Lax financial regulation

Throughout the neoliberal epoch domestic financial markets were systematically deregulated. With the liberalization of international capital markets, finance became truly global. Financial regulation, however, remained essentially a national prerogative (Posner, 2009). Banking deregulation accelerated financial innovation in the packaging, trading, and distribution of derivatives, credit default swaps, collateral debt obligations, and other securitized financial instruments. As securitization grew in importance, this development was applauded by many economists and policymakers as serving to mitigate banking risks while reducing the transaction costs of credit intermediation. When the crisis broke, it became apparent that the diversification of risk holdings, on the contrary, had made the now global financial sector highly volatile. Mortgages were used to secure mortgage-backed securities, and those securities in turn were used to secure a collateralized debt obligation. Assets came to be bought not because of the rate of return on investment but in anticipation that such assets and securities could be sold at higher prices. International capital flows were decoupled from the real economy, as financial industry acquired the licence to create money out of credit claims at a pace so rapid that the real economy product and labour markets could not possibly follow. The stage was set for a global bubble of overvalued stocks to burst into a dramatic credit squeeze.

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