TheCrisis:What Caused It?

By Julio Huato juliohuato@gmail.com Associate Professor of EconomicsSt. Francis College

The appearance of the crisis

On the surface, the crisis appears toregular people as suddenly increased riskof losing their

homes

, their

savings

, andtheir

jobs

.On Wall Street, it manifests itself as asudden, large drop in asset prices, a“flight to safety,” and the credit freeze.How did we get here?

The chain of causation

In the last few

days

, stock prices fell, not because theeconomy is in a recession (job creation: negative,industrial production: falling), but because financial firms(“banks”) were going broke.In the last few

weeks

, financials were going brokebecause they held bad loans, directly and packaged incomplex “derivatives,” as a result of credit freeze. (Aglobal problem: banks everywhere bought them. Riskwas underestimated or disregarded.)In the last few

months

, credit froze, mainly to other banks (but also to consumers and businesses, includingshort-term), because banks’ suspected other banks maygo broke.