February, 2009

Lost Trust: The Real Cause of the Financial Meltdown

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One distinguishable feature of the current financial crisis from other crises is that global credit markets, including U.S. markets came to a near stop. This problem was not due to bank runs akin to the 1933 great depression or a lack of liquidity, as has been the case in other panics. The current crisis may likely be the only one that resulted from a sudden loss of trust. Although central bankers and governments can work to implement policies to resuscitate credit markets, a more arduous task is rekindling trust. Discussing how trust evolves in the formation of markets, this paper chronicles the elements and events that led to the financial collapse of 2007–2009.