TOO BIG TO FAIL

Too Big to Fail: Global Financial Crisis, Causes, Consequences and the Role of Government

Global Financial Crisis, Causes, Consequences and the Role of Government

Introduction

The title of my article refers to an expression, “too big to fail,” that gained considerable traction and currency as a diagnosis of the recent “financial crisis” and the political response to it in the United States since the fall of 2008. Though the expression was used by economists, policy makers, and journalists before 2004, the term became linked to the crisis and strategies of response.

Many books, and to a certain degree the Congressional reports in this regard, were critical of the finance practices and governmental policies that, particularly since the late 1990s, enabled certain financial institutions in the United States such as American International Group (AIG), the Bank of America, Citigroup, Goldman Sachs, Lehman Brothers, J. P. Morgan Chase, Morgan Stanley, and Wells Fargo to operate without sufficient governmental oversight and to obfuscate their exposure to risky investments, however these are also the major players in financial crisis. (Abel, 2000) As diagnoses of a critical state of economy and government, their adoption of the catchphrase “too big to fail” (in all its alliterative irony) represented a variety of failures that at last exposed the true origins of the crisis, and rational strategies for correcting those failures. They also became productive of (and within) this critical state, a state of critique, as historians and forecasters of a society at risk because of the failure of institutions and their administrators to manage risk effectively.

Causes of Financial Crisis

This crisis has several interconnected causes. It is helpful to separate them into four causal factors familiar to recent financial crises (such as in Norway in 1987, Sweden in 1991 and Japan in 1992); and four causal factors (Aaron, Barry, and Gary, 2009) that are less familiar and have made this crisis unique in its breadth and depth.

Familiar Factors

Rising Asset Prices

As with the other major crises, house prices rose sharply leading up to this crisis—particularly in the US and other advanced countries such as the UK and Iceland. In the US, house prices rose more than 30 per cent from 2004, peaking six quarters prior to the beginning of the crisis. In emerging markets and other countries similar price increases were observed, often associated with a rapid growth in credit, resulting in an escalation of household leverage.

The Credit Boom

Rising house prices were facilitated by a boom in credit. In the US, financing to households rose rapidly after 2000, driven largely by mortgages outstanding, historically low interest rates and financial innovation. Despite low interest rates, debt servicing relative to disposable income reached record highs. Credit booms often coincide with large cyclical fluctuations in economic activity—with real output, consumption and investment rising above trend during the build-up phase of a boom and falling below trend in the unwinding phase. (Aaron, Barry, and Gary, 2009) For many emerging market economies, these credit booms had a clear relationship ...