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BPEA Article

The Crisis

Abstract

Geopolitical changes following the end of the Cold War
induced a worldwide decline in real long-term interest rates that, in turn, produced
home price bubbles across more than a dozen countries. However, it
was the heavy securitization of the U.S. subprime mortgage market from 2003
to 2006 that spawned the toxic assets that triggered the disruptive collapse of
the global bubble in 2007–08. Private counterparty risk management and official
regulation failed to set levels of capital and liquidity that would have
thwarted financial contagion and assuaged the impact of the crisis. This woeful
record has energized regulatory reform but also suggests that regulations
that require a forecast are likely to fail. Instead, the primary imperative has to
be increased regulatory capital, liquidity, and collateral requirements for banks
and shadow banks alike. Policies that presume that some institutions are “too
big to fail” cannot be allowed to stand. Finally, a range of evidence suggests
that monetary policy was not the source of the bubble.

Commenters

Jeremy C. Stein

Moise Y. Safra Professor of Economics - Harvard University

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