thesis on economic crisis

• Macroeconomics

Economic Crisis

• January 2015
• In book: Wiley Encyclopedia of Management, Volume 6. International Management

• St. John's University

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Article Contents

1. introduction, 2. key structural flaws of the new financial architecture, 3. conclusion.

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Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’

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James Crotty, Structural causes of the global financial crisis: a critical assessment of the ‘new financial architecture’, Cambridge Journal of Economics , Volume 33, Issue 4, July 2009, Pages 563–580, https://doi.org/10.1093/cje/bep023

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We are in the midst of the worst financial crisis since the Great Depression. This crisis is the latest phase of the evolution of financial markets under the radical financial deregulation process that began in the late 1970s. This evolution has taken the form of cycles in which deregulation accompanied by rapid financial innovation stimulates powerful financial booms that end in crises. Governments respond to crises with bailouts that allow new expansions to begin. As a result, financial markets have become ever larger and financial crises have become more threatening to society, which forces governments to enact ever larger bailouts. This process culminated in the current global financial crisis, which is so deeply rooted that even unprecedented interventions by affected governments have, thus far, failed to contain it. In this paper we analyse the structural flaws in the financial system that helped bring on the current crisis and discuss prospects for financial reform.

In the aftermath of the financial collapse in the USA that began in 1929, it was almost universally believed that unregulated financial markets are inherently unstable, subject to fraud and manipulation by insiders, and capable of triggering deep economic crises and political and social unrest. To protect the country from these dangers, in the mid 1930s the US government created a strict financial regulatory system that worked effectively through the 1960s. These economic and political events found reflection in the financial market theories of endogenous financial instability created by John Maynard Keynes and Hyman Minsky. Their theories generated a policy perspective supportive of the sharp shift from light to tight financial market regulation that took place after the Great Crash. Economic and financial turbulence in the 1970s and early 1980s led to both a paradigm and a policy regime shift. Efficient financial market theory and new classical macro theory replaced the theoretical visions of Keynes and Minsky, and the existing system of tight financial regulation was deconstructed through radical deregulation pushed by financial institutions and justified by efficient financial market theory. These developments facilitated the transition to a new globally-integrated deregulated neoliberal capitalism. 1

The main thesis of this paper is that, although problems in the US subprime mortgage market triggered the current financial crisis, its deep cause on the financial side is to be found in the flawed institutions and practices of the current financial regime, often referred to as the New Financial Architecture (NFA). (While the global crisis clearly has both financial- and real-sector roots, this paper deals primarily with the former.) ‘New Financial Architecture’ refers to the integration of modern day financial markets with the era's light government regulation. After 1980, accelerated deregulation accompanied by rapid financial innovation stimulated powerful financial booms that always ended in crises. Governments responded with bailouts that allowed new expansions to begin. These in turn ended in crises, which triggered new bailouts. Over time, financial markets grew ever larger relative to the nonfinancial economy, important financial products became more complex, opaque and illiquid, and system-wide leverage exploded. As a result, financial crises became more threatening. This process culminated in the current crisis, which is so severe that it has pushed the global economy to the brink of depression. Fear of financial and economic collapse has induced unprecedented government rescue efforts that have been, to date, unable to end the crisis. In the next section of the paper we present a description of key structural flaws in the financial institutions and practices of the neoliberal era that helped generate the current crisis. This section is taken from a much more detailed analysis of these structural flaws (see Crotty, 2008 ).

2.1 The NFA is built on a very weak theoretical foundation

The NFA is based on light regulation of commercial banks, even lighter regulation of investment banks and little, if any, regulation of the ‘shadow banking system’—hedge and private equity funds and bank-created Special Investment Vehicles (SIVs). Support for lax regulation was reinforced by the central claim of neoclassical financial economics that capital markets price securities correctly with respect to expected risk and return. Buyers and sellers of financial securities were, it was argued, able to make optimal decisions that led to risk being held only by those capable of managing it. The celebratory narrative associated with the NFA states that relatively free financial markets minimise the possibility of financial crises and the need for government bailouts (see Volcker, 2008, for a summary of this narrative). Crotty (2008) explains that this theoretical cornerstone of the NFA is based on patently unrealistic assumptions and has no convincing empirical support. Thus, the ‘scientific’ foundation of the NFA is shockingly weak and its celebratory narrative is a fairy tale.

2.2 The NFA has widespread perverse incentives that create excessive risk, exacerbate booms and generate crises

The current financial system is riddled with perverse incentives that induce key personnel in virtually all important financial institutions—including commercial and investment banks, hedge and private equity funds, insurance companies and mutual and pension funds—to take excessive risk when financial markets are buoyant. 2 For example, the growth of mortgage securitisation generated fee income—to banks and mortgage brokers who sold the loans, investment bankers who packaged the loans into securities, banks and specialist institutions who serviced the securities and ratings agencies who gave them their seal of approval. Since fees do not have to be returned if the securities later suffer large losses, everyone involved had strong incentives to maximise the flow of loans through the system whether or not they were sound. Total fees from home sales and mortgage securitisation from 2003 to 2008 have been estimated at $2 trillion ( Financial Times , 2008C ).

Top investment bank traders and executives receive giant bonuses in years in which risk-taking generates high revenue and profits. Of course, profits and bonuses are maximised in the boom by maximising leverage, which in turn maximises risk. In 2006, Goldman Sachs’ bonus pool totaled $16 billion—an average bonus of $650,000 very unequally distributed across Goldman's 25,000 employees. Wall Street's top traders received bonuses of up to $50 million that year. In spite of the investment bank disasters of the second half of 2007, which saw Wall Street investment banks lose over $11 billion, the average bonus fell only 4.7%. In 2008 losses skyrocketed causing the five largest independent investment banks to lose their independence: two failed, one was taken over by a conglomerate, and two became bank holding companies to qualify them for bailout money. Yet Wall Street bonuses were over $18 billion—about what they were in the boom year of 2004 ( DiNapoli, 2009 ). Bonuses at Goldman are expected to average $570,000 in 2009 in the midst of the crisis ( New York Times , 2009F).

About 700 employees of Merrill Lynch received bonuses in excess of $1 million in 2008 from a total bonus pool of $3.6 billion, in spite of the fact that the firm lost $27 billion. The top four recipients alone received a total of $121 million while the top 14 got $249 million ( Wall Street Journal , 2009A ). Losses reported by Merrill totaled $35.8 billion in 2007 and 2008, enough to wipe out 11 years of earnings previously reported by the company. Yet for the 11-year period from 1997 to 2008, Merrill's board gave its chief executives alone more than $240 million in performance-based compensation ( New York Times , 2009A ).

One of the most egregious examples of perverse incentives can be found in insurance giant AIG's Financial Products unit. This division, which gambled on credit default swaps (CDSs), contributed substantially to AIG's rising profits in the boom. In 2008 the unit lost $40.5 billion. Though the US government owns 80% of AIG's shares and invested $180 billion in the corporation, AIG nevertheless paid the 377 members of the division a total of $220 million in bonuses for 2008, an average of over $500,000 per employee. Seven employees received more than $3 million each ( Wall Street Journal , 2009C ).

These examples show that it is rational for top financial firm operatives to take excessive risk in the bubble even if they understand that their decisions are likely to cause a crash in the intermediate future. Since they do not have to return their bubble-year bonuses when the inevitable crisis occurs and since they continue to receive substantial bonuses even in the crisis, they have a powerful incentive to pursue high-risk, high-leverage strategies.

Credit rating agencies were also infected by perverse incentives. Under Basle I rules, banks were required to hold 8% of core or tier-one capital against their total risk-weighted assets. Since ratings agencies determined the risk weights on many assets, they strongly influenced bank capital requirements. Under Basle II rules banks only needed a modest sliver of capital to support triple-A securities. High ratings thus meant less required capital, higher leverage, higher profit and higher bonuses. Moreover, important financial institutions are not permitted to hold assets with less than an AAA rating from one of the major rating companies. There was thus a strong demand for high ratings. Ratings agencies are paid by the investment banks whose products they rate. Their profits therefore depend on whether they keep these banks happy. In 2005, more than 40% of Moody's revenue came from rating securitised debt such as mortgage backed securities (MBSs) and collateralised debt obligations (CDOs). If one agency gave realistic assessments of the high risk associated with these securities while others did not, that firm would see its profit plummet. Thus, it made sense for investment banks to shop their securities around, looking for the agency that would give them the highest ratings, and it made sense for agencies to provide excessively optimistic ratings. 3 The recent global financial boom and crisis might not have occurred if perverse incentives had not induced credit rating agencies to give absurdly high ratings to illiquid, non-transparent, structured financial products such as MBSs, CDOs and collateralized loan obligations. 4

Reregulation of financial markets will not be effective unless it substantially reduces the perverse incentives that pervade the system.

2.3 Innovation created important financial products so complex and opaque they could not be priced correctly; they therefore lost liquidity when the boom ended

Financial innovation has proceeded to the point where important structured financial products are so complex that they are inherently non-transparent. They cannot be priced correctly, are not sold on markets and are illiquid. According to the Securities Industry and Financial Markets Association (SIFMA), there was $7.4 trillion worth of MBSs outstanding in the first quarter of 2008, more than double the amount outstanding in 2001. Over $500 billion dollars in CDOs were issued in both 2006 and 2007, up from $157 billion as recently as 2004 (SIFMA website). The explosion of these securities created large profits at giant financial institutions, but also destroyed the transparency necessary for any semblance of market efficiency. Indeed, the value of securities not sold on markets may exceed the value of securities that are. Eighty percent of the world's $680 trillion worth of derivatives are sold over-the-counter in private deals negotiated between an investment bank and one or more customers. Thus, the claim that competitive capital markets price risk optimally, which is the foundation of the NFA, does not apply even in principle to these securities.

Even with a mathematical approach to handling correlation, the complexity of calculating the expected default payment, which is what is needed to arrive at a CDO price, grows exponentially with an increasing number of reference assets [the original mortgages]… . As it turns out, it is hard to derive a generalized model or formula that handles this complex calculation while still being practical to use. ( Chacko et al. , 2006 , p. 226)

The relation between the value of a CDO and the value of its mortgages is complex and nonlinear. Significant changes in the value of underlying mortgages induce large and unpredictable movements in CDO values. Ratings agencies and the investment banks that create these securities rely on extremely complicated simulation models to price them. It can take a powerful computer several days to determine the price of a CDO. These models are unreliable and easily manipulated statistical black boxes. Given perverse incentives, it is not surprising that market insiders refer to the process through which CDOs are marked or priced as marking to ‘magic’ or to ‘myth’. New York University's Nouriel Roubini observed that CDOs ‘were new, exotic, complex, illiquid, marked-to-model rather than marked-to-market and misrated by the rating agencies. Who could then ever be able to correctly price or value a CDO cubed?’ ( Roubini, 2008 ).

Demand for CDOs was strong in the boom because buyers could borrow money cheaply, returns were high and the products carried top ratings. But when the housing boom ended and defaults increased, the fact that no one knew what these securities were worth caused demand and liquidity to evaporate and prices to plummet. The celebratory narrative of the NFA had assured investors this could not happen. Efficient market theory asserts that liquidity will always be available to support security prices. Charles Goodhart, former member of the Bank of England's Monetary Policy Committee, noted that the theory assured investors ‘that you can always obtain funding to hold assets … and that the … short-term wholesale market, the interbank markets, the asset-backed commercial paper market and so on, would always be open and you would always have access to them’ ( Goodhart, 2009 ). Yet when the crisis hit, CDOs could be sold, if at all, only at an enormous loss. It is estimated that by February 2009, almost half of all the CDOs ever issued had defaulted ( Financial Times , 2009B ). Defaults led to a 32% drop in the value of triple A rated CDOs composed of super-safe senior tranches and a 95% loss on triple A rated CDOs composed of mezzanine tranches ( Financial Times , 2007A ).

Innovation became so intense that it outran the comprehension of most ordinary bankers—not to mention regulators. As a result, not only is the financial system plagued with losses on a scale that nobody foresaw, but the pillars of faith on which this new financial capitalism were built have all but collapsed. ( Tett, 2009 )

2.4 The claim that commercial banks distributed almost all risky assets to capital markets and hedged whatever risk remained was false

The conventional view was that banks were not risky because, in contrast to the previous era when they held the loans they made, they now sold their loans to capital markets through securitisation in the new ‘originate and distribute’ banking model. Moreover, it was believed that banks hedged whatever risk remained through CDSs. Both these propositions turned out to be false. Banks kept risky products such as MBSs and CDOs for five reasons, none of which were considered in the NFA narrative about efficient capital markets.

First, to reduce moral hazard and convince potential investors that these securities were safe, banks often had to retain the riskiest part—the so-called ‘toxic waste’.

Second, CDOs were especially attractive assets for banks to keep since they could be held off-balance-sheet with no capital reserve requirements , a development discussed below.

Third, the rate of flow of these securities through banks was so great and the time lapse between a bank's receipt of a mortgage and the sale of the MBS or CDO of which it was a part was sufficiently long that at every point in time banks held or ‘warehoused’ substantial quantities of these securities. When demand for MBSs and CDOs collapsed, banks were left holding huge amounts of mortgages and mortgage-backed products they could not sell. Global CDO issuance fell from $177 billion in the first quarter of 2007 to less than $20 billion one year later, a drop of 84%. The collapse in the price of these products is the main source of the massive bank losses that are the driving force of the crisis.

Merrill Lynch was one of the two largest underwriters of CDOs in the 3 years leading up to the crisis. While Merrill Lynch had only $3.4 billion in CDO origination in 2003, in 2006 it posted $44 billion in CDO deals. Merrill's rainmakers became addicted to the fees that flowed from financing CDOs, which reached $700 million in 2006.

Merrill apparently made a pivotal—and reckless—decision. It bought big swaths of the AAA paper itself, loading the debt onto its own books… . The amounts were staggering. By the end of June, Merrill held $41 billion in subprime CDOs and subprime mortgage bonds. Since the average deal is between $1 billion and $1.5 billion, and the AAA debt is around 80% of each deal, Merrill must have been buying nearly all the top-rated debt from dozens of CDOs… . Merrill's $41 billion exposure to subprime paper was more than its entire shareholders’ equity of $38 billion. That this huge position went unhedged astonishes everyone on Wall Street… ( Fortune Magazine , 2007 , emphasis added). 5

Fourth, when banks found the safest or ‘super senior’ tranches of mortgage backed securities hard to sell because their yield was relatively low, they kept them themselves so that they could sustain the high rate of CDO sales that kept bonuses rising. In a comment about this practice that reflects both the power of perverse incentives and the destructive dimensions of financial market competition, Citigroup CEO Charles Prince said in July 2007: ‘When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing’ ( Financial Times , 2007C ).

Fifth, given banks’ incentive to generate high profits and bonuses through high risk, they purposely kept some of the riskiest products they created.

In 2007, the Bank of England called attention to the fact that large global banks were not slimming down as the ‘originate-and-distribute model’ predicted they would. Rather, on-balance-sheet assets had exploded from $10 trillion in 2000 to $23 trillion in 2006. The main cause of this asset growth was the incredible rise in bank holdings of MBSs and CDOs, the kinds of securities that banks were supposed to sell rather than hold in the narrative of the NFA. In April 2009, the International Monetary Fund (IMF) estimated potential losses in 2007–2010 from US-originated credit assets held by banks and others at $2.7 trillion ( IMF, 2009 , p. 27). Richardson and Roubini ‘suggest that total losses on loans made by U.S. banks and the fall in the market value of the assets they are holding will reach about $3.6 trillion. The U.S. banking sector is exposed to half that figure, or $1.8 trillion’ ( Richardson and Roubini, 2009 ).

Claims that banks hedged most risk through CDSs were equally shaky. Credit default swaps are derivatives that allow one party to insure against loss from loan defaults by paying insurance fees to another party. However, since the value of credit default swaps hit $62 trillion in December 2007, while the maximum value of debt that might conceivably be insured through these derivatives was $5 trillion, it was evident that massive speculation by banks and others was taking place. Fitch Ratings reported that 58% of banks that buy and sell credit derivatives acknowledged that ‘trading’ or gambling is their ‘dominant’ motivation for operating in this market, whereas less than 30% said that ‘hedging/credit risk management’ was their primary motive. This ‘confirms the transition of credit derivatives from a hedging vehicle to primarily another trading asset class’ ( FitchRatings , 2007 , p. 9). Eric Dinallo, the insurance superintendent for New York State, said that 80% of the estimated $62 trillion in CDSs outstanding in 2008 were speculative ( New York Times , 2009D ).

By 2007 the CDS market had turned into a gambling casino that eventually helped destroy insurance giant AIG and investment banks Bear Stearns and Lehman Brothers. As of February 2009 AIG alone had suffered losses of over $60 billion on CDS contracts ( Haldane, 2009 , p. 14.) No regulator objected when AIG guaranteed $440 billion worth of shaky securities with no capital set aside to protect against loss apparently because both the securities and AIG were triple A rated. The bonus-drenched ‘geniuses at A.I.G. who wrote the insurance were willing to bet more than double their company's value that defaults would not become problematic’ ( New York Times , 2009C ). A major reason that the government invested $180 billion to save AIG was to provide protection against losses that large US and foreign institutions would have incurred from their contracts with AIG had the company folded. Goldman Sachs received $12.9 billion and Merrill Lynch $7 billion, while 20 European banks received a total of $59 billion of US taxpayer money ( New York Times , 2009E ). This reflects moral hazard of the highest order. Firms like Goldman could gamble with confidence on risky CDOs only because they bought insurance from risk-laden AIG, who they knew was drastically under-capitalised. When they lost their bet on AIG, the public was forced to pay the bill because former Goldman Chief Executive Henry Paulson, acting in his capacity as Secretary of the Treasury, decided to rescue AIG even though he had previously let Lehman Brothers default (Paulson had to have known that Goldman would receive billions of dollars as the result of his decision). Though CDO prices had plunged, the government inexplicably paid banks their full face value. The regulators thus allowed the dominant financial firms and their top bonus recipients to engage in publicly subsidised win–win gambles.

Securitisation and the rise of CDSs did raise big-bank profits for many years, but they eventually created huge losses that more than wiped out the cumulative gains made over the long boom. As early as December 2007, Citigroup had ‘lost more money than it made from financial instruments based on U.S. subprime mortgages…’ ( Bloomberg , 2007 ).

2.5 Regulators allowed banks to hold assets off balance sheet with no capital required to support them

In the late 1990s, banks were allowed to hold risky securities off their balance sheets in SIVs with no capital required to support them. The regulatory system thus induced banks to move as much of their assets off-balance-sheet as possible. When the demand for risky financial products cooled off in mid 2007, bank-created off-balance-sheet SIVs became the buyer of last resort for the ocean of new MBSs and CDOs emanating from investment banks. At the end of 2007, J.P. Morgan Chase & Co. and Citigroup each had nearly $1 trillion in assets held off their books in special securitisation vehicles. For Citigroup this represented about half the bank's overall assets. ( Wall Street Journal , 2008 ). 7

SIVs were supposed to be stand-alone institutions that paid service fees to the originating banks, but to which the originating banks had no obligations or commitments. They borrowed short-term in the commercial paper market and used this money to buy long-term, illiquid but highly profitable securities such as CDOs—a very dangerous game. To enable this commercial paper to receive AAA ratings and thus low interest rates, originating banks had to provide their SIVs with guaranteed lines of credit. This made the banks vulnerable to problems experienced by their supposedly independent SIVs.

When problems in the housing market triggered a wave of subprime defaults, the value of MBSs and CDOs collapsed. This triggered a mass exodus from the asset-backed commercial paper market. US asset-backed commercial paper outstanding fell from $1.2 trillion in July 2007 to $840 billion by the year's end. With the disappearance of their major source of funding, banks were forced to move these damaged assets to their balance sheets. In late July 2008 analysts at Citigroup forecast that up to $5 trillion worth of assets might be forced back on to bank balance sheets ( Financial Times , 2008B ). Contrary to the assumed transparency of financial markets, until SIVs began to collapse very few experienced financial market professionals knew they existed. ‘“In spite of more than 30 years in the business, I was unaware of the extent of banks’ off-balance-sheet vehicles such as SIVs” Anthony Bolton, president of investments at Fidelity International, recently observed’ ( Tett, 2009 ).

The combination of bank write downs on assets held on-balance-sheet combined with devalued SIV assets that had to be moved back onto balance sheets severely eroded bank capital. This in turn forced banks to try to lower their risk by raising interest rates and cutting loans to other financial institutions and to households and nonfinancial businesses.

2.6 Regulators allowed giant banks to measure their own risk and set their own capital requirements. Given perverse incentives, this inevitably led to excessive risk-taking

Deregulation allowed financial conglomerates to become so large and complex that neither insiders nor outsiders could accurately evaluate their risk. The Bank for International Settlement told national regulators to allow banks to evaluate their own risk—and thus set their own capital requirements—through a statistical exercise based on historical data called Value at Risk (VAR). Government officials thus ceded to banks, as they had to ratings agencies, crucial aspects of regulatory power. VAR is an estimate of the highest possible loss in the value of a portfolio of securities over a fixed time interval with a specific statistical confidence level. The standard exercise calculates VAR under negative conditions likely to occur less than 5% of the time.

There are four fundamental flaws in this mode of risk assessment. First, there is no time period in which historical data can be used to generate a reliable estimate of current risk. If firms use data from the past year or less, as is standard practice, then during boom periods such as 2003 to mid 2007 VAR exercises will show that risk is minimal because defaults and capital losses on securities are low. Banks thus need to set aside only a small amount of capital against estimated risk, which allows them to aggressively expand leverage, which in turn accelerates security price increases. The chairman of the UK's Financial Services Authority said that VAR ‘fails to allow for the fact that historically low volatility may actually be an indication of irrationally low risk-aversion and therefore increased systemic risk’ ( Financial Time s, 2009A ). On the other hand, if data from past decades are used, the existence of past crises will raise estimated risk, but financial markets will have undergone such fundamental change that these estimates will bear no relation whatever to current risk.

Second, VAR models assume that security prices are generated by a normal distribution. In a normal distribution the likelihood that an observation many standard deviations beyond a 95% or even a 99% confidence interval will occur is infinitesimal. In fact, security prices follow a distribution in which the preponderance of observations are ‘normal’, but every five to ten years observations occur that are so far from the mean that they are virtually incompatible with the assumption of a normal distribution. Examples of this well-known ‘fat tail’ phenomenon include the precipitous drop in stock prices that took place in August 1987, the global crisis brought on by the collapse of the giant hedge fund Long Term Capital Management, the Asian crisis and the recent global stock market and CDO crash. In August 2007, two large hedge funds managed by Goldman Sachs collapsed, forcing Goldman to inject $3 billion into the funds. To explain why Goldman should not be held responsible for their collapse, chief financial officer David Viniar said ‘We were seeing things that were 25 standard deviation moves, several days in a row’ ( Financial Times , 2007B , p. 25). The Director for Financial Stability of the Bank of England noted that, under a normal distribution, ‘a 25-sigma event would be expected to occur once every 6×10 124 lives of the universe’ adding, tongue-in-cheek, that when he tried to calculate the probability of such an event occurring several days in a row, ‘the lights visibly dimmed over London’. Even a 7.3 standard deviation event should occur only once every 13 billion years ( Haldane, 2009 , p. 2). Allowing banks to estimate risk and set capital requirements on the assumption that large losses cannot happen left them vulnerable when the crisis erupted.

Third, the asset-price correlation matrix is a key determinant of measured VAR. The lower the correlation among security prices, the lower the portfolio's risk. VAR models assume that future asset price correlations will be similar to those of the recent past. However, in crises the historical correlation matrix loses all relation to actual asset price dynamics. Most prices fall together as investors run for liquidity and safety, and correlations invariably head toward one, as they did in the recent crisis. Again, actual risk is much higher than risk estimates from VAR exercises.

Fourth, the trillions of dollars in assets held off balance sheet were not included in VAR calculations ( Blankfein, 2009 ).

Reliance on VAR helped create the current crisis and left banks with woefully inadequate capital reserves when it broke out. A Financial Times editorial observed that ‘risk management models … were catastrophic’ ( Financial Times , 2008D ). The Financial Time ’s Gillian Tett concluded that ‘it was sheer madness for financiers ever to have relied so heavily on these VAR models during the first seven years of this decade’ ( Tett, 2008B ). VAR-determined capital requirement are just one of many possible examples of totally ineffective regulatory processes within the NFA. Financial markets were not just lightly regulated, such regulation as did exist was often ‘phantom’ regulation—ineffective by design.

The problems involved in risk management through VAR were apparent to everyone who understood even the outline of the procedure; you do not need specialist knowledge to spot them. I explained the problems associated with VAR in Crotty, 2007 , a paper written in 2006, well before the crisis developed. Yet only a few influential financial observers warned against the futility of standard risk management practices prior to the crisis because VAR-based risk assessment maximised bonuses. No one wanted to kill the goose that was laying golden eggs.

VAR was dangerous. It gave firms a false sense of complacency, because it ignored certain risks and relied heavily on past price movements. In some markets, VAR actually increased risk, because every trader assessed risk in the same flawed way. In other markets, traders [using different VAR models] calculated VAR measures that varied ‘by 14 times or more.’ … LTMC's VAR models had predicted that the fund's maximum daily loss would be in the tens of millions of dollars, and that it would not have collapsed in the lifetime of several billion universes. ( Partnoy, 2003 , p. 263)

2.7 Heavy reliance on complex financial products in a tightly integrated global financial system created channels of contagion that raised systemic risk

It was claimed that in the NFA, complex derivatives would allow the risk associated with securities to be divided into its component parts, such as interest rate and counter-party risk. Investors could buy only those risk segments they felt comfortable holding. And rather than concentrate in banks as in the ‘Golden Age’ financial system, it was argued, risk would be lightly sprinkled on agents all across the globe. Since markets price risk correctly, no one would be fooled into holding excessive risk, so systemic risk would be minimised. Then New York Fed Chairman, and current Secretary of the Treasury, Timothy Geithner stated in 2006: ‘In the financial system we have today, with less risk concentrated in banks, the probability of systemic financial crises may be lower than in traditional bank-centered financial systems’ ( Geithner, 2008 ). In 2006 the IMF proclaimed that the dispersion of credit risk ‘has helped to make the banking and overall financial system more resilient’ ( Tett, 2009 ).

There are major flaws in this argument. As Financial Times columnist Martin Wolf put it: ‘The proposition that sophisticated modern finance was able to transfer risk to those best able to manage it has failed. The paradigm is, instead, that risk has been transferred to those least able to understand it’ ( Wolf, 2009 ). First, and perhaps most important, it implicitly assumed that the NFA would not generate more total risk than the previous tightly-regulated bank-based regime, but only spread a given system-wide risk across more investors. However, the degree of system-wide risk associated with any financial regime is endogenous. The effect of regime change on systemic risk depends on the amount of real and financial risk it creates and the way it disperses that risk, factors strongly affected by the mode of regulation. The structure of the NFA inevitably created excessive risk.

Second, derivatives can be used to speculate as well as to hedge. In the boom, hedging via derivatives is relatively inexpensive, but financial institutions guided by perverse incentives do not want to accept the deductions from profit and the bonus pool that full hedging entails. ‘Why financial institutions don't hedge risk more adequately is no mystery. It … costs money and cuts into returns—and, of course, their fees’ ( Wall Street Journal , 2007A ). Conversely, after serious trouble hits financial markets, agents would like to hedge risk, but the cost becomes prohibitive. For example, to insure $10 million of Citigroup debt against default for 5 years through CDSs cost about $15,000 a year in May 2007, but $190,000 in February 2008. Moreover, a rise in the cost of hedging can occur quickly and unexpectedly. The cost of insuring Countrywide debt rose from $75,000 in early July 2007 to $230,000 one month later; it then jumped by $120,000 in just one day ( Wall Street Journal , 2007B ). By January 2008, the cost of insuring Countrywide's debt was $3 million up front and $500,000 annually.

Ironically, while the ability to hedge via derivatives can make an individual investor safer, it can simultaneously make the system riskier. For example, hedging often involves dynamic derivative trading strategies that rely on liquid continuous markets with low to moderate transactions costs. A typical dynamic hedge involves shorting the risky asset held and investing in a risk-free asset. The hedge adjusts whenever the asset price, interest rate or volatility changes, which they do continuously. Every time the asset price declines or volatility increases, the risky asset must be sold; this is what makes the hedge ‘dynamic’. When problems hit, price falls and volatility rises. Institutions with dynamic hedges must sell their risky assets, which accelerates the rate of price decrease, which in turn forces more hedged-asset sales. If many investors have made similar dynamic hedges and are selling, liquidity dries up and prices can free-fall.

Consider the role played by AIG in the exploding CDS market. Many institutions used CDSs to hedge against a loss in the value of their CDOs (one reason banks bought CDS protection is that it lowered their capital requirements). Insurers such as AIG piled up immense commitments to pay in the event of defaults or capital losses with little capital to back these commitments. When losses hit security markets AIG could not pay off its contracts; it became insolvent. 8 Had the government not put $180 billion into AIG, many large financial institutions around the world would have failed. Ultimately, CDSs made the system more fragile because they facilitated excessive risk-taking.

Third, the narrative insists that derivatives unbundle risk, dividing it into simpler segments. But in fact, sophisticated derivatives such as CDOs re-bundle risk in the most complicated and non-transparent ways: this is what financial engineering and structured derivative products do. 9 These derivatives also add substantial ‘embedded’ leverage to the underlying or primitive products to enhance investor profits. Das explains how layers of unseen leverage added to derivative products by investment bankers sold to Orange County California caused unforeseen catastrophic losses: ‘Greenspan had been right—risk had truly been unbundled. We had packaged it right back up and shoved it down the eager throats of the wealthy taxpayers of Orange County’ ( Das, 2006 , p. 50).

Fourth, the celebratory NFA narrative applauded globalisation of financial markets because it created channels of risk dispersion. But securitisation and funding via tightly integrated global capital markets simultaneously created channels of contagion in which a crisis that originated in one product in one location (US subprime mortgages) quickly spread to other products (US prime mortgages, MBSs, CDOs, home equity loans, loans to residential construction companies, credit cards, auto loans, monoline insurance and auction rate securities) and throughout the world. The complexity of the networks linking markets together created immense fragility in the system: ‘Complexity adds to the danger that any one part of the hyper-financial system can bring down the whole’ ( Financial Times , 2008A ).

New and complex instruments to transfer credit risks in combination with large banks engaging in an ‘originate and distribute’ business model have amplified the consequences of the undeniable excesses in the US mortgage market … In the end, the new instruments of credit risk-transfer distributed fear instead of risk. ( Weber, 2008 )

2.8 The NFA facilitated the growth of dangerously high system-wide leverage

As noted, structural flaws in the NFA created dangerous leverage throughout the financial system. Annual borrowing by US financial institutions as a percent of gross domestic product (GDP) jumped from 6.9% in 1997 to 12.8% a decade later.

From 1975 to 2003, the US Securities and Exchange Commission (SEC) limited investment bank leverage to 12 times capital. However, in 2004, under pressure from Goldman Sachs chairman and later Treasury Secretary Henry Paulson, it raised the acceptable leverage ratio to 40 times capital and made compliance voluntary ( Wall Street Watch , 2009 , p. 17). This allowed large investment banks to generate asset-to-equity ratios in the mid to upper 30s just before the crisis, with at least half of their borrowing in the form of overnight repos, money that could flee at the first hint of trouble. 10 With leverage rates this high, any serious fall in asset prices would trigger a dangerous deleveraging dynamic.

Commercial banks appeared to be adequately capitalised, but only because they over-estimated the value of on-balance-sheet assets while holding a high percentage of their most vulnerable assets hidden off-balance-sheet. In fact, they were excessively leveraged, as the crisis revealed. Many European banks had leverage ratios of 50 or more before the crisis ( Goodhart, 2009 ), while Citibank's and Bank of America's ratios were even higher ( Ferguson, 2008 ). By the end of 2008 many large banks had seen their equity position evaporate to the brink of insolvency and beyond. Only massive government bailouts kept these ‘zombie banks’ alive.

Rising leverage was facilitated in part by the easy money policies of the Fed. To avoid a deep financial crisis following the collapse of the late 1990s stock market and internet booms, the Fed began to cut short-term interest rates in late 2000 and continued to hold them at record lows through to mid-2004. Financial firms were thus able to borrow cheaply, which, under different circumstances, might have fueled a boom in productive capital investment. However, given perverse incentives in financial markets, the spectacular returns to financial risk-taking, and a sluggish real economy in which growth was sustained primarily through the impact of rising debt and financial wealth on aggregate demand, the additional funds were mostly used for speculative financial investment.

Increased leverage helped push the size of financial markets to unsustainable heights relative to the real economy. By 2007 the global financial system had become, to use Hyman Minsky's famous phrase, ‘financially fragile’. The term is usually applied to a cycle phase, but in this case the condition had become secular. Any serious deterioration in the cash flows required to sustain security prices could have triggered a dangerous de-leveraging process. Falling housing prices and rising mortgage defaults provided that trigger. By January 2009, housing prices had declined by almost 28% according to the Case–Shiller index and mortgage default rates rose steadily. Structured financial security price declines were stunning. One reason was that: ‘The leverage used to put [CDOs] together can amplify losses [in the downturn]. For example, a 4 percent loss in a mortgage backed security held by collateralized debt obligations can turn into almost a 40% loss to the holder of the CDO itself’ ( New York Times , 2007 ). New York Fed Chairman Timothy Geithner expressed concern about the destructive power of reverse leverage in May 2007: ‘As market participants move to protect themselves against further losses, by selling positions, requiring more margin, hedging against further declines, the shock is amplified and the brake becomes the accelerator’ ( Geithner, 2008 ).

The downward spiral was exacerbated by the role ratings agencies played in the regulatory system. Facing a wave of criticism for having led investors astray in the boom with overly optimistic ratings, agencies belatedly shifted assets to higher-risk categories in the crisis. A small rating downgrade can lead to a large increase in required capital; the relation is not linear. Banks therefore had to come up with more capital to support their assets. Banks were thus forced to sell assets into a collapsing market. Meanwhile, margin calls forced borrowers to sell securities. The de-leveraging process froze credit markets. Since modern nonfinancial business and household sectors run on credit, the shrinking availability and rising cost of borrowing led to a slowdown in economic growth that in turn worsened the global financial crisis. The NFA had finally brought the global economy to the edge of the abyss.

The past quarter century of deregulation and the globalisation of financial markets, combined with the rapid pace of financial innovation and the moral hazard caused by frequent government bailouts helped create conditions that led to this devastating financial crisis. The severity of the global financial crisis and the global economic recession that accompanied it demonstrate the utter bankruptcy of the deregulated global neoliberal financial system and the market fundamentalism it reflects. Many of its most influential supporters, including Alan Greenspan, have recanted. Senior Financial Times columnist Martin Wolf recently wrote: ‘The era of financial liberalisation has ended’ ( Wolf, 2009 ).

Several decades of deregulation and innovation grossly inflated the size of financial markets relative to the real economy. The value of all financial assets in the US grew from four times GDP in 1980 to ten times GDP in 2007. In 1981 household debt was 48% of GDP, while in 2007 it was 100%. Private sector debt was 123% of GDP in 1981 and 290% by late 2008. The financial sector has been in a leveraging frenzy: its debt rose from 22% of GDP in 1981 to 117% in late 2008. The share of corporate profits generated in the financial sector rose from 10% in the early 1980s to 40% in 2006, while its share of the stock market's value grew from 6% to 23%.

The scope and severity of the current crisis is a clear signal that the growth trajectory of financial markets in recent decades is unsustainable and must be reversed . It is not possible for the value of financial assets to remain so large relative to the real economy because the real economy cannot consistently generate the cash flows required to sustain such inflated financial claims. It is not economically efficient to have such large proportions of income and human and material resources captured by the financial sector. 11 Financial markets must be forced to shrink substantially relative to nonfinancial sectors, a process already initiated by the crisis, and the nontransparent, illiquid, complex securities that helped cause the financial collapse must be marginalised or banned.

Governments thus face a daunting challenge: they have to stop the financial collapse in the short run to prevent a global depression, while orchestrating a major overhaul and contraction of financial markets over the longer run . The US economy is especially vulnerable because growth over the past few decades has been driven largely by rising household spending on consumption and residential investment. Consumption as a percent of GDP was 63% in 1980, 67% in 1998 and 70% in 2008. Since real wages were stagnant and real family income growth was slow, rising household spending was increasingly driven by the combined effects of rising debt and the increase in household wealth created by stock market and housing booms. Household debt was 48% of GDP in 1985, about where it had been in 1965. But it grew to 66% by 1998, then accelerated to over 100% by late 2008.

This dynamic process has reversed direction in the crisis. The saving rate is rising rapidly as households repay debt and attempt to rebuild wealth to create a cushion against job and income loss. Meanwhile, wealth is evaporating. Stock and residential housing values in the US have dropped by more than a combined $15 trillion, a 24% decline from the 2007 peak of $64 trillion. 12 According to Robert Solow, as a result of these developments ‘we are looking at a potential drop in consumer spending of something like $650 billion a year’, which is far larger than the annual impact of President Obama's fiscal stimulus package ( Solow, 2009 ). Falling wealth along with deteriorating labour market conditions and declining business investment spending have caused aggregate demand to collapse. Governments have been wise to use public funds as a partial counterweight to the impact of falling private spending on aggregate demand. Indeed, more needs to be done in this regard. It was also sensible to use public money to slow the rate of financial collapse, though the US government in particular has been spectacularly inefficient in its financial intervention policies.

The financial-services industry is condemned to suffer a horrible contraction… . It is hard to believe that financial services create enough value to command such pre-eminence in the economy. ( The Economist , 2009 )

For such a transition to be effective, two difficult tasks must be accomplished. Efficient financial theory must be replaced as the guide to policy making by the more realistic theories associated with Keynes and Minsky, and domination of financial policy making by the Lords of Finance must end.

The design and implementation of the changes needed in financial markets is a political as much as an economic challenge. Unfortunately, most elected officials responsible for overseeing US financial markets have been strongly influenced by efficient market ideology and corrupted by campaign contributions and other emoluments lavished on them by financial corporations. Between 1998 and 2008, the financial sector spent $1.7 billion in federal election campaign contributions and $3.4 billion to lobby federal officials ( Wall Street Watch , 2009 , p. 17). Moreover, powerful appointed officials in the Treasury Department, the SEC, the Federal Reserve System and other agencies responsible for financial market oversight are often former employees of large financial institutions who return to their firms or lobby for them after their time in office ends. Their material interests are best served by letting financial corporations do as they please in a lightly regulated environment. We have, in the main, appointed foxes to guard our financial chickens.

Unfortunately, the people President Obama has selected to guide his administration's financial rescue and reregulation programmes are almost uniquely unqualified to accomplish the dual objectives of down-sizing financial markets and eliminating dangerous securities. Chief economic advisor Lawrence Summers is a former Treasury Secretary who in 1999 supported the repeal of the 1930s legislation that separated investment and commercial banking, thereby legalising the creation of giant financial conglomerates and dramatically increasing the share of the industry that was ‘too big to fail’. Uniting commercial bank deposit and loan operations with investment banks and hedge and private equity funds was dangerous, yet Summers applauded Congress for refusing to regulate ‘a system for the 21st century [that] will better enable American companies to compete in the new economy’ ( Labaton, 1999 ). When Congress considered regulating financial derivatives trading, including CDSs, Summers told Congress that consideration of such legislation ‘cast a shadow of regulatory uncertainty over an otherwise thriving market’ ( Wall Street Watch , 2009 , p. 44). 13 Current Treasury Secretary Geithner and Summers were both protégés of Robert Rubin, a former chairman of Goldman Sachs and former Treasury Secretary, and currently an influential advisor to President Obama. The proposal to regulate financial derivatives ‘was quashed by opposition from [Clinton's] Treasury Secretary Robert Rubin…’ ( Wall Street Watch , 2009 , p. 17).

As president of the New York Federal Reserve Bank, Geithner had responsibility for seeing that giant financial conglomerates such as Citigroup avoided excessive risk, a task at which he failed miserably. He neither restrained their risk-taking nor warned the public that they had become excessively risky. ‘Mr. Geithner's five years as president of the New York Fed [was] an era of unbridled and ultimately disastrous risk-taking by the financial industry’ in which he ‘forged unusually close relationships with executives of Wall Street's giant financial institutions’ ( Becker and Morgenson, 2009 ). Geithner also bears substantial responsibility for the inefficiency of the financial rescue operations undertaken to date. For example, much of the Troubled Asset Relief Program in effect used taxpayer money to finance bonuses for top bank employees and dividends for shareholders with no positive impact on financial market performance.

Between 1998 and 2008 Rubin was a top official at Citigroup, where he received a cumulative $150 million in compensation. His main impact on bank policy was to push for the kind of aggressive risk taking that crashed the firm. Rubin ‘believed that Citigroup was falling behind rivals like Morgan Stanley and Goldman, and he pushed to bulk up the bank's high-growth fixed-income trading, including the CDO business’ ( New York Times , 2008 ).

At every stage, Geithner et al. have made it clear that they still have faith in the people who created the financial crisis—that they believe that all we have is a liquidity crisis that can be undone with a bit of financial engineering, that ‘governments do a bad job of running banks’ (as opposed, presumably, to the wonderful job the private bankers have done), that financial bailouts and guarantees should come with no strings attached. This was bad analysis, bad policy, and terrible politics. This administration, elected on the promise of change, has already managed, in an astonishingly short time, to create the impression that it's owned by the wheeler-dealers. ( Krugman, 2009 )

Until this administration adopts a radical change of course in its financial market policies, US and global financial markets are likely to remain fatally structurally flawed. 14

The ideas in this paper are drawn from Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture ( Crotty, 2008 ). Issues treated here are also addressed in other publications ( Crotty, 2009 ; Crotty and Epstein, 2009 ). I am grateful for research support from the Economics Department at UMASS through the Sheridan Scholars program and to Douglas Cliggott and Rob Parenteau for helpful advice.

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See Crotty (2002) for an explanation of the historical economic and political processes through which the neoliberal regime came to replace Golden Age institutions and practices.

An analysis of the effects of perverse incentives in different market segments is presented in Crotty, 2008 .

Ratings agencies also gave large investment banks like Lehman and Merrill Lynch solid investment grade ratings that allowed them to borrow cheaply. ‘It's almost as if the higher the rating of a financial institution, the more likely it was to contribute to financial catastrophe. In pursuit of their own short-term earnings, [ratings agencies] did exactly the opposite of what they were meant to do: rather than expose financial risk they systematically disguised it’ ( Lewis and Einhorn, 2009 ).

‘As late as April 5, 2007, one analyst at a major rating firm said their ratings model didn't capture “half” of a deal's risk…’ ( Wall Street Journal , 2009B ).

The collapse of Merrill Lynch resulted in the firing of chief executive Stan O'Neill. This episode demonstrates the power of perverse incentives: O'Neill received exit pay of $161 million for his part in destroying the firm.

Regulators simply accepted bankers’ assurance that they would sell these assets quickly: they did not check whether in fact this was true.

SIVs contributed to the non-transparency of financial markets. ‘The largest Citigroup SIV is Centauri Corp., which had $21 billion in outstanding debt as of February 2007… There is no mention of Centauri in its 2006 annual filing with the Securities and Exchange Commission’ ( Wall Street Journal , 2007C ).

‘AIG, due to its high credit rating, did not have to post collateral until it was downgraded. At that point, the collateral calls were so massive that they effectively made the insurance giant insolvent’ ( Financial Times , 2009D ).

See Bookstabber (2007) and Das (2006) for concrete examples of the risk- and complexity-augmenting properties of structured financial products.

Half of the spectacular rise in investment bank's return on equity in the four years leading up to the crisis was generated by higher leverage rather than smart investing, efficient innovation or even boom-induced capital gains on trading assets.

A study of the career choices of Harvard undergraduates found that the share entering banking and finance rose from less than 4% in the late 1960s to 23% in recent years ( New York Times , 2009B ).

Global financial assets have declined in value by $50 trillion ( Financial Times , 2009C ).

In 2008 Summers received $5.2 million for part-time service as an advisor to a hedge fund, and was paid $2.7 million for speaking appearances, including at banks such as Citigroup, Goldman Sachs and JP Morgan. Revelation of these facts ‘threatened to undermine public trust in the administration's economic plans’ ( Financial Times , 2009E ).

It is possible, but not likely, that Europe will act independently of the USA and aggressively reregulate their financial markets.

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The Great Recession and Its Aftermath

The period known as the Great Moderation came to an end when the decade-long expansion in US housing market activity peaked in 2006 and residential construction began declining. In 2007, losses on mortgage-related financial assets began to cause strains in global financial markets, and in December 2007 the US economy entered a recession. That year several large financial firms experienced financial distress , and many financial markets experienced significant turbulence. In response, the Federal Reserve provided liquidity and support through a  range of programs  motivated by a desire to improve the functioning of financial markets and institutions, and thereby limit the harm to the US economy. 1    Nonetheless, in the fall of 2008, the economic contraction worsened, ultimately becoming deep enough and protracted enough to acquire the label “the  Great Recession ." While the US economy bottomed out in the middle of 2009, the recovery in the years immediately following was by some measures unusually slow. The Federal Reserve has provided unprecedented monetary accommodation in response to the severity of the contraction and the gradual pace of the ensuing recovery.  In addition, the financial crisis led to a range of major reforms in banking and financial regulation, congressional legislation that significantly affected the Federal Reserve.

Rise and Fall of the Housing Market

The recession and crisis followed an extended period of expansion in US housing construction, home prices, and housing credit. This expansion began in the 1990s and continued unabated through the 2001 recession, accelerating in the mid-2000s. Average home prices in the United States more than doubled between 1998 and 2006, the sharpest increase recorded in US history, and even larger gains were recorded in some regions. Home ownership in this period rose from 64 percent in 1994 to 69 percent in 2005, and residential investment grew from about 4.5 percent of US gross domestic product to about 6.5 percent over the same period. Roughly 40 percent of net private sector job creation between 2001 and 2005 was accounted for by employment in housing-related sectors.

The expansion in the housing sector was accompanied by an expansion in home mortgage borrowing by US households. Mortgage debt of US households rose from 61 percent of GDP in 1998 to 97 percent in 2006. A number of factors appear to have contributed to the growth in home mortgage debt. In the period after the 2001 recession, the Federal Open Market Committee (FOMC) maintained a low federal funds rate, and some observers have suggested that by keeping interest rates low for a “prolonged period” and by only increasing them at a “measured pace” after 2004, the Federal Reserve contributed to the expansion in housing market activity (Taylor 2007).  However, other analysts have suggested that such factors can only account for a small portion of the increase in housing activity (Bernanke 2010).  Moreover, the historically low level of interest rates may have been due, in part, to large accumulations of savings in some emerging market economies, which acted to depress interest rates globally (Bernanke 2005). Others point to the growth of the market for mortgage-backed securities as contributing to the increase in borrowing. Historically, it was difficult for borrowers to obtain mortgages if they were perceived as a poor credit risk, perhaps because of a below-average credit history or the inability to provide a large down payment. But during the early and mid-2000s, high-risk, or “subprime,” mortgages were offered by lenders who repackaged these loans into securities. The result was a large  expansion in access to housing credit , helping to fuel the subsequent increase in demand that bid up home prices nationwide.

Effects on the Financial Sector

After home prices peaked in the beginning of 2007, according to the Federal Housing Finance Agency House Price Index, the extent to which prices might eventually fall became a significant question for the pricing of mortgage-related securities because large declines in home prices were viewed as likely to lead to an increase in mortgage defaults and higher losses to holders of such securities. Large, nationwide declines in home prices had been relatively rare in the US historical data, but the run-up in home prices also had been unprecedented in its scale and scope. Ultimately, home prices fell by over a fifth on average across the nation from the first quarter of 2007 to the second quarter of 2011. This decline in home prices helped to spark the financial crisis of 2007-08, as financial market participants faced considerable uncertainty about the incidence of losses on mortgage-related assets. In August 2007, pressures emerged in certain financial markets, particularly the market for asset-backed commercial paper, as money market investors became wary of exposures to subprime mortgages (Covitz, Liang, and Suarez 2009). In the spring of 2008, the investment bank Bear Stearns was acquired by JPMorgan Chase with the assistance of the Federal Reserve. In September, Lehman Brothers filed for bankruptcy, and the next day the  Federal Reserve provided support to AIG , a large insurance and financial services company. Citigroup and Bank of America sought support from the Federal Reserve, the Treasury, and the Federal Deposit Insurance Corporation.

The Fed’s support to specific financial institutions was not the only expansion of central bank credit in response to the crisis. The Fed also introduced a number of  new lending programs  that provided liquidity to support a range of financial institutions and markets. These included a credit facility for “primary dealers,” the broker-dealers that serve as counterparties for the Fed’s open market operations, as well as lending programs designed to provide liquidity to money market mutual funds and the commercial paper market.  Also introduced, in cooperation with the US Department of the Treasury, was the Term Asset-Backed Securities Loan Facility (TALF), which was designed to ease credit conditions for households and businesses by extending credit to US holders of high-quality asset-backed securities.

Initially, the expansion of Federal Reserve credit was financed by reducing the Federal Reserve’s holdings of Treasury securities, in order to avoid an increase in bank reserves that would drive the federal funds rate below its target as banks sought to lend out their excess reserves. But in October 2008, the Federal Reserve gained the authority to pay banks interest on their excess reserves. This gave banks an incentive to hold onto their reserves rather than lending them out, thus mitigating the need for the Federal Reserve to offset its expanded lending with reductions in other assets. 2

Effects on the Broader Economy

The housing sector led not only the financial crisis, but also the downturn in broader economic activity. Residential investment peaked in 2006, as did employment in residential construction. The overall economy peaked in December 2007, the month the National Bureau of Economic Research recognizes as the beginning of the recession. The decline in overall economic activity was modest at first, but it steepened sharply in the fall of 2008 as stresses in financial markets reached their climax. From peak to trough, US gross domestic product fell by 4.3 percent, making this the deepest recession since World War II. It was also the longest, lasting eighteen months. The unemployment rate more than doubled, from less than 5 percent to 10 percent. 

In response to weakening economic conditions, the FOMC lowered its target for the federal funds rate from 4.5 percent at the end of 2007 to 2 percent at the beginning of September 2008. As the financial crisis and the economic contraction intensified in the fall of 2008, the FOMC accelerated its interest rate cuts, taking the rate to its effective floor – a target range of 0 to 25 basis points – by the end of the year. In November 2008, the Federal Reserve also initiated the first in a series of large-scale asset purchase (LSAP) programs, buying mortgage-backed securities and longer-term Treasury securities. These purchases were intended to put downward pressure on long-term interest rates and improve financial conditions more broadly, thereby supporting economic activity (Bernanke 2012).

The recession ended in June 2009, but economic weakness persisted. Economic growth was only moderate – averaging about 2 percent in the first four years of the recovery – and the unemployment rate, particularly the rate of long-term unemployment, remained at historically elevated levels. In the face of this prolonged weakness, the Federal Reserve maintained an exceptionally low level for the federal funds rate target and sought new ways to provide additional monetary accommodation. These included additional LSAP programs, known more popularly as quantitative easing, or QE. The FOMC also began communicating its intentions for future policy settings more explicitly in its public statements, particularly the circumstances under which exceptionally low interest rates were likely to be appropriate. For example, in December 2012, the committee stated that it anticipates that exceptionally low interest rates would likely remain appropriate at least as long as the unemployment rate was above a threshold value of 6.5 percent and inflation was expected to be no more than a half percentage point above the committee’s 2 percent longer-run goal. This strategy, known as “forward guidance,” was intended to convince the public that rates would stay low at least until certain economic conditions were met, thereby putting downward pressure on longer-term interest rates.

Effects on Financial Regulation

When the financial market turmoil had subsided, attention naturally turned to reforms to the financial sector and its supervision and regulation, motivated by a desire to avoid similar events in the future. A number of measures have been proposed or put in place to reduce the risk of financial distress. For traditional banks, there are significant increases in the amount of required capital overall, with larger increases for so-called “systemically important” institutions (Bank for International Settlements 2011a;  2011b).  Liquidity standards will for the first time formally limit the amount of banks’ maturity transformation (Bank for International Settlements 2013).  Regular stress testing will help both banks and regulators understand risks and will force banks to use earnings to build capital instead of paying dividends as conditions deteriorate (Board of Governors 2011).    

The  Dodd-Frank Act of 2010  also created new provisions for the treatment of large financial institutions. For example, the Financial Stability Oversight Council has the authority to designate nontraditional credit intermediaries “Systemically Important Financial Institutions” (SIFIs), which subjects them to the oversight of the Federal Reserve. The act also created the Orderly Liquidation Authority (OLA), which allows the Federal Deposit Insurance Corporation to wind down certain institutions when the firm’s failure is expected to pose a great risk to the financial system. Another provision of the act requires large financial institutions to create “living wills,” which are detailed plans laying out how the institution could be resolved under US bankruptcy code without jeopardizing the rest of the financial system or requiring government support.

Like the  Great Depression  of the 1930s and the  Great Inflation  of the 1970s, the financial crisis of 2008 and the ensuing recession are vital areas of study for economists and policymakers. While it may be many years before the causes and consequences of these events are fully understood, the effort to untangle them is an important opportunity for the Federal Reserve and other agencies to learn lessons that can inform future policy.

• 1  Many of these actions were taken under Section 13(3) of the Federal Reserve Act, which at that time authorized lending to individuals, partnerships, and corporations in “unusual and exigent” circumstances and subject to other restrictions. After the amendments to Section 13(3) made by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Federal Reserve lending under Section 13(3) is permitted only to participants in a program or facility with “broad based eligibility,” with prior approval of the secretary of the treasury, and when several other conditions are met.
• 2  For more on interest on reserves, see Ennis and Wolman (2010).

Bibliography

Bank for International Settlements. “ Basel III: A global regulatory framework for more resilient banks and banking system .” Revised June 2011a.

Bank for International Settlements. “ Global systemically important banks: Assessment methodology and the additional loss absorbency requirement .” July 2011b.

Bernanke, Ben, “The Global Saving Glut and the U.S. Current Account Deficit,” Speech given at the Sandridge Lecture, Virginia Association of Economists, Richmond, Va., March 10, 2005.

Bernanke, Ben,“Monetary Policy and the Housing Bubble,” Speech given at the Annual Meeting of the American Economic Association, Atlanta, Ga., January 3, 2010.

Bernanke, Ben, “Monetary Policy Since the Onset of the Crisis,” Speech given at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyo., August 31, 2012.

Covitz, Daniel, Nellie Liang, and Gustavo Suarez. “The Evolution of a Financial Crisis: Collapse of the Asset-Backed Commercial Paper Market.” Journal of Finance 68, no. 3 (2013): 815-48.

Ennis, Huberto, and Alexander Wolman. “Excess Reserves and the New Challenges for Monetary Policy.” Federal Reserve Bank of Richmond Economic Brief   no. 10-03 (March 2010).   

Federal Reserve System, Capital Plan , 76 Fed Reg. 74631 (December 1, 2011) (codified at 12 CFR 225.8).

Taylor, John,“Housing and Monetary Policy,” NBER Working Paper 13682, National Bureau of Economic Research, Cambridge, MA, December 2007.     

Written as of November 22, 2013. See disclaimer .

Essays in this Time Period

• Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
• Federal Reserve Credit Programs During the Meltdown
• The Great Recession
• Subprime Mortgage Crisis
• Support for Specific Institutions

Related People

Ben S. Bernanke Chairman

Board of Governors

2006 – 2014

Timothy F. Geithner President

New York Fed

2003 – 2008

Related Links

• FRASER: Text of Dodd Frank Act

Federal Reserve History

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PhD Thesis: Knowledge management during an economic crisis: The case of Greek firms

Knowledge management is a concept which has emerged during the previous years. The present thesis aims to explore knowledge management in relation to the economic crisis using the case of Greek firms. For that purpose a sample of 120 employees was selected from firms in various sectors, and an additional 11 managers and employees were interviewed. The results of the research indicate that employees have an overall positive perception over knowledge management but there are some issues, mostly having to do with corporate culture and the lack of use of state-of-the-art KM information systems. However, knowledge management can be a vehicle of development for firms that seek to exit from the economic crisis. Hence, firms should not allow the economic crisis to drive them into reductions of knowledge management programs and strategies, but instead should focus on utilizing knowledge management so as to improve their performance

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Abstract The concept of Learning Organisation (LO) has become a key theme for organisations operating in turbulent working environments. During the past years, there is a growing tendency by contemporary organisations adopting Knowledge Management (KM) approaches to produce core competencies. Just like the similarities and differences that both LO and KM may have, academics and practitioners shift their focus on the positive side of the aforementioned concepts. However, the present paper discusses a range of potential negative consequences, such as the concept of organisational conflict, that the adoption of LO and KM might bring into surface. This paper aims to serve as a critical pilot study for examining the conditions under which Greek-based enterprises implement the concepts of LO and KM in their working practices. Through the conduction of in-depth interviews with twenty executives and managers working in Greek-based enterprises, the authors scrutinize three issues. Primarily, this study explores the interviewees’ lack of knowledge and understanding regarding the concepts of LO and KM. Secondly, the authors aim to recognize to what extent the adoption of the aforementioned concepts are influenced by the Greek societal values. Finally, based on the subjects’ responses, this pilot study critically discusses the general belief that LO and KM are just an excuse for downsizing and for altering power relations within an organisation. Keywords: Knowledge Management, Learning Organisation, Conflict, Criticism

John Garrick

Abstract: This paper draws on Jean-François Lyotard’s (1984) seminal study The Postmodern Condition: A Report on Knowledge to reflect on two macro-level catastrophes: the global financial crisis (GFC) of 2009 (and its continuing effects throughout the Eurozone and elsewhere) and Fukushima. These two case studies probe aspects of these grand failures to reveal serious deficiencies in integrity at work, the changing nature of contemporary working relationships, knowledge management and fashionable new approaches to organisational learning. The paper draws upon Lyotard’s ‘performativity theory’ to examine how people in commercial enterprises may often define ‘knowledge’, how this is transferred and how, in turn, managing this knowledge affects working relationships, learning and change.

Journal of Knowledge Management

Satyendra Singh

http://mmm-gi.blogspot.com/p/no3year-2013.html

Anita Cucovic , Geo - See

Abstract:It is an undisputed fact that this is the age of knowledge and a time of constant changes which are unpredictable. The globalisation trends and ever increasing networking of economy, information, technology, management (…) give rise to intellectual and group knowledge, namely to intellectual capital as the nonmaterial part of an organisation’s capital. Formal education is not sufficient, and further training is required in line with contemporary requirements which the market imposes, in addition to it not providing development of personal skills which are necessary in everyday management, and which in synergy with professional knowledge provide for the proper results. Today, knowledge represents the most important capital of an enterprise, and it is necessary to develop an efficient and effective system of managing this resource, as it is that in particular which provides greater productivity, innovation, more qualitative performance of business activities, and provides competitive advantage. In previous periods the emphasis within organisations was on technology and technological changes, while today, in the age of knowledge technology continues to be important, but only as a product of internal engagement of intellectual capacities. Therefore, this imposes the fact that only through successful knowledge management enterprises are able to successfully manage their business.

Edlira Margilaj

The fast pace of globalization and technological progress has dramatically changed market conditions and competition strategies. In present-day society based on knowledge, or &quot;knowledge - based society&quot;, the amount of knowledge in use has increased considerably and it has produced many challenges for its (knowledge) control and management. Knowledge Management - KM is becoming nowadays one of the most significant practices of companies in developed countries aiming at the increase of profits and competitive advantages. For a successful implementation of Knowledge Management, it is important the identification of barriers or critical factors which affect the success of the KM process. Most of these factors belong to human department. The purpose of this study is to investigate the recognition and implementation of Knowledge Management in business organizations in Albania, as well as to reveal some of the barriers and critical success factors of KM in such organizations. In ...

Bhojaraju Gunjal

Chuks Eresia-eke , Stanford Makore

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155 Financial Crisis Essays & Examples

Looking for finance essay topics? You’re in the right place! The subject of financial economics is worth exploring.

💸 Top 10 Finance Essay Topics

🏆 top financial crisis essay examples, 💰 financial crisis essay topics, 👍 financial crisis research paper topics, 🏧 exciting financial essay topics, 📑 financial crisis topics for essays, ❓ research questions about financial crisis.

A financial crisis means massive depreciation of financial assets. It usually happens in the forms of banking, currency, and debt crises. Though the issue is studied well, financial crises still occur in various parts of the world.

In your finance crisis essay, you might want to focus on financial management in turbulent periods. Another idea is to discuss what it takes to survive a global financial crisis. One more option is to compare various types of financial crises. Whether you are assigned an argumentative essay, analytical paper, or research proposal, this article will be helpful. Here we’ve collected financial crisis research paper topics, current essay titles, writing tips, and financial crisis essay samples.

• The financial system and its components
• The role of investors in the financial system
• Personal, corporate, and public finance
• Financial risk management
• Quantitative finance and financial engineering
• Behavioral finance: the psychology of investors
• Early history of finance
• History and development of money
• Experimental finance and its goals
• Mathematical modeling in financial markets analysis
• Financial Crisis of 2007-2008 in ‘The Big Short’ Movie Michael predicted that it would devaluate mortgage bonds and, therefore, decided to short the housing market, that is, to bet on the market crash.
• 2008 Financial Crisis in Dubai In order to address the collapse in the real estate market observed in Dubai in 2008, the Emirate’s authorities focused on elaborating stricter regulations on developers of the housing projects and on the buyers. 26 […]
• Impact of World Financial Crisis on the UAE Economy The decline in economic growth was reflected in the significant reduction in the country’s GDP. However, the profitability and growth of the sector reduced substantially in 2009 due to the following factors.
• Causes and Solutions of the 2008 Financial Crisis The current essay describes the causes of the Financial Crisis of 2008 and the solutions suggested by the Keynesian school of thought.
• The Global Financial Crisis and Its Impacts In addition, a case of a company is studied to evaluate the impact of GFC on a particular firm, and consider the capability of the firm to survive the crisis.
• ‘What Went Wrong? An Initial Inquiry into the Causes of the 2008 Financial Crisis’ Additionally, failures at the managerial group also resulted in the crash as it led to a re evaluation of the cost of the agencies by the investors.
• Argentina’s Financial Crisis: A Critical Review of Causes and Effects The unprecedented expansion in the country’s markets and economy at large was attributed to the rise in agricultural exports. The country’s economy was heading in the right direction following the introduction of the convertibility system.
• Disadvantages of Developed Country (America) When 2008 Financial Crisis However, the scholars do not singly use this as a reason of terming a country as being developed but also adds on to the fact that people in that country should be having the freedom […]
• Social Distancing, Financial Crisis and Mental Health The lockdown leads to the inability of people to go to the hospital for mental health consultation and treatment due to the anti-COVID measures. It is possible to talk about the spread of mental health […]
• Aspects of the 2008 Financial Crisis According to Eisinger, none of the participants in the story in the film had any idea of the coming crisis. One of the connections between the film and the textbook is that of corporate social […]
• Essential Points From the Financial Crisis The first important point on slide 10 is the failure to penalize the originator for passing the mortgage to the provider.
• Argentina and Russia’s Financial Crisis Investors’ loss of faith in the Russian economy caused them to sell their Russian holdings, lowering the value of the Russian rouble and raising fears of a financial crisis.
• Ethical Questions in the 2008-2009 Financial Crisis What followed was an investigation of the genesis of the crisis, which revealed that catastrophic failure in oversight, the systemic weakening of usury laws, and outright thuggery by banks and mortgage salespeople were the major […]
• The 2008 Financial Crisis and Housing Policies Under the State Department of Housing and Urban Development, the government introduced the Section 8 Voucher. The function of this voucher was to meet the gap between what the renters would get and the actual […]
• 2008 Financial Crisis from a Neoliberal Perspective While such a position seems reasonable, the overall adherence of the financial system, including accounting and auditing, contributed to the crisis due to the unbearable level of loans and fictitious assets dominating the business.
• Corporate Social Capital During Financial Crisis The credit crisis related to the mortgage problem in 2008 has been one of the massive financial issues of the world since the times of the Great Depression.
• 2008 Global Financial Crisis in Andrew Sorkin’s “Too Big to Fail” The book Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System from Crisis and Themselves, written by Andrew Ross Sorkin, explores the events and consequences […]
• Financial Crisis in Greece It is doubtless that the value of money is essential in determining a number of factors like the stability of the economy and inflation.
• The Euro Financial Crisis Causes and Outcomes The involvement of the central banks of is an attempt to demonstrate that all the central bankers are collaborating. The Euro crisis has exarcebated the currency swap process as it is now more expensive to […]
• The 2007 Financial Crisis: Development of the Prices of Shares, Corporate Bonds and Loans The crippling of the financial system in the US and the UK in the period beginning late 2007 was a product of crippling loans.
• Challenges Facing College Sports After Financial Crisis When the housing bubble caused financial depression in the national economy, colleges and universities were some of the most affected institutions, especially because the state and federal legislatures were forced to cut funding, the major […]
• How Money Market Mutual Funds Contributed to the 2008 Financial Crisis While how the prices of shares fell below the set $1 per share was a complex process, it became one of the greatest systemic risks posed by the MMMF to the investors and the economy […]
• How Quantitative Models Contribute to the Financial Crisis The motivation behind this study lies in the desire to understand why and how the economies of many countries around the world, especially in the Middle East, have been shaken to the core by the […]
• South Africa’s Response to Global Financial Crisis Desire to the achieve objective that duly fulfils the needs of an individual while being disadvantageous to the majority of individuals led to the crisis.
• Global Financial Crisis Impact on Multi-Nationals The credit crisis was linked to the sub-prime mortgage business. So as to encourage lending, the interest rates were also lowered credibly.
• Qantas’ Actions in the Financial Crisis Context The actions taken by Qantas in reducing their costs can be said to be influenced by the global financial crisis, where the decline of the number of passengers in September 2009 was 0.
• Prospects for Chindia After 2008 Global Financial Crisis According to the Australian business press, the recent economic growth achieved was a result of the relationship between itself and the two countries i.e. However, China experienced a hitch on its international markets especially in […]
• The Investment Industry in Kuwait Today (During Financial Crisis) One of the confessions was that the investment authority of Kuwait otherwise known as would not be in a position to provide financial support that would assist in the restoration of confidence that was already […]
• Financial Crisis Management in the United Nations A crisis can be defined as the perception of an abnormal situation that is beyond the capability of the business and its scope to deal with.
• Lehman Brothers and the 2008 Financial Crisis As a result, when the management of the bank expected assistance from other firms and the Bank of America, it did not receive the help it needed.
• 2008 Global Financial Crisis: Crises of Capitalism? Although I had an idea of the possible catalysts of the 2008 global financial meltdown before watching the video, Harvey presented a clear report of the events that occurred before the crisis and put them […]
• Corporate Government During the World Financial Crisis The chairman is the leader of the board of directors while the CEO is the person who oversees the day to day activities of the company; each of them performs a distinct and critical role […]
• Nucor Corporation After Financial Crisis in the US However, in 2009, the company made the largest loss in its history of $299 million; the loss was the first annual loss since 1966. The depreciated purchasing power parity of the people in 2009 is […]
• Global Financial Crisis and Its Ethical Causes The reason for this is simple the analysis of what had brought about this particular financial crisis and what accounted for the subtleties of its extrication points out to an undeniable fact that it was […]
• Apple and Hewlett Packard During 2008 Financial Crisis Though the general demand has not reached the level it was before the crisis, many companies have taken advantage of the rising demand and have made tremendous sales. However, the company has increased its spending […]
• Banking Instability During the Global Financial Crisis Though the combination of aspects that resulted in the banking instability in the course of the global financial crisis had never been witnessed previously, the shift from extreme risk-taking to fiscal chaos was a common […]
• General Electric and the Financial Crisis of 2008 Although GE’s success is often attributed to the significant amount of financial assets that the company has, it owes its survival through the 2008 crisis to the careful and well-thought-out plan of investing in the […]
• Rotana Company’s Financial Crisis and Culture This statement can be seen as being true to the values of the company and how it addressed the issues caused by the 2008 financial crisis.
• British and Dutch Banks After 2008 Financial Crisis Many countries utilised the opportunity of the crisis to work on improving corporate governance and leadership to avoid similar crises in the future.
• Australian Banks in the Global Financial Crisis To understand how Australian banks managed the GFC, it is essential to pay attention to the very structure of its banking.
• Financial Crisis and Great Recession Causality The financial crisis is typically viewed as a primary factor behind the development of the Great Recession. Instead, the financial crisis of 2008 can be deemed a prerequisite of the Great Recession as well as […]
• Financial Crisis in Ferguson’s “The Ascent of Money” By Ferguson, the main purpose of the historian is to relieve humanity from the financial illusions on the examples of the past.
• Global Financial Crisis and Regulatory Responses In the aftermath of the crisis, the government through the Federal Reserve embarked on a mission to restore these financial institutions to their original position.
• The Shadow Banking System: Financial Crisis Source The so-called shadow banking system, comprised of numerous institutions operating outside the regulated banking system, has undoubtedly contributed greatly to the emergence of the latest global financial crisis.
• Financial Crisis and Its Impact on UAE Construction The determination of this research is to evaluate the enactment of construction corporations in the United Arab Emirates for the period of the pre and post worldwide eras of financial disaster, which is from 2006 […]
• 1997 Asian Financial Crisis and Its Consequences Beja explores the impacts the crisis had on these countries and the outcomes that occurred years after the end of the crisis.
• American Financial Crisis and Its Prevention The interviewee brings about the idea of bureaucracy and political aspects that contributed to the problem, highlighting the corruption and ineffectiveness in the government when bailing out the institutions.
• Financial Crisis of 2008 and Consumer Behavior Although the main cause of the global financial crisis that began in 2007 was the bursting of the housing bubble, economists largely agree that the ensuing recession was the outcome of a combination of several […]
• British Airways Performance and Global Financial Crisis This paper analyzes the performance of British Airways’ leadership in the wake of the global financial crisis. BA CityFlyer, which is a subsidiary of the British Airways, dominates operations in the London municipality airport.
• Financial Crisis of 2007-2008: Laws and Policies Nevertheless, one should not assume that the absence of legal safeguards is the only factor that led to this crisis since it is necessary to consider the development of the economy and lack of internal […]
• Financial Crisis in Greece: Origin and Aspects This essay seeks to establish the nature and origin of the crisis, Greece’s advantages and disadvantages in the Eurozone, and Greece’s fiscal policy.
• Austerity Measures after of the World Financial Crisis That is why it becomes obvious that there is a great need in some austerity measures whose main aim is to overcome the results of the world financial crisis and guarantee the stability of the […]
• US Financial Crisis Hit and Its Economy Effect He is an economist and runs a column in the Atlantic magazine on financial matters in the U.S. The article is by Lee Don, a columnist, and journalist in the U.
• The 2008 Financial Crisis In September 2008, the two giant mortgage companies faced the danger of bankruptcy as they had guaranteed close to half of the total mortgages in the US.
• Impact of the Global Financial Crisis on the World The recent global financial crisis happened between the years 2007 and 2008 that was a serious threat to the financial markets in the United States and the rest of the world.
• Effects of Hedge Funds on the Global Financial Crisis The article titled “Do not Blame Hedge Funds for Financial Crisis, Study Says,” in 19th September 2012 issue of the The Wall Street Journal, attempts to remove the hedge fund from blame in the global […]
• Role of International Financial Institutions in 2008 Financial Crisis Even more disappointing is the fact that the financial regulatory standards that were in place were unable to anticipate and therefore avert the ramifications of the financial crisis before it happened as should have been […]
• Global Financial Crisis: Corruption and Transparency Due to the large number of the emerging markets, the global financial regulators lacked a proper mechanism to handle the situation.
• Managing Financial Crises In this line, the financial institutions would have distributed the risk to all the stakeholders. The involvement of many players in the management systems of banks makes it out rightly difficult to blame banks for […]
• Training and Skills Development Programs vs. the Global Financial Crisis The Level of education influences the rate of unemployment in an economy. The increase in gross domestic products is attributed to levels of education and employment.
• The Worst of the Global Financial Crisis Is Still To Come Therefore, considering the numerous flaws that exist in the global economic system and the fact that, most governments have deviated from addressing the real causes of the global financial crisis; hence, formulate strategies of avoiding […]
• States regulatory response to the current financial crisis Having been cited by the International Monetary Fund as the leading contributor towards the world economy in 2007, the onset of the financial crisis meant economic disaster to the state.
• Financial Risk Management: Based on the 2008 Global Financial Crisis While it is believed that the U.S.subprime mortgage market might have prompted the occurrence of the global financial crisis, the primary cause of the crisis was founded on the flawed institutional practices and the instability […]
• The global financial crisis of 2008 The magnitude and the level of disruption of the global economies have led to speculation of various causes that has contributed to its occurrence.
• EU Financial Crisis: Risk Management Failures This is for example over- dependence on: the capability of managers to create returns.the merits of financial innovation in efficiently spreading returns and risks in the market, the sufficiency of data and models used for […]
• Public Discourse under the Financial Crisis in the U.S and Canada The number of people that lost their jobs, the number of companies that ran into bankruptcy and dwindled in self-destruction through foreclosures and closures, the amount of money that was pumped into the economy by […]
• Impacts of Financial crisis on Bahrain Impacts of financial crisis on the country’s economy have accelerated debate within the mainstream of economics and many market analysts have devised economic stimulus plan to confront the crisis.
• Effect of Global financial crisis on the Gulf Countries The financial crisis which hit the US in the late months of the year 2007 have over time spread to almost all other countries in the world.
• Cultural Change at Texaco and Financial Crisis The most important and influential challenge was the opportunity to solve the questions of exclusion and discrimination of the minorities and women from the company’s workforce in such high status posts like management.
• After the 2007-2010 Financial Crisis: Across the Chaos and Destruction to the Universal Order Because of the half-baked decisions concerning the integration in the Eurozone had been taken, the Great Britain had to sign the agreement with Brussels concerning the further economical steps, which is likely to drive to […]
• Global Financial Crisis Problems This paper discusses the problem created by the global financial crisis and assesses the viability of the courses of actions taken to counter the problem.
• Global Financial Crisis of 2007-2010 In particular, it has shown that many financial institutions are too much dependent on one another, and the collapse of one organization can result in the collapse of the entire system.
• Eurozone Financial Crisis Henceforth, an analysis is drawn of the causes of crisis in the Eurozone. In addition, the effect of this Eurozone crisis did spread to other countries.
• East Asian Financial Crisis Analysts have argued that the inherent problem with the approach in the region, especially in Japan, was primarily due to much involvement of the government in guiding the free economy.
• The Financial Crisis Causes: Moral Hazard and Adverse Selection The consequences were similar in most parts of the world with the main indicators being debt crises, high unemployment rates, a reduction in the number of home ownership facilities and the demand for the same, […]
• East Asian Financial Crisis of 1997-98 However, the quick actives responses by the states in the region helped in the quick aversion of the crisis and its impacts on the region’s economy.
• American Financial Crisis It discussed the underlying causes of the crisis and the impact it has had on the economy of the United States.
• Spain’s Financial Crisis The disproportionate growth in the real estate sector, coupled with the expansion of credit needed to finance it, is at the basis of the economic imbalances.
• Global Financial Crisis Causes and Impacts After a number of years since the first occurrence of the crisis, it is still not possible to explain fully the impact of the global financial crisis because the economic emergency keeps on hindering and […]
• Minsky’s Economic volatility theory as an evaluation of Financial Crisis The modern Marxist, FSA, and organizational Keynesian perspectives associate the causes of the financial slow down with the implementation of the liberal development framework in 1970s when the “Accord of Detroit” development framework was ditched.
• The Global Financial Crisis of 2008-2009 The two key sectors that take the blame for the financial crisis of 2008 and 2009 are the financial sector and the real estate industry.
• Global Financial Crisis Initially, the collapse of AIG, the under-performance of Fallie Mac and Fannie Mac and the merging of the Bank of America and the Merrill Lynch were the start point of the financial problems in the […]
• Global Financial Crisis of the United States Mortgage Industry The deterioration of economies called for government to take fast and immediate measures to rescue their nations; the United Nations for instance had to make policies that protected its local industry from the adverse effects […]
• What Caused the 2008 Financial Crisis in the USA? The opposite trends in the cost of mortgage credit and the housing prices also made the home owners participate more in the market since the risk of default was much lower.
• The Global Financial Crisis and Capitalism for the Elite Rich This Ideology adopted by many if not all of the western nations upholds the private ownership of business and institutions and the owners of these entities are allowed to spread out as much as they […]
• The UK Banking Practice That Led to Financial Crisis Crisis of the magnitude that was experienced is a real threat to the economy of any country and it is imperative for people to learn as much as they can to avoid the circumstance that […]
• The effect of global financial crisis on Saudi Arabian economy The countries stability of the banking sector was also seen in the change in banking activities over the period of global financial crisis, the country recorded the worst banking growth rate in the years between […]
• The effect of the global financial crisis on political and financial risks The negative effects of the global financial crisis have been felt in most parts of the world i.e.in the advanced countries, the emerging markets and in the developing world.
• Global Trade During the Financial Crisis (from 2006 to 2010) Each of the major trade regions of the world seemed to concentrate more on a given branch of trade and give their outputs to the rest of the world.
• Global Financial Crisis Impact on Australian and World Economies After affecting the banking and credit sectors in the US, the global crisis slowly crept to other countries and in the process became a world crisis.
• International Finance. Main Causes of Recent Financial Crisis One of the specific factors that can be attributed to the recent international financial crisis was the loss on housing mortgage loans due to the decline of mortgage prices in the market.
• The 2008 global financial crisis Soros asserts that whereas the U.S.subprime mortgage market is believed to have prompted the current financial crisis, the basis of the crisis derived from the flawed practices and institutions of the current financial system.
• Benefits of the Old Fashioned Business Models in the light of Global financial Crisis The purpose of this essay is to establish the benefits and drawbacks of old fashioned business models in the light of global financial crisis with reference to Airdrie bank of Lanarkshire in the UK.
• The Recent Financial Crisis The financial crisis has been considered by most economists to be the worst crisis since the Great Depression as it contributed to the failure of major financial institutions in the U.S.and the decline of consumer […]
• Turkey’s 2000-2001 Financial Crisis The first crisis began at the early 90’s while the second began at the beginning of the 21st century. This led to the collapse of the exchange rate and the beginning of the country’s second […]
• The 1997-1998 Asian Financial Crisis This growth was associated with “inflow of investments, improvements in technology, increases in education, a ready supply of labor as people moved from the countryside to the cities to work in factories, and reduced restrictions […]
• Impact of the Global Financial Crisis on the Healthcare Industry The global financial crisis threatened to lead to the total breakdown of the global economy. The global financial crisis reduced the funding of that the healthcare facilities received from the government.
• Changes in Financial Markets and it impact on Recent Financial Crisis Due to the above reason, this study seeks to examine the reasons behind the changes in financial markets during the last 30 years and the role of these changes in the recent financial crisis.
• Cause of the Financial Crisis The reason for this is quite apparent it was namely the Democrats’ preoccupation with ‘combating poverty’ that resulted in passing of the infamous Community Reinvestment Act and in reinforcing its provisions through the course of […]
• The Global Financial Crisis Every entity is faced with the inevitable reality of making financial decisions in the following departments; investment for instance where to open shop, dividends for example whether or not to pay and when, working capital […]
• Theories on Causes of Financial Crisis A financial system shock disrupted the situation and the prices of the houses fell and many people could not pay their loans.
• Wesfarmers Limited and the Global Financial Crisis In order to put into perspective the effect of the GFC, we shall study the profitability of the firm from 2007 to 2010.
• Regulation in the Financial Crisis 2008 While numerous claims have been put forth to explain the causes of the 2007-2009 financial crisis, there is almost a universal agreement that the major causes of the financial crisis was the combination of a […]
• The 2008 Financial Crisis: Causes and Consequences Foster and Magdoff Perspective of 2008 Financial Crisis Foster and Magdoff theory that attempts to explain the 2008 financial crisis attributes it to broader factors of monopoly finance capitalism which is a function of a […]
• Ethical Aspects of the Financial Crisis Yet, they would agree that to some degree, the origins of the financial crisis can be traced to the immoral behavior of some individuals who attempted to maximize their own benefits of at the expense […]
• Is Globalization the Main Culprit for the 2008 Global Financial Crisis? Globalization has eroded the powers and the sovereignty of the state, the role of the state to regulate and to steer forward the economy has been largely ignored at the expense of the market, these […]
• The Importance of Ethics in Business in Light of the Recent Global Financial Crisis The lack of concern for the overall good of the society stemmed from the increase in equity-based compensation to top executives which resulted in the declaration that “the paramount duty of management and board is […]
• What Was the Biggest Financial Crisis?
• Did Financial Crisis Alter the Level of Competition in the EMU Banks?
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• What Are the Three Stages of Financial Crisis?
• Did Firms Manage Earnings More Aggressively during the Financial Crisis?
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• Did the Financial Crisis in Japan Affect Household Welfare Seriously?
• Did the Global Financial Crisis Alter the Oil–Gasoline Price Relationship?
• Was the 2008 Financial Crisis Caused by Lack of Ethics?
• Was the Financial Crisis Caused by Bankers or Government?
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The Causes of the Economic Crisis, and Other Essays Before and After the Great Depression

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Stimulus or laissez-faire? That’s the essential debate about what to about financial crisis in our time. It was the same in the 1930s.

In this world before and after the Great Depression, there was a lone voice for sanity and freedom: Ludwig von Mises. He speaks in The Causes of the Economic Crisis , a collection of newly in print essays by Mises that have been very hard to come by, and are published for the first time in this format.

Here we have the evidence that the master economist foresaw and warned against the breakdown of the German mark, as well as the market crash of 1929 and the depression that followed.

He presents his business cycle theory in its most elaborate form, applies it to the prevailing conditions, and discusses the policies that governments undertake that make recessions worse. He recommends a path for monetary reform that would eliminate business cycles and provide the basis for a sustainable prosperity.

In foreseeing the interwar economic breakdown, Mises was nearly alone among his contemporaries. In 1923, he warned that central banks will not “stabilize” money; they will distort credit markets and generate booms and busts. In 1928, he departed dramatically from the judgment of his contemporaries and sounded an alarm: “every boom must one day come to an end.”

Then after the Great Depression hit, he wrote again in 1931. His essay was called: “The Causes of the Economic Crisis.” And the essays kept coming, in 1933 and 1946, each explaining that the business cycle results from central-bank generated loose money and cheap credit, and that the cycle can only be made worse by intervention.

Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later it must become apparent that this economic situation is built on sand.

Did the world listen? The German-speaking world knew his essays well, and he was considered a prophet, until the Nazis came to power and wiped out his legacy. In England, his student F.A. Hayek made the Austrian theory a presence in academic life.

In the popular mind, the media, and politics, however, it was Keynes who held sway, with his claim that the depression was the fault of the market, and that it can only be solved through government planning.

Just at the time he wanted to be fighting, Mises had to leave Austria, forced out by political events and the rising of the Nazis. He wrote from Geneva, his writings accessible to too few people. They were never translated into English until after his death. Even then, they were not circulated widely.

The sad result is that Mises is not given the credit he deserves for having warned about the coming depression, and having seen the solution. His writings were prolific and profound, but they were swallowed up in the rise of the total state and total war.

But today, we hear him speak again in this book.

Bettina B. Greaves did the translations. It is her view that in the essays, Mises provides the clearest explanation of the Great Depression ever written. Indeed, he is crystal clear: precise, patient, and thorough. It makes for a gripping read, especially given that we face many of the same problems today.

This book refutes the socialists and Keynesian, as well as anyone who believes that the printing press can provide a way out of trouble. Mises shows who was responsible for driving the world into economic calamity. It was the inevitable effects of the government’s monopoly over money and banking.

Just as in his attack on socialism, here he was brilliant and brave and prescient. Mises was there, before and after. He was writing about contemporary events. He issued the warnings that the world did not heed, the warnings we must heed today.

Ludwig von Mises was the acknowledged leader of the Austrian school of economic thought, a prodigious originator in economic theory, and a prolific author. Mises’s writings and lectures encompassed economic theory, history, epistemology, government, and political philosophy. His contributions to economic theory include important clarifications on the quantity theory of money, the theory of the trade cycle, the integration of monetary theory with economic theory in general, and a demonstration that socialism must fail because it cannot solve the problem of economic calculation. Mises was the first scholar to recognize that economics is part of a larger science in human action, a science that he called praxeology .

Wages, Unemployment, and Inflation 06/20/2024 • Mises Daily • Ludwig von Mises There is only one way that leads to an improvement of the standard of living for the wage-earning masses, viz., the increase in the amount of capital invested. All other methods, however popular they may be, are not only futile, but are actually detrimental to the well-being of those they allegedly want to benefit.

Governments Never Give Up Power Voluntarily 03/01/2024 • Mises Wire • Ludwig von Mises [A selection from Liberalism .] All those in positions of political power, all governments, all kings, and all republican authorities have always looked askance at private property. There is an...

The Real Meaning of Inflation and Deflation 01/02/2024 • Mises Daily • Ludwig von Mises [Excerpted from Chapter 17 of Human Action.] The services money renders are conditioned by the height of its purchasing power. Nobody wants to have in his cash holding a definite number of pieces of...

Auburn: Mises Institute, 2006

The Mises Institute is a non-profit organization that exists to promote teaching and research in the Austrian School of economics, individual freedom, honest history, and international peace, in the tradition of Ludwig von Mises and Murray N. Rothbard. 

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