The Crisis of 2007--09: Nature, Causes, and Reactions

This article analyses the nature and causes of the financial crisis of 2007--09 as well as the regulatory responses. There are two types of crises: banking crises, which affect the money stock and thus threaten the economy, and financial crises, which may destroy wealth but do not endanger the economy as a whole. Banking crises can be precipitated by a shortage of capital or by a shortage of liquidity. The 2007--09 crisis was a banking crisis, caused by a capital shortage. Numerous explanations have been given for this crisis. In this article these explanations are organized into ten groups. The main factors were easy money, excessive leverage, risk-management failures, bad lending, too-big-to-fail (TBTF) policies, inadequate supervision, and ill-thought-out regulation. The flurry of responses to the crisis is then summarized. Some are welcome, but the article concludes that unless the fear of failure returns to banking, so that management, shareholders, bondholders, and all creditors (except small depositors) suffer in a failure, then all other reforms will ultimately be pointless. Oxford University Press 2010, all rights reserved, Oxford University Press.