The Financial Crisis – A Great Summary

Thanks to Baseline Scenerio here is a very good summary of the causes of the financial crisis by the “La Follette Policy Report” from the University of Wilsconsin Madison. Last year I gave a number of speeches on this topic and it is good to see our lists match up. Interest rates that were kept to long for too long was a primary culprit, as was US overconsumption. These factors are related to what they call the “”capital flow cycle” in which foreign capital floods a country, stimulates as economic boom, encourages financial leverage and risk taking, and eventually culminates in a crash.” Of course we are now in the process of trying to reverse much of this, though large US budget deficits will be pulling in excess foreign capital for some time to come. Meanwhile US consumption can no longer be the driver of global growth and “who will take up this role remains the next big question.”

One thought on “The Financial Crisis – A Great Summary

  1. The La Follette Policy Report is a really good read, but it is flawed by being too moralistic. If borrowing and deficits were the cause, then we should be mired in an extended recession rather than appearing to be emerging from one.

    It is also flawed for minimizing the effect of credit default swaps, derivatives and structured finance. Credit default swaps were the immediate cause of the failure of Bear Stearns, AIG and Lehman and came close to bringning down Merrill and Citi.

    2008 in retrospect was a classic panic, and we see spreads in almost all debt classes return to pre-October 2008 levels, which could not possibly occur under the La Follette thesis.

Leave a Reply

Your email address will not be published.