Working Paper: CEPR ID: DP6596
Authors: Willem H. Buiter
Abstract: The paper studies the causes of the current financial crisis and considers proposals for mitigation and prevention of future crises.The crisis is was the product of a ?perfect storm? bringing together a number of microeconomic and macroeconomic pathologies. Among the microeconomic systemic failures were: wanton securitisation, fundamental flaws in the rating agencies? business model, the procyclical behaviour of leverage in much of the financial system and of the Basel capital adequacy requirements, privately rational but socially inefficient disintermediation, and competitive international de-regulation. Proximate local drivers of the specific way in which these problems manifested themselves were regulatory and supervisory failure in the US home loan market. Among the macroeconomic pathologies that contributed to the crisis were, first, excessive global liquidity creation by key central banks and, second, an ex-ante global saving glut, brought about by the entry of a number of high-saving countries (notably China) into the global economy and a global redistribution of wealth and income towards commodity exporters that also had, at least in the short run, high propensities to save.In the UK, failures of the Tripartite financial stability arrangement between the Treasury the Bank of England and the FSA, weaknesses in the Bank of England?s liquidity management, regulatory failure of the FSA, an inadequate deposit insurance arrangement and deficient insolvency laws for the banking sector contributed to the financial disarray.Despite this, it may well be possible to minimize the spillovers over from the crisis beyond the financial sectors of the industrial countries and the housing sectors of the US and a few European countries.
Keywords: Collateral; Financial Stability; Leverage; Liquidity; Rating Agencies; Regulation; Securitization
JEL Codes: D52; D53; E32; E44; E58; F37; G21; G24; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| procyclical behavior of leverage (E44) | financial crisis (G01) |
| Basel capital adequacy requirements (G28) | procyclical behavior of leverage (E44) |
| procyclical behavior of leverage (E44) | asset price fluctuations (G19) |
| asset price fluctuations (G19) | systemic instability (D50) |
| excessive global liquidity creation by central banks (F65) | mispricing of risk (G19) |
| global saving glut (E21) | mispricing of risk (G19) |
| mispricing of risk (G19) | liquidity crisis (G01) |
| regulatory failures in UK and US (G18) | financial turmoil (G01) |
| tripartite financial stability arrangement flaws (F32) | inadequate responses to emerging risks (H12) |