Undergraduate Economist

Perspectives of an economics student

On the (US) Financial Crisis of 2008-200?

Posted by Alex M Thomas on October 7th, 2008

I initially thought of writing a post which explains the possible causes of the present financial crisis in the United States. But, to my dismay, I found that it has been/are being discussed by the BBC, IMF, New Left Review, EPW and Wikipedia. (The list is not exhaustive.) However, I was delighted about the fact that I did not have blog about the details; I can directly plunge into my reflections regarding the crisis. Therefore, the present post is concerned with a few issues that have risen in my mind owing to the crisis.

1) Should financial institutions be completely unregulated? In other words, does a ‘free market’ set up result in a favourable outcome, where the resources are allocated efficiently? By ‘free market’, I mainly refer to a situation where market forces like “demand” and “supply” are not tinkered by any external body.

2) Is it financially prudent for financial institutions to invest much more than their savings? Investment and savings need to be understood as financial capital. Money was advanced on the premise that the future conditions will be favourable; there was no actual collateral. This is what happened in the sub-prime lending market. To add to that, the drive to make faster and higher profits induced the banks to lend that money to (unregulated) financial intermediaries. Money (funds) was not advanced for production purposes (industrial capital). Financial capital is a way to make huge profits in comparison with industrial capital, which produce commodities by means of commodities. With the progress of Capitalism as a mode of production, the wealth of the nation (understood as GDP by orthodox economists) has changed from industry to financial services – derivatives especially. In textbooks, progress is shown by a movement from agriculture to manufacturing and finally to services. In my opinion, it is the institutionalization of financial capital which is the source of present crisis.

3) The system thrived of the belief that the ‘alarms’ created by the quantitative analysts (Quants) would sound. [For more on Quants, read this.] They rely on mathematical models to estimate risks. Remember Black-Scholes, Markowitz and Robert Merton, Nobel Prize winners in Economics! One of the things that we learn from reading Keynes’s General Theory is that expectations cannot be quantified. To build elegant models, expectations can be quantified to some extent with the aid of probability. But, it shouldn’t be used in policy making lest the expectations of the individuals change drastically. But, New Keynesian Macroeconomics has to its (de)merit ‘Rational Expectations’; I wonder about the extent of the interpretations of Keynes’s works.

Another interpretation to the crisis would be that, the market does identify ‘problem makers’ within it. Think of the various asset bubble bursts that have taken place. But, with the complex and tight interdependencies of various economies in the world, a financial crisis can have repercussions on other countries as well, mainly through international trade. Thus, it is important that every country devotes resources for (trying to) understanding these interdependencies for solving the problems of today.


Read this essay at Risk Latte. I am happy to find such views on a financial company website.

5 Responses to “On the (US) Financial Crisis of 2008-200?”

  1. Chirag Jain Says:

    Their are growing articles on the blogosphere on the “US Financial Crisis” and thanks for not writing the same thing on its history and instead invoking questions on regulation and other connect causes.
    In your 3rd point, I agree wholeheartedly with “One of the things that we learn from reading Keynes’s General Theory is that expectations cannot be quantified”.

    Signing off for now but will be back later, Chirag.

  2. vinay Says:

    toxic financial products like derivatives and mortagages with poor regulation on behalf of U.S government was the prime cause for the recent credit crisis. of course, these products are best tools to gain leverage in a free market economy, but if unchecked against the backdrop of prevailing economic conditions…they are like lethal weapons ready to destroy… world’s financial system.

  3. nihar Says:

    what with increased expectations of clientele from its investments, of asset management companies from its profits, and of people in general from the much-volatile science of economics, there is very little holistic thinking prevalent in the markets. in the name of free economy and with ever-flowing money investment decisions aren’t made on long-term analyses.

    this might sound poetic, but is the reality

  4. Sugandha Says:


    The deal is we are not living in the classical set up. We want
    laissez faire to prevail when banks make abnormal profits. But when it goes bust, we want a government bailout. Such a system is bound to collapse. What is your take on these bailout packages financed by tax payers?

    And for your take on quants, I couldn’t agree more!

  5. Ganja Turtle Says:

    Good post, Alex… models depend on assumptions and when the assumptions do not hold true, neither do the models.

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