The Global Financial
Crisis of 2008
“The global pool of money”
Subprime crisis  housing bust  credit
crunch  global financial crisis  Great
• ¼ of residential mortgages “underwater”
(w/negative equity)
• “real” unemployment is about 17% (counting
discouraged and underemployed workers)
• cuts to public spending (social services) at all
• And now: “foreclosure crisis”
Role reversal?
In the lead-up to the 2008 global
financial crisis, the “hot money” is
pouring into the US, fueling a
“speculative real estate boom” like
the ones seen in East Asia in the late
History of US financial regulation
1940s-1970s: Regulatory Expansion
1980s-present: Deregulation
circa 2011?
• uncertainty
• crisis
Key events in US financial regulation
1940s-1970s - Regulatory Expansion: highly regulated financial
institutions, high capital requirements, capital controls, etc., took us out of
historical boom-bust cycles
• Glass-Steagall Act (1933) mandated a separation between commercial
banking (handling deposits and lending) and investment banking (buying/selling
securities, underwriting, etc.)
1980s-present - Deregulation: placing faith in free markets, regulation
was loosened, regulatory agencies downsized, increasingly leveraged
banks, growth of derivatives, high-frequency trading – highly volatile
Sparked by the Reagan revolution, deregulation continued under Democratic and
Republican administrations alike
• Gramm-Leach-Bilely Financial Services Modernization Act
(1999):tore down Glass-Steagall's wall separating commercial and investment
• Commodity Futures Modernization Act (2000): banned the
regulation of derivatives
2010: Dodd-Frank Wall Street Reform & Consumer Protection Act
Critics charge the bill is weak, and many provisions won’t take effect for years
Bill does not fundamentally address incentive structures that promote risk taking
or Too Big To Fail (TBTF) -- systemic risk
 TARP (aka the bank bail-out) made big banks bigger
Arguments for separating
commercial & investment banking
Conflicts of interest characterize the granting of credit
(lending) and the use of credit (investing) by the same
Depository institutions possess enormous financial power,
by virtue of their control of other people’s money (O-P-M),
must be limited to ensure soundness and competition in the
market for funds (loans or investments)
Securities activities can be risky, leading to enormous
losses, which could threaten the integrity of deposits
• In turn, the Government insures deposits and could be
required to pay large sums if depository institutions were to
collapse as the result of securities losses
Depository institutions are supposed to be managed to limit
risk, so managers may not be conditioned to operate
prudently in more speculative securities businesses
“Why We Have to Change
Joseph Stiglitz, Excerpted from
Freefall: Free Markets and the
Sinking of the Global Economy,
The Great Recession that began in
America in 2008 soon turned global
Millions of Americans lost their
homes & jobs
 Many more saw their retirement and
education investments dwindle in
 Soon tens of millions lost their jobs
• 20m in China alone
Economic bubbles
economic bubble: buying and selling in
high volumes in assets with inflated values
(i.e., at prices far in excess of intrinsic
values). Sometimes called speculative
bubbles, they are typically the result of a
"bandwagon effect," where investors,
seeing an upward trend in prices, quickly
enter the market; typically, bubbles are
followed by even faster sell-offs once
prices decline.
Boom-bust cycle
Boom-bust cycle: a pattern of performance over
time in an economy or an industry that alternates
between extremes of rapid growth (booms) and
extremes of slow growth or decline (busts), as
opposed to sustained steady growth, extreme
form of business cycle
Examples of "Booms & Busts":
Holland's Tulip mania in the 1630s
California Gold Rush of the late 1840s
Roaring Twenties that led to Wall Street Crash of 1929
Dot-com bubble in the late 1990s
Subprime lending boom in the 1990s and early 2000s,
followed by the Subprime Mortgage Crisis of 2006 and
Housing bubbles
In late stages, characterized by:
• rapid increases in valuations of real property until
unsustainable levels are reached (relative to incomes,
price-to-rent ratios, and other indicators of affordability)
• reduction in price levels
• falling home prices put many owners "underwater," in a
position of negative equity (a mortgage debt higher than
the value of the property)
US Housing Bubble:
• At national level in the US, housing prices peaked in
early 2005, and started to decline in 2006
• Underlying causes are complex; factors include
historically low interest rates, lax lending standards
(including predatory lending), and a speculative fever
Current crisis has uncovered deep flaws in
capitalist system, esp. American-style capitalism
Even incomes in the middle have
stagnated for at least a decade
 Increasing income/wealth inequality
 Declining social mobility
statistical chances of a poor American making
it to the top are lower than in “Old Europe”
Rugged individualism & market fundamentalism
have undermined community and trust
Even in a market economy, trust is
the grease that makes society
 Big lesson of the crisis is that our
complex financial system still
depends on trust – when trust broke
down, financial system froze
Excessive risk-taking in the financial
sector caused the crisis. Solution?
Reinstitute regulations & change
incentive structures that reward
excessive risk-taking
• reinstitute Glass-Steagall
(some version of it)
Increase transparency
 Increase capital requirements for
 Overall: reduce leverage & place
restrictions on risky products
But US response–NSA bail-outs–
was shaped by same political
forces that caused crisis
revolving door: movement of personnel
between roles as legislators and regulators
(of industries personnel had previously
legislated on)
• can lead to “regulatory capture”
moral hazard, or the adverse incentives
provided by bail-outs & expectations of
bail-outs, has only increased
Too Big To Jail?
America’sTheft Inflection Point?

3.22 – The Global Financial Crisis