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Financial Institutions and Markets pp 37–69Cite as

Palgrave Macmillan

Too Much Right Can Make a Wrong: Setting the Stage for the US Financial Crisis

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Abstract

The financial crisis that started in 2007 exposed a number of flaws in the financial system. Many of these flaws were associated with financial instruments that were issued by the shadow banking system, especially securitized assets. The volume and complexity of securitized assets grew rapidly during the run-up to the financial crisis that began in 2007. This chapter discusses how the financial crisis can be viewed as a possible but logical outcome of a system where investors are overconfident, busy, and investing other peoples’ money and intermediaries are set up to take advantage of investors’ tendencies. The investor-intermediary risk cycle in this crisis is common to other crises. However, there are a number of factors that may have made the 2007 crisis more severe. Among them are the length of the precrisis period, the shift from financial intermediaries to the shadow banking system, the increasing interconnectedness among financial firms, and the increased leverage at some financial firms.

This paper is a revised and extended version of “Investor behavior in the period before the 2007–2008 financial crisis,” in Managing Systemic Risk ed. J. R. LaBrosse, R. Olivares-Caminal, and D. Singh (Cheltenham: Edward Elgar, 2011 [forthcoming]). I would like to thank Crystal Cun for research assistance and the participants at presentations at the Federal Reserve Bank of Chicago and the FUNCAS conference “Crisis y Regulación Financiera” for comments. The views in this chapter are those of the author and may not represent the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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Author information

Authors and Affiliations

  1. Federal Reserve Bank of Chicago, USA

    Richard J. Rosen (Economic Advisor and Senior Economist)

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  1. Richard J. Rosen
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Editor information

Editors and Affiliations

  1. Loyola University Chicago, USA

    George G. Kaufman (Professor of Economics and Finance) (Professor of Economics and Finance)

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© 2010 Robert R. Bliss and George G. Kaufman

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Rosen, R.J. (2010). Too Much Right Can Make a Wrong: Setting the Stage for the US Financial Crisis. In: Bliss, R.R., Kaufman, G.G. (eds) Financial Institutions and Markets. Palgrave Macmillan, New York. https://doi.org/10.1057/9780230117365_2

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