Here’s an excerpt from Monkeywrenching the World Economy ,a fairly concise overview of the thinking behind the Financial Crisis.
“Here’s what happened: Before to the meltdown, the depository “regulated” banks got their funding through the repo market by exchanging collateral (mainly mortgage-backed securities) for short-term loans with the so-called “shadow banks” (investment banks, hedge funds, insurers) But after Lehman defaulted, the funding stream was severely impaired because the prices on mortgage-backed securities kept falling. When the bank-funding system went on the fritz, stocks went into a nosedive sending panicky investors fleeing for the exits. As unbelievable as it sounds, no one saw this coming.
The reason that no one anticipated a run on the shadow banking system, is because the basic architecture of the financial markets has changed dramatically in the last decade due to deregulation. The fundamental structure is different and the traditional stopgaps have been removed. That’s why no one knew what to do during the panic. The general assumption was that there would be a one-to-one relationship between defaulting subprime mortgages and defaulting mortgage-backed securities (MBS). That turned out to be a grave miscalculation. The subprimes were only failing at roughly 8 percent rate when the whole secondary market collapsed. Former Treasury Secretary Paul O’Neill explained it best using a clever analogy. He said, “It’s like you have 8 bottles of water and just one of them has arsenic in it. It becomes impossible to sell any of the other bottles because no one knows which one contains the poison.”
And that’s exactly what happened. The market for structured debt crashed, stocks began to plummet, and the Fed had to step in to save the system. Unfortunately, that same deeply-flawed system is being rebuilt brick-by-brick without any substantive changes.. The Fed and Treasury support this effort, because–as agents of the banks–they are willing to sacrifice their own credibility to defend the primary
profit-generating instruments of the industry leaders. (Goldman, JPM, etc) That means that Bernanke and Geithner will go to the mat to oppose any additional regulation on derivatives, securitization and off-balance sheet operations, the same lethal devices that triggered the financial crisis.
So, there was no conspiracy to blow up the financial system, but there is an implicit understanding that the Fed will serve the interests of Wall Street by facilitating asset bubbles through “accommodative” monetary policy and by opposing regulation. It’s just “business as usual”, but it’s far more damaging than any conspiracy, because it ensures that the economy will continue to stagnate, that inequality will continue to grow, and that the gigantic upward transfer of wealth will continue without pause. “