Update on the Financial Crisis of 2008–???

In an earlier paper in this journal (Murphy, 2009), I explained the nature of the financial crisis of 2008 and how the effects of it would be very costly long-term because of the failure of government policies to deal with it effectively. Here I provide an important update and perspective for the future. As I indicated in a brief report published in October 2008 in the Oakland Press (Murphy, 2008a) and in a working paper (downloaded over 10,000 times as one of the most read financial working papers of all time at www.ssrn.com), the financial crisis was caused by the deregulation of credit default swaps (CDSs) and by the use of purely statistical models of credit lacking in any financial common sense. The solution provided in those articles still apply, although the government’s counterproductive attempts to address the problem have already greatly magnified the costs that could have so easily been avoided. The world’s largest banks should have been allowed to fail, with the government regulators taking control of their branches and basic deposit/lending activities as they are supposed to do in the case of all bank failures. These government banks could have been privatized later once the banks had been sanitized of their non-core activities (including credit default swaps) that caused their demise. Doing so would have caused huge losses to investors (especially hedge funds), but 99% of the people wouldn’t have been seriously affected.