According to one view, shared among others by Nobel prize winner and New York Times columnist Paul Krugman, the financial sector debacle has its origins in the “global imbalance” — the phenomenon of large current account surpluses in China and a few other countries co-existing with large U.S. deficits. The global imbalance is reflected in large mismatches in the current account positions of some countries and its mirror image in the form of domestic savings investment mismatches.
The financial crisis that hit the global economy since the summer of 2007 is without precedent in post-war economic history. It has been said to be the worst financial crisis since the 1930’s. Although its size and extent are exceptional, the crisis has many features in common with similar financial-stress driven recession episodes in the past. The crisis was preceded by long period of rapid credit growth, low risk premiums, abundant availability of liquidity, strong leveraging, soaring asset prices and the development of bubbles in the real estate sector. Over-stretched leveraging positions rendered financial institutions extremely vulnerable to corrections in asset markets. As a result a turn-around in a relatively small corner of the financial system (the US subprime market) was sufficient to topple the whole structure. Such episodes have happened before (e.g. Japan and the Nordic countries in the early 1990s, the Asian crisis in the late-1990s). However, this time is different, with the crisis being global akin to the events that triggered the Great Depression of the 1930s. (According to www. ec.europa.eu 2011)
Global imbalance is only an indirect cause. The main culprits were deficient financial regulation and the failure of market discipline resulting in a systematic flouting of rules and regulations by banks. As the sub-prime crisis showed, practically all banks used their ingenuity to develop structures and products that were outside the normal regulatory confines... [continues]
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