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We use normal accident theory to analyze the financial sector, especially that part of the financial sector that processed home mortgages, and the mortgage meltdown. We maintain that the financial sector was highly complex and tightly coupled in the years leading up to the mortgage meltdown. And we argue that the meltdown exhibited characteristics of a system or normal accident; the result of a component failure (unusually high mortgage defaults) that, in the context of unique conditions (which included low interest rates and government policy encouraging home loans to less credit-worthy households), resulted in complex and tightly coupled interactions that financial elites and government officials were ill-equipped to control. We also consider the role that agency and wrongdoing played in the design of the financial system and the unfolding of the mortgage meltdown. We conclude that a fundamental restructuring of the financial system, so as to reduce complexity and coupling, is required to avert future similar financial debacles. But we also conclude that such a restructuring faces significant obstacles, given the interests of powerful actors and the difficulties of labeling those responsible for the meltdown as wrongdoers.

In recessions, depository institutions accounted for most declines in mortgage flows. Recently, they partially offset their withdrawals from primary markets with accumulations of mortgage-backed securities. Increases in direct flows into agency and private pools also countered the declining flows elsewhere. As the less-procyclical secondary mortgage markets grew and matured, they increasingly stabilized mortgage flows. During periods of international financial crises or of domestic economic stress, GSEs may have been particularly effective in stabilizing mortgage markets and moderating business cycles.

The current crisis in the mortgage securitization industry highlights significant failures in our models of how markets work and our political will, organizational capability, and ideological desire to intervene in markets. This article shows that one of the main sources of failure has been the lack of a coherent understanding of how these markets came into existence, how tactics and strategies of the principal firms in these markets have evolved over time, and how we ended up with the economic collapse of the main firms. It seeks to provide some insight into these processes by compiling both historical and quantitative data on the emergence and spread of these tactics across the largest investment banks and their principal competitors from the mortgage origination industry. It ends by offering some policy proscriptions based on the analysis.

The precise relationships between neoliberalization, financialization, and rising risk are still being debated in the literature. This paper examines, and challenges, the Financial Instability Hypothesis (FIH) developed by Hyman Minsky and his adherents. In this perspective, the level of financial risk builds over time as participants orient their behavior in relation to assessments of past levels of risk performance, leading them to overly optimistic valuation estimates and increasingly risky behavior with each subsequent cycle. However, there are problems with this approach, and many questions remain, including how participants modify their exposure to risk over time, how risk is scaled, and who benefits from changes in exposure to risk. This paper examines such questions and proposes an alternate perspective on financial instability and risk, in light of the history of risk management within Canada’s housing finance sector. The rise of financialization in Canada has been accompanied by shifts in the sectoral and scalar locus of risk within the housing sector, from the federal state, to lower levels of government, third-sector organizations, and finally, private households. In each case, the transfer of risk has occurred as participants in each stage sought to reduce their own risk exposure in light of realistic and even pessimistic (not optimistic) expectations deriving from past exposure, contradicting basic assumptions of Minsky’s FIH. This is the process that has driven the neoliberalization of housing finance in Canada, characterized by the socialization of lender risk while households increasingly take on the financial and social risks relating to shelter.

This chapter proposes a comparative analysis of the monetary policies undertaken by the Federal Reserve Board and the European Central Bank after the 2008 subprime crisis. We point out the twin nature of the financial crises in Europe in comparison with the US crises: in addition to the role of bank funding, the euro area countries have also experienced a structural problem of balance of payment disequilibria. This explains why in the early stages of the subprime crisis, the Fed has succeeded in tackling the illiquidity problems facing the banking sector, while the ECB did not. The Fed could then focus on tackling the recession in the real sector by adopting quantitative easing policies to exert downward pressure on the long-term interest-rate. In the euro area quantitative easing policies came later, in 2013. Even the forward guidance policies have been different between the two central banks. Unlike the ECB, the Fed has gone through diverse forward guidance policies: qualitative, calendar-based, and state-contingent. The chapter proposes a new survey of the monetary policies after the subprime crisis by comparing two strategies in different contexts: the United States and the euro area.

A comment by an analyst-cum-investor reads, “A year ago, I didn't expect the U.S. economy to fall into recession in 2008 because I was confident consumers would continue to do what they do so well: spend money. I had plenty of company, and ultimately we were all wrong.” During the Fall of 2007, while working in Tokyo to prepare a manuscript for publication, I wrote, “I come to a rather disturbing prognosis about the U.S economy: high likelihood of a recession” (Azis, 2008). Indeed, it is always tricky to predict crisis and recession, let alone to comprehend how a small segment of a financial market, that is, subprime credit, could bring down the world's largest economy into the worst recession since World War II. Every Spring semester on the first day of my class on “Economics of Financial Crisis,” I always cautioned students that financial crisis is explainable but not predictable.