The Institutional Factors of the Financial Crisis in the United States

Abstract

The financial crisis in the United States that started at the end of 2007 revealed the failure of both the market and the government. This chapter applies institutional economics and financial economics approaches and refers to an analysis of the risk of gambling, which discovers that a “loss equilibrium” exists that is commonly accepted by people when the risk probability of financial products becomes too high given the limit to their lives and wealth. The risk probability of financial products increases and the number of transactions of these products becomes much larger because innovating and producing financial products cannot be constrained by physical costs. Thus, the risk probability and transaction scope of financial products exceed the boundary of safety through both supply and demand. In contrast, the financial innovations that intend to reduce the risk probability of individual projects may increase the risk probability at the social level. Given the political structure of the United States, Wall Street financial groups have stronger lobbying power because of their concentration of wealth, and Congress could not pass any legislation to constrain Wall Street. In addition, under the effect of the people’s will, the administration, the legislature, and the central bank are apt to carry out looser macro policies and encourage consumption credit, thus further weakening a cautious culture in society. Finally, high-risk financial products are developed broadly, resulting in a financial crisis.

Translated from Research of Institutional Economics (《制度经济学研究》), Volume 32, Issue 2, 2011