When an economy or a particular segment of the economy collapses quickly and unexpectedly, this is often termed a financial meltdown. To be termed a meltdown, the collapse must be sufficiently severe that the wider economy suffers. The credit crisis of 2008 could be correctly termed a meltdown, as could the stock market collapse of 1928. However, application of the term is to some extend subject.
Definition
The term "meltdown" is drawn from the actions of an unregulated nuclear power plant. If the reactor to a power plant is not cooled then reaction of the nuclear material will continue unchecked until the reactor has reached extremely high temperatures. At this point, the reactor will cease working and melt-down --literally melt itself. In an financial context, this can apply to a market that overheats until it destroys itself.
Causes
Financial meltdowns can be caused by a number of things. In all cases, however, a particular segment of the economy will be extremely overvalued by investors. At some point, this overvaluation will be unsustainable and the market will collapse. This differs from a bubble in that prices not only drop precipitously, but trading in that segment of the market comes to a near halt, making valuation of the assets difficult.
Short-term Effects
The short-term effects of a financial meltdown are the inability to trade in that area of the market. During the credit crisis of 2008, certain kinds of financial instruments, including several varieties of mortgage-backed securities, were essentially untradable. This led to instability in other areas of the economy as certain companies that were invested heavily in these areas became a worry point for investors and lost much of their value.
Long-term Effects
The long-term effects of a financial meltdown can be serious if not remedied. While the United States was able to recover from many of the effects of the credit crisis of 2008 -- value returned to the stock market and mortgage backed securities resumed trading -- in other cases, an economy may not recover. Meltdowns can trigger financial tailspins in which a lack of trading activity and confidence can send the economy into a depression that lasts years.
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