What Caused The Global Financial Crisis?

Professor L. Randall Wray, discussing the global financial crisis in broad strokes. The economist Hyman Minsky developed a theory of financial fragility and the long-run evolution of the economy, summarized briefly as "stability is destabilizing." In the aftermath of the Great Depression, the worst banks had failed, the remaining ones were scarred by the memories of the disaster, and the government had put in place extensive regulation to ensure they behaved, and this variety of capitalism (what Minsky called "paternalistic capitalism") proved very stable.
But stability is destabilizing. As time wore on and memories faded, people changed their outlook and changed their behavior. Banks took on greater risk, and fringe financial institutions (which came to be known as shadow banks) put increased pressure on the traditional banks by taking on even bigger bets. Politicians came to view financial regulation as burdensome, and academic economic theory became so far removed from reality that the models used by the top economists at the central banks didn't even allow for the possibility of a financial crisis.
As a result of World War 2, government debt ballooned, and these safe government bonds served as private wealth which was leveraged in order to grow and keep full employment in the post-war era. But as fiscal policy tightened (the focus shifted from "full employment" to "balance the budget"), and real wages stagnated, further growth could only be accomplished by piling on private debt, which grew to astounding heights by the mid-2000s. These debts are liabilities for the borrowers, but assets for the holders, and so the huge increase in debt meant huge increases in financial wealth for the top 1%, and all this money needs to be managed, hence Minsky's term "money-manager capitalism."
Important changes were also happening to the way financial institutions were operating. The mid-century bank business model consisted of issuing deposits (bank money) in order to finance purchase of mortgage notes from borrowers, which the bank would then hold and collect the interest income. But to evade regulations, compete with shadow banks, and avoid a potential adverse change in the interest rate, banks shifted to a new much more fragile business model. In the new model, banks would make loans with the intent to package them into securities and sell them as quickly as possible, and as a result, the bank didn't care very much whether you could pay back the loan, and didn't bother to find out (which is sort of the whole point of having banks). Other institutions would then issue short-term or even overnight debt to yet other financial institutions, in order to finance their purchase of these packages of mortgages. These mortgage-backed securities would then be carved into sections and sold to yet other financial institutions. As a result of all of this, debt between financial institutions rocketed upward.
All of this private debt makes the system increasingly fragile, leading to what Minsky called "Ponzi finance." If you are dependent on your income to be able to make your debt payments, then an unexpected fall in income could force you to default. If your creditors were counting on your debt payments to be able to make their own debt payments, then now they are forced to default as well. And so on. The result is a ripple of contagion, leading to bankruptcies, fire-sales of assets, and possibly bank runs. As financial institutions stop lending or even close down, normal business investment falls, and the result on Main Street is unemployment and people losing their homes.
To get more detail on the causes of the crisis and the long-run evolution of the financial system, as well as suggestions for what to do about it, read Wray's book on Minsky's work, entitled "Why Minsky Matters": www.barnesandn...
Watch the whole video here: • Randall Wray
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[@roccomillion5614]

Thank you Dr wray. Great explaination.

[@thomasd2444]

04:00 - For every dollar there was $5 of private debt? $5 of public debt? A $5 mix-total?

[@barrygaynor1025]

Did it have anything to do with irresponsible fiscal policies and mismanagement? How about corruption? Could it have anything to do with our failure to learn from the stock market crash of 1929 and the subsequent Great Depression?

[@IvanVesely920]

Is the prof. talking about financial institution commercial paper collateralized (repo) funding of positions?

[@james1098778910]

What's the connection between household debt and the bubble bubble 2008?

[@danmoore9363]

Private sector debt is important.

[@derekmcdaniel6029]

Lots of government debt: "very safe balance sheets", not everyday that you hear that from commentators.

[@Tenebrousable]

"Yeah, we got too much debt, let's lower the interest rate." You don't fix too much debt by taking more of it. You people are a joke.

[@andrewprice8820]

The proper tool is prudential regulation, not tweaking interest rates.

[@Tenebrousable]

@@andrewprice8820 What regulation? Do you assing a bureacrate to assess if the loan is good or not? Someone without zero skin in the game, to asses if the investment is good or not? Easiest thing of all, is to gamble with other peoples monies. You nor anyone else in the whole literal world knows what the regulation should be. Tweaking the interest rate is the biggest part of the problem. If we give them that power? They will allways lower those rates. To enable more government deficit spending. And exasbarating the boom and bust cycle. As we have seen trough the recent 50 year history. That results in more debt that can be accounted for. As we have also seen.

[@jorelj7748]

@@Tenebrousable You write like an uneducated person. Why should I listen to what you have to say? You're clearly not anything like an expert.

[@Tenebrousable]

@@jorelj7748 You shouldn't. Just look and see, and figure out what it means yourself. Do we (the people) have too much or too little debt? Do we want more of it? Do government want more of it? Does government want us (the people) get more debt? We are hurting because all we have is debt, and no income nor savings to keep the house of cards standing. How much food will California produce, if FED prints a trillion dollars, and all the farmers stay home, do you think?

[@isawaturtle]

@@Tenebrousable as soon as you said “print” that gave away the fact you don’t know what you’re talking about.