The Global Financial Crisis according to Nolan McCarty

Global Financial Crisis Survey

Nolan McCarty is a Professor of Politics and Public Affairs at Princeton and co-author of Political Bubbles: Financial Crises and the Failure of American Democracy.

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

Majority Conclusions

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?

"Everyone" was at fault: Wall Street, the government, and our wider society. Wall Street deserves proximate blame, but the crisis was aided by a dysfunctional political and regulatory system.

3. The Global Financial Crisis effectively ended in the year

2009. The U.S. crisis began to wind down after the bank stress tests in 2009. But the seeds of the next crisis were sown by the very limited reforms of Dodd-Frank (and the ensuing regulatory delay and backsliding)

4. What were the primary causes of the Global Financial Crisis?

Five factors turned the housing bubble that hit the U.S. and other countries into a full-fledged crisis. The first was deregulation that permitted innovative new financial instruments, such as exotic mortgage products, CDO tranches, and credit default swaps to emerge without meaningful regulation. The second was deregulation that permitted financial firms to engage in a riskier range of activities. The third was a reduction in the monitoring capacity of regulators, either through deliberate neglect or in the failure of staffing and budgets to expand at the same rate as the markets they were supposed to regulate. The fourth was the shifts in competition policy that allowed the creation of financial institutions that were too big (and too politically powerful) to fail. The fifth component was the privatization of government financing of mortgages through Fannie and Freddie, which created two additional too-big-to-fail institutions.

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

The main failures of financial regulatory reform in the U.S. are that little was done to address complexity and concentration in the financial sector. Dodd-Frank responded to complexity with a very complex piece of legislation and a mandate for regulators to implement it with an even more complex set of rules. Such complexity creates large risks for regulatory backsliding and poor implementation. Dodd-Frank also did not deal sufficiently with concentration and too-big-to-fail. This perpetuates financial risk and the political risk that the sector will be able to undermine regulatory efforts.

Compiled by Gary Karz, CFA
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Global Financial Crisis Survey

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