Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation

Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation

by Jeffrey Friedman, Wladimir Kraus


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The financial crisis has been blamed on reckless bankers, irrational exuberance, government support of mortgages for the poor, financial deregulation, and expansionary monetary policy. Specialists in banking, however, tell a story with less emotional resonance but a better correspondence to the evidence: the crisis was sparked by the international regulatory accords on bank capital levels, the Basel Accords.

In one of the first studies critically to examine the Basel Accords, Engineering the Financial Crisis reveals the crucial role that bank capital requirements and other government regulations played in the recent financial crisis. Jeffrey Friedman and Wladimir Kraus argue that by encouraging banks to invest in highly rated mortgage-backed bonds, the Basel Accords created an overconcentration of risk in the banking industry. In addition, accounting regulations required banks to reduce lending if the temporary market value of these bonds declined, as they did in 2007 and 2008 during the panic over subprime mortgage defaults.

The book begins by assessing leading theories about the crisis—deregulation, bank compensation practices, excessive leverage, "too big to fail," and Fannie Mae and Freddie Mac—and, through careful evidentiary scrutiny, debunks much of the conventional wisdom about what went wrong. It then discusses the Basel Accords and how they contributed to systemic risk. Finally, it presents an analysis of social-science expertise and the fallibility of economists and regulators. Engagingly written, theoretically inventive, yet empirically grounded, Engineering the Financial Crisis is a timely examination of the unintended—and sometimes disastrous—effects of regulation on complex economies.

Product Details

ISBN-13: 9780812243574
Publisher: University of Pennsylvania Press - University of Pennsylvania Press, Inc.
Publication date: 10/24/2011
Pages: 224
Product dimensions: 5.90(w) x 9.10(h) x 1.00(d)

About the Author

Jeffrey Friedman is a visiting scholar in the Department of Government at the University of Texas, Austin. He is the editor of What Caused the Financial Crisis, also available from the University of Pennsylvania Press, and editor of the journal Critical Review. Wladimir Kraus is a doctoral candidate in economics at Universite Paul Cezanne Aix-Marseille and associate editor of Critical Review. Together, Friedman and Kraus maintain Causes of the Crisis, a blog that publishes updated information about the financial crisis.

Table of Contents

List of Figures and Tables
Glossary of Abbreviations and Acronyms

1 Bonuses, Irrationality, and Too-Bigness: The Conventional Wisdom About the Financial Crisis and Its Theoretical Implications
2 Capital Adequacy Regulations and the Financial Crisis: Bankers' and Regulators' Errors
3 The Interaction of Regulations and the Great Recession: Fetishizing Market Prices
4 Capitalism and Regulation: Ignorance, Heterogeneity, and Systemic Risk

Appendix I. Scholarship About the Corporate-Compensation Hypothesis
Appendix II. The Basel Rules off the Balance Sheet

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