Chapter 18

Learning from the 2007–08 Financial Crisis


Understanding the causes of the crisis

Seeing why no one could predict the crisis

Learning lessons from the crisis

The 2007–08 global financial crisis was extremely painful. In the U.S., it ushered in a deep recession from which it is only nearing a full recovery now, some eight years later. But the pain wasn’t confined to America. All over the world, living standards fell, nest eggs vanished, and houses and jobs were lost. We saw in Chapter 17 how a banking crisis may result from a self-fulfilling expectation. But well before the crisis, many safeguards had been established to protect against such bad outcomes and steer the economy to a good equilibrium. How did the crisis happen despite these protections? And how was it that few if any economists or other market participants saw the crisis coming? Can policy-makers do anything to limit crises or at least reduce their impact in the future?

Housing clearly played a key role in the crisis. In this chapter, we explore how commercial banking changed in the last 20 years and how that changed the nature of housing finance. We return to the ideas of complexity and coordination failure but set these now in a different kind of banking network that many now call the shadow banking system. Finally, we talk about why it’s hard for economists or anyone else to predict crises and what policy changes may make them less severe in the future. Everyone agrees (we think) that ...

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