Friday, December 17, 2010

Causes of the 2008 financial collapse

Paul Krugman provided a very quick and accurate description of what caused the 2008 Financial Collapse and set off the Great Recession.
First, there was a widely spread housing bubble, not just in the United States, but in Ireland, Spain, and other countries as well. This bubble was inflated by irresponsible lending, made possible both by bank deregulation and the failure to extend regulation to “shadow banks,” which weren’t covered by traditional regulation but nonetheless engaged in banking activities and created bank-type risks.

Then the bubble burst, with hugely disruptive consequences. It turned out that Wall Street had created a web of interconnection nobody understood, so that the failure of Lehman Brothers, a medium-size investment bank, could threaten to take down the whole world financial system.
This is shorthand, but quite accurate.

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