Asset markets

The findings of a number of researchers who have studied the causes of the current financial crisis in America conclude that the policy distortions started with gradual undermining of the Glass Steagall Act, from the 1980s; and the rise of the neo-classical theory of free markets (which advocates markets deregulation) Shiller (2005, p 43) argues that business cycles in the financial markets would not have been a major problem had banks been kept off the asset markets.

The same argument is advanced by Summers (2008) who asserts that the deregulations in the banking sector exposed the banks to the bubbles and bursts of asset markets. Wray (2009) traces the poor regulatory framework in the U. S to the New Financial Architecture (NFA) which he claims is represented by a globally networked system of giant bank conglomerates and shadow banking system of investment bank, hedge funds and bank created special investment vehicles (walmart outsourcing).

In short, most scholars agree that the Riegle-Neal interstate banking and Branching efficiency Act of 1994 and the repeal of Glass Steagall Act in 1999 through the Gramm-Leach-Bliley Financial Act played a crucial role in laying the foundation which led to this crisis (Mishkin, 2009, p 268; Grotty, 2009). Atkinson, Wigall, and Lee (2009) have also concluded that the Basel II accord on international bank regulation also opened an arbitrage opportunity for banks which led to the acceleration of off-balance-sheet activities.

In the same paper, they claim that SEC 2004 decision to allow investment banks to manage there own risk was a major policy blunder. Soros puts it this way. “Since 1980, regulations have been progressively relaxed until they have practically disappeared. …………authorities could no longer calculate their risks and started relying on the risk management methods of the banks themselves (Soros 2008)” At the same time, scholars have concluded that the other root cause of the problem is traceable to the easy availability of credit. Diamond, etal (2009, p 615) argue that the policies affecting liquidity availed a lot of funds to the banks.

The 1% federal interest rate, the % interest rate in Japan, the fixed exchange rate in china and large reserves of sovereign wealth funds are listed in his paper as sources of cheap credit which fueled the economic boom in America led to an inflation of prices around the world. The claims that interest rates were low are supported by statistics which indicates that real short term interest rates were negative from mid 2001 to mid 2005, given the modest values of inflation (Yellen, 2008) The low interest rates, in turn, ignited a housing boom.