11 - Understanding our Political Economy - unforeseen consequences of

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Lesson 11 - Unforeseen Consequences of Deregulation

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Understanding our Political Economy LESSON ELEVEN Unforeseen Consequences of Money Markets and Financial Deregulation

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“Volatility was low because the world was awash with wild money; but abundant liquidity was giving the false sense that stability was due to some magical structural improvement in the financial system. Investors from Asia to Arabia were wiring billions of dollars to fund managers in New York, buying every piece of paper that [Wall Street’s] mortgage desks could sell, …”

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THE ECONOMY

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“Rather than running their books in a way that rigorous analysis suggests will be safe, banks sometimes run their books in a way that the capital requirements deem to be safe, even when it isn’t. …”

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“Subprime mortgages presented a classic example of this problem. Bonds backed by toxic mortgages were given the top (AAA) rating, partly because the rating agencies were paid by the bond issuers, which dulled the incentive to be critical. …”

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“Once the AAA seal of approval was affixed to subprime assets, banks were happy to hold them because capital requirements allowed them to do so without putting aside much capital. Regulation and rating agencies thus became a substitute for analysis of the real risks in mortgage bonds.”

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END OF LESSON ELEVEN

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