Tuesday, May 25, 2010

[IWS] CRS: CAUSES OF THE FINANCIAL CRISIS [9 April 2010]

IWS Documented News Service
_______________________________
Institute for Workplace Studies----------------- Professor Samuel B. Bacharach
School of Industrial & Labor Relations-------- Director, Institute for Workplace Studies
Cornell University
16 East 34th Street, 4th floor----------------------
Stuart Basefsky
New York, NY 10016 -------------------------------Director, IWS News Bureau
________________________________________________________________________

 

Congressional Research Service (CRS)

 

Causes of the Financial Crisis

Mark Jickling, Specialist in Financial Economics

April 9, 2010

http://opencrs.com/document/R40173/2010-04-09/download/1013/

[full-text, 10 pages]

 

Summary

The current financial crisis began in August 2007, when financial stability replaced inflation as

the Federal Reserve’s chief concern. The roots of the crisis go back much further, and there are

various views on the fundamental causes.

 

It is generally accepted that credit standards in U.S. mortgage lending were relaxed in the early

2000s, and that rising rates of delinquency and foreclosures delivered a sharp shock to a range of

U.S. financial institutions. Beyond that point of agreement, however, there are many questions

that will be debated by policymakers and academics for decades.

 

Why did the financial shock from the housing market downturn prove so difficult to contain?

Why did the tools the Fed used successfully to limit damage to the financial system from previous

shocks (the Asian crises of 1997-1998, the stock market crashes of 1987 and 2000-2001, the junk

bond debacle in 1989, the savings and loan crisis, 9/11, and so on) fail to work this time? If we

accept that the origins are in the United States, why were so many financial systems around the

world swept up in the panic?

 

To what extent were long-term developments in financial markets to blame for the instability?

Derivatives markets, for example, were long described as a way to spread financial risk more

efficiently, so that market participants could bear only those risks they understood. Did

derivatives, and other risk management techniques, actually increase risk and instability under

crisis conditions? Was there too much reliance on computer models of market performance? Did

those models reflect only the post-WWII period, which may now come to be viewed not as a

typical 60-year period, suitable for use as a baseline for financial forecasts, but rather as an

unusually favorable period that may not recur?

 

Did government actions inadvertently create the conditions for crisis? Did regulators fail to use

their authority to prevent excessive risk-taking, or was their jurisdiction too limited and/or

compartmentalized?

 

The multiple roots of the crisis are mirrored in the policy response. Two bills in the 111th

Congress—H.R. 4173, passed by the House on December 11, 2009, and Senator Dodd’s

Restoring American Financial Stability Act, as ordered reported by the Senate Banking

Committee on March 22, 2010—address many of the purported causal factors across the entire

financial system. The bills address systemic risk, too-big-to-fail, prudential supervision, hedge

funds, derivatives, payments systems, credit rating agencies, securitization, and consumer

financial protection. (For a summary of major provisions, see CRS Report R40975, Financial

Regulatory Reform and the 111th Congress, coordinated by Baird Webel.)

 

This report consists of a table that presents very briefly some of the arguments for particular

causes, presents equally brief rejoinders, and includes a reference or two for further reading. It

will be updated as required by market developments.

 



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****************************************
Stuart Basefsky                   
Director, IWS News Bureau                
Institute for Workplace Studies 
Cornell/ILR School                        
16 E. 34th Street, 4th Floor             
New York, NY 10016                        
                                   
Telephone: (607) 255-2703                
Fax: (607) 255-9641                       
E-mail: smb6@cornell.edu                  
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