The Crisis

Geopolitical changes following the end of the Cold War induced a worldwide decline in real long-term interest rates that, in turn, produced home price bubbles across more than a dozen countries. However, it was the heavy securitization of the U.S. subprime mortgage market from 2003 to 2006 that spawned the toxic assets that triggered the disruptive collapse of the global bubble in 2007-08. Private counterparty risk management and official regulation failed to set levels of capital and liquidity that would have thwarted financial contagion and assuaged the impact of the crisis. This woeful record has energized regulatory reform but also suggests that regulations that require a forecast are likely to fail. Instead, the primary imperative has to be increased regulatory capital, liquidity, and collateral requirements for banks and shadow banks alike. Policies that presume that some institutions are "too big to fail" cannot be allowed to stand. Finally, a range of evidence suggests that monetary policy was not the source of the bubble.