Washington Consensus and the Global Financial Crisis of 2008

Question

How did the Washington Consensus contribute to the Global Financial Crisis of 2008?

Answer

The global financial crisis of 2008 occurred in a neoliberal economic environment which had been in place since the 1980s (Palma, 2009). The Washington Consensus encompasses capitalist neoliberal economic policies such as free markets and free trade, with deregulation/liberalisation based on laissez-faire principles (Williamson, 2004). In the post crisis situation, Williamson (2009) argued the Washington Consensus based system was responsible. The 2008 crisis, similar to past financial crises, started with a liquidity crisis (Aliber and Kindleberger, 2015). Aliber and Kindleberger (2015) observe crises manifest when liquidity escalates out of control, in this case it was the result of buyers and lenders taking excessive risks. The risk taking was facilitated by neoliberal policies which deregulated the financial markets (Palma, 2009). However, contrary to many economic theory assumptions, the market players did not act in a rational manner; instead they suffered from irrational exuberance, and leveraged the inequality that is inherent in neoliberalism to maximise profits, especially in the sub-prime markets (Palma, 2009). The inequality in assets, and the lenders unregulated actions, motivated by unrealistic expectations of loan performance created the toxic loans (Acharya et al., 2009). The development of the mortgage bond market, created by the demand by investors for new assets, was itself a product of deregulation and capitalist desires to create profits. This then allowed the problem to spread internationally into many markets, with the initial lenders selling on mortgages to investors, and able to release funds and repeat the process (Diamond and Rajan, 2009). This increased the scope and the scale of the problem, all due to the deregulated market forces driving policies that created inequality and resulted in the liquidity crisis in 2008.

References

Acharya, V., Philippon, T., Richardson, M., and Roubini, N., 2009. The Financial Crisis of 2007-2009: Causes and Remedies. Financial Markets, Institutions & Instruments, 18(2), pp.89–137. Aliber, R.Z., and Kindleberger, C.P., 2015. Manias, Panics, and Crashes: A History of Financial Crises. 7th ed. London: Palgrave Macmillan. Diamond, D.W., and Rajan, R., 2009. The Credit Crisis: Conjectures about Causes and Remedies. [online] Available at: http://www.nber.org/papers/w14739.pdf.[Accessed on 30/06/2016] Palma, G., 2009. Global Financial Crisis - Toxic Assets, Toxic Ideology. [online] Available at: http://www.rrojasdatabank.info/Transcriptpalmatoxic09.pdf. [Accessed on 30/06/2016] Williamson, J., 2004. A Short History of the Washington Consensus. In: From the Washington Consensus towards a new Global Governance. [online] Barcelona: Fundación CIDOB. Available at: https://piie.com/publications/papers/williamson0904-2.pdf. [Accessed on 30/06/2016] Williamson, J., 2009. The Washington Consensus and the Global Crisis. [online] Peterson Institute for International Economics. Available at: https://piie.com/commentary/speeches-papers/washington-consensus-and-global-crisis. [Accessed on 30/06/2016]