Advancing a Free Society

The cause of the crisis (and how to prevent the next one)

Monday, November 21, 2011

One standard narrative of the cause of the financial crisis coming from people generally on the left is that a free-market ideology blinded policy-makers. They foolishly followed a policy of deregulation that allowed banks to run amok. And calls for regulation, such as attempts to regulate the derivative market, were ignored.

This theory is partly correct. There was some deregulation–various policy changes that let banks expand their activities. What this narrative ignores are other government policies that raised the likelihood of irresponsible investing but that were not based on a free-market ideology. In the particular, there were the relentless bailouts of large creditors that took place in the run-up to the crisis–interventions that were inconsistent with free-market ideology and that destroyed the feedback loops that might have prevented the crisis from occurring.

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