The 2008 Financial Crisis: Crash Course Economics #12

Trading transactions in

financial

derivatives are under the watchful eye of market participants and mechanisms have been established that allow large banks to default on their obligations in a controllable and predictable manner. But there is no consensus on whether this law is enough to prevent future crises. So what have we learned from all this? One of the main factors that led to the

2008

financial

crisis

was corrupt incentives. A perverse incentive is when a policy has a negative effect opposite to the intended effect. For example, mortgage brokers received bonuses because they lent more money, but that encouraged them to make riskier loans, which ultimately hurt profits.

This brings us to moral hazard, which is when one person takes on more risk because another person will bear the burden. of that loss. Banks and lenders who are willing to make loans to borrowers with poor credit because they plan to sell the mortgage to someone else. They all thought that they would escape danger later. The phrase “too big to fail” is a perfect example of moral hazard. If banks know the government will bail them out, they will have an incentive to make risky or perhaps unwise bets. Former Federal Reserve Chairman Alan Greenspan summed it up eloquently when he said: "If they're too big to fail, they're too big." When something terrible happens, people naturally look for someone to blame, and in the financial

crisis

of

2008

, no one had to look far because blame and pain spread throughout the American economy.

The government failed to regulate or supervise the financial system, and to quote the report of the bipartisan Commission of Inquiry into the Financial Crisis: “Oversight agencies were not in place, as a result of widespread confidence in the self-correcting nature of markets and the ability of financial institutions to monitor themselves effectively.” The report placed some of the blame on years of lack of enforcement in the financial sector, and also blamed regulators themselves for not doing more. The financial industry has failed. Everyone in the sector is borrowing too much money and taking on too much risk, from large financial institutions to individual borrowers.

Institutions were taking out huge loans to invest in risky assets, and large numbers of homeowners were taking out mortgages they couldn't afford. But what we must remember about this massive systemic failure is that it occurred in a system made up of human beings and with human flaws. Some did not understand what was happening, others were willfully ignoring the problem, and others were simply unethical motivated by the huge amounts of money involved. I think that today we should give the last word to the report of the Commission of Inquiry into the Economic Crisis: “To paraphrase Shakespeare, the fault lies not with the stars but with us,” they wrote.

Thanks for follow me. Crash

course

: the economy is made with the help of all these kind people. We can avoid our own financial crisis every month thanks to your support on Patreon. You can help keep Crash Course free for everyone forever. And get great rewards at Patreon.com. Given our topic today, be forceful but rational.