Origins of the ‘Great Recession’

The purpose of this chapter is to discuss the origins of the crisis that emerged in August 2007, which we now know as the ‘great recession’. The focus is on the emphasis given to the Efficient Market Hypothesis (EMH), namely that all unfettered markets clear continuously, thereby making it highly unlikely that disequilibria, such as bubbles, will be the root of the crisis. Indeed, in terms of the EMH framework, economic policy designed to eliminate bubbles would lead to a situation of ‘financial repression’, which would be regarded as a very regrettable outcome. Ever since the early 1970s, when governments across the world succeeded in implementing financial liberalisation initiatives, in particular in the USA and the UK, the focus has been on creating financial markets that are free from any policy interference. This is based on the belief that liberalised financial markets are very innovative, and sure enough they are; indeed they were. Over the period prior to the ‘great recession’ and after the intense period of financial liberalisation especially in the USA, great strides were seen in the development and extension of new forms of securitisation and use of derivatives. This was a financial engineering practice, which led to the growth of collateralised debt instruments, especially so in the form of collateralised mortgages.