What Caused The Global Financial Crisis according to Larry Allen

The Global Financial Crisis according to Larry Allen

Larry Allen is a Professor of Economics at Lamar University in Texas. He is the author of The Global Economic Crisis: A Chronology (2013) The Encyclopedia of Money (1999, 2009), and Global Financial System 1750-2000 (2004).

1. Which FCIC View best represents the causes of the Financial Crisis?

Dissenting Views By Hennessey, Holtz-Eakin & Thomas

2. Which narrative presented by Douglas Elliott and Martin Baily of the Brookings Institute in Telling the Narrative of the Financial Crisis: Not Just a Housing Bubble best represents the causes of the Financial Crisis?

The blame for the crisis should be laid at the feet of Wall Street.

3. The Global Financial Crisis effectively ended in the year 2011
After 2011 the number of bank failures began to drop off significantly, marking that year as the last year of the financial crisis. The economic crisis is still on going.

4. What were the primary causes of the Global Financial Crisis?
The economy emerged from the recession of 2001 with a weak-winged, bubble driven expansion. The Federal Reserve faced the thorny task of defusing bubble-building forces without erasing the gains the economic recovery had captured from the bubbles. Investors began embracing riskier investments in a bid to maintain rates of return in the face of a long trend of declining interest rates. In cautious monetary tightening the yield curve flattened out, tending to equalize short-term and long-term interest rates. Since banks make profits by borrowing short-term at low rates and lending long-term at higher rates, the flatter yield curve weakened the banking system. Banks tried to save themselves by undertaking riskier investments, and using advanced technology to better evaluate risks. Traditional mortgage applications appeared less important in a world where the computer and internet afforded newer methods of collecting and evaluating vital information about each applicant. It was hoped that newer technology provided better information and better information made free markets work even better. It was a well-sounding, well-intended strategy that did not meet all the needs of the situation.

5. What still should change as a result of the crisis?

A worldwide savings glut is making it difficult to maintain an adequate level of demand for goods and services. Interest rates have gone as low as they can go to assist in this problem. China and perhaps other East Asian countries need social programs that reduce the need for high savings in those countries. Reducing income inequality can help with the savings glut, but that is very controversial. Strengthening the middle class puts more people in a position to borrow excess savings to finance consumer goods. The upper middle class Jones will up its spending to keep up with the living standard of the lower middle class Jones.

A second problem is booming commodity prices relative to prices of manufactured goods. There is much evidence that booming commodity prices are a symptom of easy monetary policies. Eventually these booming commodity prices will bring forth extra supplies of commodities and these prices will fall. Cheaper commodities will straighten the path for robust economic recovery in the advanced economies. The emerging economies will suffer a setback when commodity prices break, but the advanced economies will see a sounder recovery.

Elevated unemployment reflects the ongoing assimilation of newer technologies. Ultimately a reduction of the hours worked per week can help the unemployment rate, but it might not be feasible for one government to act unilaterally in this area.

Compiled by Gary Karz, CFA
Host of InvestorHome

Global Financial Crisis Survey

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