Two Theories of the Subprime Crisis: Governance Failure or Mere Greed?

21 Pages Posted: 12 Dec 2009

Date Written: December 11, 2009


This paper examines two theories of the current financial epoch referred to as the 'subprime crisis.' One theory is rooted in a tradition of policy activism which holds that the failure of the financial system was fundamentally driven by institutional faults, especially in private sector risk management and public sector regulatory functions. Referred to here as the 'Financial Architecture' school of thought, this broad outlook underpins the system reform approaches currently being taken by much of the developed world. The other theory is more polyglot but emphasises the irrational and often self-destructive aspects of human behaviour as well as the limits to change of complex systems which lead to inevitable cycles and collapses, of which this latest is but a particularly prominent example. Referred to here as the 'Inevitability' school, the basic notion here is, to quote Shakespeare, that the fault is not so much within our stars but within ourselves. Authors implicitly or explicitly supporting this view include Hyman Minsky, George Soros and various behavioural finance theorists. Interestingly, John Maynard Keynes can be claimed by both policy camps, with Fiscal Architecture school adherents using demand reflation as one of its activist instruments while the more pessimistic Inevitability school, including post-Keynesian Minsky, can refer to Keynes' observations about animal spirits and other nonrational elements of human economies. This paper provides a framework for assessing the relative merit of these two theories in explaining the current debacle and then applies that framework to existing evidence focusing on the role that institutional governance failure may or may not have played. The general conclusion is that both schools explain parts of the crisis, and that institutional reforms are likely to have relatively little preventive effect beyond the short to medium term.

Keywords: governance, subprime crisis, GFC, Keynes, Minsky

JEL Classification: E65, E32

Suggested Citation

Gordon, Cameron Elliott, Two Theories of the Subprime Crisis: Governance Failure or Mere Greed? (December 11, 2009). Available at SSRN: or

Cameron Elliott Gordon (Contact Author)

University of Canberra ( email )

Canberra, Australian Capital Territory 2601
6201 2685 (Phone)

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