The credit crunch explained: how overregulation could threaten economic recovery


It is now eighteen months since the collapse of one of Bear Stearns’s credit hedge funds lit the credit crunch bonfire. Banks (including Bear Stearns) have been going up in smoke ever since and the fire has now spread to the real economy. Perhaps hardly surprisingly, with every day that has passed the siren voices prophesising the need for a fundamental reconstruction of every pillar of the market economy grow ever louder and more confident. From bank regulation, via market liberalisation and free capital flows through to classical economics itself none of the foundations of the Friedman-Reagan-Thatcher consensus are now unquestioned. To mis-cite Francis Fukuyama, history has started again.

At its heart the credit crunch is a narrow term describing an unprecedented loss of mutual confidence between banks and a consequent failure to lend to each other and into the wider economy – hence the economic knock on effect on us all. Eighteen months may be too soon to conclude with complete confidence what went wrong in the acronym-packed world of high finance but it is surely soon enough to attempt an interim assessment. Leaving aside the debate on the right macro-economic response to the consequent recession, what emerges is that though some very important improvements to financial services regulation certainly are required (when are some changes not required?) a fundamental re-regulating of our entire globalising economy is not necessary. An examination of the actual causes of the initial credit crunch “on the ground” shows clearly why.

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