Ebook Lessons of the Financial Crisis
The story of the financial crisis will be retold endlessly as one of wide spread greed, corruption, and incompetence, enabled by a policy agenda dominated by an ideology of deregulation. Yet even if the marketplace had been populated by more ethical and intelligent individuals, and even if their activities had been more carefully scrutinized by more diligent regulators, there would almost surely still have been a major financial boom and bust such is the power, as history attests, of cheap money.
The crisis offers a sobering lesson about the dangers of policies that fuel the rapid buildup of debt across the economy. In recent years, individuals and financial institutions borrowed at unprecedented levels, funneling such funds into housing and real estate assets, in particular. As with all levered investments (investments made with borrowed money), this practice generated great profits as the assets rose in value. And as with all levered investments, it produced great losses when the assets fell in value. Leverage can create the mirage of investment acumen in a rising market that is only unmasked as recklessness in a declining one. Excessive leverage in the economy needs to be prevented because credit does not return to normal once asset prices stop rising and start falling. It becomes dangerously scarce as lenders are forced to ration, and often compete aggressively for, funds to cover losses. This causes a rapid contraction of economic activity generally.
Although debt fueled manias and crashes undoubtedly have roots in human psychology, trying to eradicate failings of human nature through regulation is not merely exceptionally ambitious but also prone to serious unintended consequences. After all, risk taking is the very source of economic progress. Mainstays of the financial markets such as mortgages, mutual funds, and credit cards would be impossible without it. The priorities should therefore be, first, to identify and correct policies that cause certain risks to be significantly underpriced, and therefore taken on at greater levels than can be justified by the potential losses involved; and, second, to put in place new policies that make the financial system more resilient in the face of risk taking gone bad.
Contents
Foreword
Acknowledgments
Council Special Report
Introduction
A Synopsis of the Crisis
An Agenda for Policy Reform
Conclusion
Endnotes
About the Author
Advisory Committee
CGS Advisory Committee
CGS Mission Statement
IIGG Mission Statement
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