Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’
AbstractThe main thesis of this paper is that the ultimate cause of the current global financial crisis is to be found in the deeply flawed institutions and practices of what is often referred to as the New Financial Architecture (NFA) – a globally integrated system of giant bank conglomerates and the so-called ‘shadow banking system’ of investment banks, hedge funds and bank-created Special Investment Vehicles. The institutions are either lightly and badly regulated or not regulated at all, an arrangement defended by and celebrated in the dominant financial economics theoretical paradigm – the theory of efficient capital markets. The NFA has generated a series of ever-bigger financial crises that have been met by larger and larger government bailouts. After a brief review of the historical evolution of the NFA, the paper analyses its structural flaws. The problems discussed in order are: 1) the theoretical foundation of the NFA – the theory of efficient capital markets – is very weak and the celebratory narrative of the NFA accepted by regulators is seriously misleading; 2) widespread perverse incentives embedded in the NFA generated excessive risk-taking throughout financial markets; 3) mortgage-backed securities central to the boom were so complex and nontransparent that they could not possibly be priced correctly; their prices were bound to collapse once the excessive optimism of the boom faded; 4) contrary to the narrative, excessive risk built up in giant banks during the boom; and 5) the NFA generated high leverage and high systemic risk, with channels of contagion that transmitted problems in the US subprime mortgage market around the world. Understanding the profound problems of the NFA is a necessary step toward the creation of a new and improved set of financial institutions and practices likely to achieve core policy objectives such as faster real sector growth with lower inequality. JEL Categories:
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by University of Massachusetts Amherst, Department of Economics in its series UMASS Amherst Economics Working Papers with number 2008-14.
Date of creation: Sep 2008
Date of revision:
Other versions of this item:
- James Crotty, 2009. "Structural causes of the global financial crisis: a critical assessment of the 'new financial architecture'," Cambridge Journal of Economics, Oxford University Press, vol. 33(4), pages 563-580, July.
- James Crotty, 2008. "Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’," Working Papers wp180, Political Economy Research Institute, University of Massachusetts at Amherst.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Peter Folkman & Julie Froud & Sukhdev Johal & Karel Williams, 2007. "Working for themselves? Capital market intermediaries and present day capitalism," Business History, Taylor & Francis Journals, vol. 49(4), pages 552-572.
- Reinhart, Carmen M. & Rogoff, Kenneth S., 2008.
"Is the 2007 US Sub-Prime Financial Crisis So Different? An International Historical Comparison,"
11129156, Harvard University Department of Economics.
- Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "Is the 2007 US Sub-prime Financial Crisis So Different? An International Historical Comparison," American Economic Review, American Economic Association, vol. 98(2), pages 339-44, May.
- Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(3), pages 291-299, September.
- Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison," NBER Working Papers 13761, National Bureau of Economic Research, Inc.
- Gene Amromin & Steven A. Sharpe, 2008.
"Expectations of risk and return among household investors: Are their Sharpe ratios countercyclical?,"
Finance and Economics Discussion Series
2008-17, Board of Governors of the Federal Reserve System (U.S.).
- Gene Amromin & Steven A. Sharpe, 2009. "Expectations of risk and return among household investors: Are their Sharpe ratios countercyclical?," Proceedings, Federal Reserve Bank of San Francisco, issue Jan.
- William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
- Raghuram G. Rajan, 2005.
"Has Financial Development Made the World Riskier?,"
NBER Working Papers
11728, National Bureau of Economic Research, Inc.
- Raghuram G. Rajan, 2005. "Has financial development made the world riskier?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, issue Aug, pages 313-369.
- Caballero, R J. & Krishnamurthy, A., 2008. "Musical chairs: a comment on the credit crisis," Financial Stability Review, Banque de France, issue 11, pages 9-11, February.
- Janet L. Yellen, 2008. "The financial markets, housing, and the economy," Speech 48, Federal Reserve Bank of San Francisco.
- L. Randall Wray, 2007.
"Lessons from the Subprime Meltdown,"
Economics Working Paper Archive
wp_522, Levy Economics Institute.
- L. Randall Wray, 2006. "Can Basel II Enhance Financial Stability?: A Pessimistic View," Economics Public Policy Brief Archive ppb_84, Levy Economics Institute.
- Markus K. Brunnermeier, 2008. "Deciphering the Liquidity and Credit Crunch 2007-08," NBER Working Papers 14612, National Bureau of Economic Research, Inc.
- James Crotty, 2007. "If Financial Market Competition is so Intense, Why are Financial Firm Profits so High? Reflections on the Current ‘Golden Age’ of Finance," Working Papers wp134, Political Economy Research Institute, University of Massachusetts at Amherst.
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page. reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Lisa Saunders).
If references are entirely missing, you can add them using this form.