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The political, regulatory and market failures that caused the US financial crisis

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  • Tarr, David G.

Abstract

This paper discusses the key regulatory, market and political failures that led to the 2008-2009 United States financial crisis. While Congress was fixing the Savings and Loan crisis, it failed to give the regulator of Fannie Mae and Freddie Mac normal bank supervisory power. This was a political failure as Congress was appealing to narrow constituencies. In the mid-1990s, to encourage home ownership, the Administration changedenforcement of the Community Reinvestment Act, effectively requiring banks to lower bank mortgage standards to underserved areas. Crucially, the risky mortgage standards then spread to other sectors of the market. Market failure problems ensued as banks, mortgage brokers, securitizers, credit rating agencies, and asset managers were all plagued by problems such as moral hazard or conflicts of interest. The author explains that financial deregulation of the past three decades is unrelated to the financial crisis, and makes several recommendations for regulatory reform.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5324.

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Date of creation: 01 May 2010
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Handle: RePEc:wbk:wbrwps:5324

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Keywords: Debt Markets; Access to Finance; Emerging Markets; Banks&Banking Reform; Bankruptcy and Resolution of Financial Distress;

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  1. Efraim Benmelech & Jennifer Dlugosz, 2010. "The Credit Rating Crisis," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 161-207 National Bureau of Economic Research, Inc.
  2. Grossman, G.M. & Helpman, E., 1992. "Protection for Sale," Papers, Princeton, Woodrow Wilson School - Public and International Affairs 162, Princeton, Woodrow Wilson School - Public and International Affairs.
  3. Steven C. Bourassa & Ming Yin, 2006. "Housing Tenure Choice in Australia and the United States: Impacts of Alternative Subsidy Policies," Real Estate Economics, American Real Estate and Urban Economics Association, American Real Estate and Urban Economics Association, vol. 34(2), pages 303-328, 06.
  4. Efraim Benmelech & Jennifer Dlugosz, 2009. "The Alchemy of CDO Credit Ratings," NBER Working Papers 14878, National Bureau of Economic Research, Inc.
  5. Jaffee Dwight M. & Perlow Mark, 2008. "Investment Banking Regulation After Bear Stearns," The Economists' Voice, De Gruyter, De Gruyter, vol. 5(5), pages 1-5, September.
  6. Rong Fan & Joseph G. Haubrich & Peter Ritchken & James B. Thomson, 2002. "Getting the most out of a mandatory subordinated debt requirement," Working Paper 0214, Federal Reserve Bank of Cleveland.
  7. Ben S. Bernanke & Cara S. Lown, 1991. "The Credit Crunch," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 22(2), pages 205-248.
  8. Neil Bhutta, 2008. "Giving credit where credit is due? the Community Reinvestment Act and mortgage lending in lower-income neighborhoods," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2008-61, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Abdala Rioja, Yamile E, 2011. "All Things Considered: The Interaction of the Reasons for the Financial Crisis," MPRA Paper 33408, University Library of Munich, Germany.

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