Financial Crisis: Imbalances, Irrationality and Regulation

Abstract

During the end of the past economic expansion, agents were over optimistic about the increasing path of asset prices and their corresponding low risk. This confidence based on an opaque real risk levels as well as on historically low interest rates, contributed to a rapid growth of credit expansion in developed countries, mostly but not exclusively in the form of mortgages. The excessive risk taking of banks and financial institutions was due in part to the prevailed regulatory conditions, which were not that effective in dealing with the reduction of systemic risk. In particular, the regulatory regime failed to provide enough transparency in the financial system to protect the investors. Also, a fragmented regulatory structure contributed to have less available information complicating the task of assigning accurate asset prices and realistic risks levels.

Keywords: Financial crisis

JEL Classification: A10, G10