Sunday, October 19, 2008

Causes of the Financial Crisis

Tyler Cowan discusses the causes of the financial crisis in the New York Times. His one paragraph summary is that:
Over all, then, the three fundamental factors behind the crisis have been new wealth, an added willingness to take risk and a blindness to new forms of systematic risk. All three were needed to bring about the scope of the current mess — so that means we’ve had some very bad luck on top of everything else.
New wealth matters because it led to the savings glut and a fall in real interest rates. The money had to go somewhere. The problem is where the financial system channeled those savings.

It is important to also recognize that when a boom takes place those who are betting on the bubble continuing are making large gains. They tend to shout down then naysayers at that point. That is why it is hard to implement any policy to pop the bubble. Given this is unlikely to ever change, one would hope we can at least implement policies that reduce systemic risks. But that is also easier said than done.

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