Lessons from the 2007 Financial Crisis

38 Pages Posted: 6 Jun 2008

See all articles by Willem H. Buiter

Willem H. Buiter

Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Columbia University; Independent Economic Adviser; Independent

Date Written: December 2007

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 Classification: D52, D53, E32, E44, E58, F37, G21, G24, G28

Suggested Citation

Buiter, Willem H., Lessons from the 2007 Financial Crisis (December 2007). CEPR Discussion Paper No. DP6596, Available at SSRN: https://ssrn.com/abstract=1140525.

Willem H. Buiter (Contact Author)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Columbia University ( email )

420 West 118th Street
New York, NY
United States

Independent Economic Adviser ( email )

Independent ( email )

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