!DOCTYPE html PUBLIC "-//W3C//DTD XHTML 1.0 Strict//EN" "http://www.w3.org/TR/xhtml1/DTD/xhtml1-strict.dtd"> Streamline Training & Documentation: Inventory of Proposed Causes of the Financial Crisis

Sunday, May 31, 2009

Inventory of Proposed Causes of the Financial Crisis

Reports produced by the Congressional Research Service (CRS) at the Library of Congress are not routinely made available to the public. I agree with OpenCRS that this is an unsatisfactory state of affairs. Until such time as the policy changes, anyone wanting to have a look at material from CRS is dependent on a site such as OpenCRS, or on making a special request for a particular report to a member of Congress.

A timely example of a CRS report that has made it into the public domain is "Causes of the Financial Crisis" (January 29, 2009) by Mark Jickling, a Specialist in Financial Economics at CRS.

Jickling explains the purpose and structure of his report in the summary with which it begins:
While some may insist that there is a single cause, and thus a simple remedy, the sheer number of causal factors that have been identified tends to suggest that the current financial situation is not yet fully understood in its full complexity. This report consists of a table that summarizes very briefly some of the arguments for particular causes, presents equally brief rejoinders, and includes a reference or two for further reading. It will be updated as required by market developments.
Jickling's table enumerates twenty-six causal factors that have been proposed by various analysts and commentators:
  • Imprudent mortgage lending

  • Housing bubble

  • Global financial imbalances (e.g., China's accumulation of vast amounts of US Treasury debt instruments)

  • Securitization

  • Lack of transparency and accountability in mortgage finance

  • Rating agencies

  • Mark-to-market accounting

  • Deregulatory legislation

  • Shadow banking system (e.g., hedge funds)

  • Non-bank runs (e.g., at Bear Stearns)

  • Off-balance sheet finance

  • Government-mandated subprime lending (e.g., by Fannie Mae and Freddie Mac)

  • Failure of risk management systems (e.g., as discussed here)

  • Financial innovation (e.g., development and marketing of new types of derivatives)

  • Complexity of certain financial instruments (which made their riskiness extremely hard, if not impossible, to assess)

  • Human frailty (e.g., proneness to making irrational decisions concerning investments)

  • Bad computer models

  • Excessive leverage

  • Relaxed regulation of leverage

  • Credit default swaps (CDS)

  • Over-the-counter derivatives (about which information concerning risk exposures is limited)

  • Fragmented regulation

  • No systemic risk regulator

  • Short-term incentives

  • Tail risk (i.e., risk associated with extremely rare, but not impossible, events)

  • Black Swan theory (i.e., the notion that the financial crisis is due to such an extremely rare confluence of factors that trying to guard against future repetition would require unduly onerous new regulations that would very seriously inhibit growth)
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