to do so by lenders. Housing prices were also increasing, emboldening lenders into thinking that foreclosure would be a way to remain profitable even if borrowers defaulted.
Credit default swaps
Investors buying risky mortgage-backed securities got insurance/ bet that these securities will fail; and this insurance business was neither public nor regulated. So, insurers such as AIG failed.
Consequences
In 2007, people started defaulting, real estate prices fell. Investors lost much money.
Bank collapse
Banks (especially investment banks who created and held on to mortgage-backed securities) which invested in bad mortgages were insolvent (or solvent only in paper because they refused to liquidate their toxic assets at current market value).
Credit crisis
Money market mutual funds, which gave out short term loans to businesses (commercial paper market) partially suffered because of loans to those who invested in mortgage-backed securities, and such short term lending froze due to a panic. Investors who managed the global savings pool became very risk-averse.
So, this led to a big slow-down in investment as both types of investors were not willing to lend money -either to regain solvency in case of banks or due to risk aversion. This credit-crisis hit countries like Iceland, which were now unable to low-interest loans.
Effect on industry
Shrinking markets caused industries such as GM to fail.
Effect on consumers
Consumers lost jobs, owed huge debt, felt poorer and reduced spending.
Profit
Some mutual funds (like Magnetar) profited from this crisis because they understood, encouraged and bet against risky securities using credit default swaps.
Employees of investment banks who created the heavily traded risky
mortgage-backed securities and ignored their fiduciary duty towards the investor got rich from bonuses earned from fees received by the bank.
Mitigation
Central banks created a lot of new money in a huge effort to encourage investment/ lending and thus growth; and to finance efforts to rescue failing businesses.
Banks and industries were rescued - Eg: by US government subsidizing people who bought toxic assets from banks at slightly higher prices.
Devaluation
Commodity prices (esp: oil price) increased.