Remembering the Collapse of Lehman Brothers

In the video above, Greg Ip and Zanny Minton Beddoes discuss the Lehman Brothers collapse five years later. Their question is whether the world economy is now sufficiently protected from future shocks. They conclude that the World Financial Crisis of 2007-2008 was caused by excessive debt and financial interconnectedness brought about by Globalization. As fallout from the Financial Crisis, problems still remain in the European Union as the weaknesses of a purely monetary union were exposed (individual countries had lost their ability to use monetary policy). They also point out that the role of Central Banks still remains unclear. Before the Financial Crisis, Central Banks had bought in to the Great Moderation, the assumption that wise monetary policy had eliminated the business cycle. Banks had failed to see that low interest rates fueled a housing bubble that eventually led to the Subprime Mortgage Crisis as the bubble popped. The Central Banks had insufficient focus on financial stability and too much focus on inflation. Monetary policy, even unconventional monetary policy at the zero-bound, may be too blunt an instrument to pop bubbles.

The conclusion from their argument, which they do not explicitly make, is that stronger financial regulation prior to the development of bubbles is needed in the future rather than hoping that monetary policy (or liberal fiscal policy, for that matter) can be counted on to recover from financial crises.