2013 Reports

Five Years Later: Lessons from the Financial Crisis

Shafer, Jeffrey R.

The deepest economic collapse in 75 years occurred because of a widespread failure across the financial system rather than a single cause. In order to safeguard the economy in the future, I propose in this paper that strong regulation, implementation and enforcement of systemic protections and emergency lending capabilities are needed. I examine the problems that converged to create the financial crisis, and provide 10 insights from that period. Among the causes of the crisis I examine: global imbalances, a housing bubble, loose monetary policy, a very large increase in short-term market financing of broker dealers and portfolios, excessive leverage, and shadow banking. The paper provides new insight into how the crisis is connected to the fall of residential mortgage-backed securities prices and their drop in value as collateral. It also discusses the connection to incentive compensation and to opacity driven by complex financial instruments such as collateralized debt obligations (CDOs), derivatives, and exotic mortgages, which may not have been fully understood by many who dealt with them, including those who designed them.