Economic Brief
Understanding Market Failure in the 2007-08 Crisis
Download essayDid market failures cause the 2007-08 financial crisis? While economists have made substantial progress exploring this question, the answer remains unclear. The answer is important because financial regulation that does not address a specific market failure risks causing new inefficiencies and unintended consequences in the financial system and broader economy. To demonstrate how economic theory can be used to identify market failures and guide policy, this Economic Brief discusses a common market failure called a "pecuniary externality" and demonstrates the pitfalls of applying regulations in situations where the precise sources of market failures are not well-understood.
Additional Resources
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Lacker, Jeffrey M., "Committing to Financial Stability," Speech at the George Washington University Center for Law, Economics and Finance, Washington, D.C., November 5, 2014.
Santos, João, "Evidence from the Bond Market on Banks' 'Too-Big-to-Fail' Subsidy," Federal Reserve Bank of New York Economic Policy Review, December 2014, vol. 20, no. 2.
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