After the Great Depression of the 1930s, the U.S. government created a strict financial regulatory system based off of the theories of John Maynard Keynes and Hyman Minsky. With continual success, a swift shift from tight to light financial market regulations replaced the visions of Keynes and Minsky in the 1970s. Backed by financial institutions and efficient financial market theory, a new globally integrated neoliberal capitalism was constructed. But due to a flawed New Financial Architecture (NFA), running on accelerated deregulation accompanied by rapid financial innovation stimulated powerful financial booms, the economy grew frangible, and crashed. Considered to be the worst financial crisis since the Great Depression, the Global Economic Crisis of 2007-08 shattered the American economy. Despite numerous varying perspectives, James Crotty and Thomas Palley illustrate through a structuralist and post-Keynesian perspective how deregulation caused the financial paradigm to fail by consequently encouraging substandard decision-making and perverse incentives, and the resulting flawed aspects of the economy’s underlying macroeconomic structure.

In August of 2007, the subprime mortgage market crumbled. Not only did the subprime mortgage market meltdown trigger the financial crisis, but the meltdown also most importantly initiated much deeper and further problematic flaws and policy failures within the NFA. Crotty first states that the core of the new financial structure was established based off of very inadequate ideologies because of the lack of regulations. “The NFA is based on very minimal regulation of commercial banks, even lighter regulation of investment banks and little, if any regulation of the ‘shadow banking system’—hedge and private equity funds and bank created Special Investment Vehicles (SIVs)." In the combination of the overall flawed financial paradigm and the deregulation, the NFA practically provided a perfect setting in the financial world for the selfishness of human nature to spiral into catastrophe. The neoliberal model became an increasingly fragile and unstable macroeconomic environment, prone to corruption.

Perverse incentives and extremely high risk-taking played a huge role in the downfall. While fees did not have to be returned if the securities turned out to suffer great losses, everyone involved had the desire to maximize the flow of loans, whether or not they were ideal. Another example of perverse incentives was with credit rating agencies. Since rating agencies determined the risk weights on many assess, the high ratings meant less required capital, higher leverage, higher profit ,and higher bonuses. This lead to a very high demand for high ratings, “…it made sense for investment banks to shop their securities around, looking for the agency that would give them the highest ratings, and it made sense for agencies to provide excessively optimistic ratings." Since inflation was escalating, the creation of important financial products too complex to be fully comprehended and priced correctly blurred the capabilities to regulate large profit securities at giant financial institutions. The non-transparency of CDOs and values created unpredictable significant changes, easily manipulated movements, and made the neoliberal model unreliable.

Due to minimal regulation, banks began to make loans that pushed themselves over their own capacity, “No regulator objected when AIG guaranteed $440 billion worth of shaky securities with no capital set aside to protect against loss apparently because both the securities and AIG were triple A rated." Eventually, the mass profits big-banks acquired over the course of the years diminished and created huge losses much more than their initial profits. Deregulation also allowed banks to hold assets off balance sheets through CDOs with no capital required to support them, and allowed giant banks to measure their own risk and set their own capital requirements, causing inaccurate evaluations of risk promoted by perverse incentives. Excessive risk taking continued due to structural flaws within the NFA creating increased leverage that helped push the size of financial markets to unsustainable heights relative to the real economy. Crotty states, “Their material interests are best served by letting financial corporations do as they please in a lightly regulated environment." In a sense, “We have, in the main, appointed foxes to guard our financial chickens. ”

Besides tight regulations, basic theoretical aspects of a structural and Keynesian economic model are a financial structure focused upon the idea of government intervention in relation to the changes in aggregate demand, and balancing both full employment and price stability. Rising wages meant profitable aggregate demand, which contributed to full employment. Full employment in turn provided an incentive to invest, which raised productivity, thereby supporting higher wages. After 1980 and the advancement of neoliberalism, the commitment to achieving full employment was no longer a priority and the link between productivity growth and wages split. In place of wage growth as the heart of demand growth, the new model substituted borrowing and asset price inflation. Advocates of the new neoliberal belief considered inflation as their primary policy concern.

The deregulation of the NFA created a domino effect not only to the new financial structure itself, but also to the underlying macroeconomic environment factors, destroying the stable virtuous circle growth model based on full employment and wages tied to productivity growth. Palley states that the new neoliberal model was formed due to financial booms and cheap imports. Prices kept raising created financial bubbles. These bubbles compromised massive debt and size, so intensified to the point that the borrowing capacity of the substandard model could no longer detain the pressure. Furthermore, as the world goes through constant changes and surging development, globalization continually becomes strong and stronger. That being said, the neoliberal model induced globalization, encouraging free trade and capital mobility; meaning that Americans had to progressively compete with lower-paid foreign workers for wages that increased income inequality and outsourcing. From a structural and Keynesian perspective, there is an emphasis on the importance of keeping inflation low while maintaining full employment. Offshoring caused lower wages, thereby decreasing wage growth, increased unemployment, and disconnecting wages from productivity growth. “The problem is that this new system created a widening hole in US the economy by undermining domestic production, employment, and investment." The neoliberal policies not only undermined the demand in advanced countries, but they failed to achieve global balance by creating a reasonable amount of demand in the developing countries. The U.S. proceeded with flawed economic global relations by importing at irrational rates that pushed the global economy on verge to depression.

 James Crotty and Thomas Palley both propose very strong arguments. I strongly agree with Crotty on the fact that deregulation was the biggest influential factor to the financial crisis despite Palley stating the deregulation was a contributing factor but not the leading cause. By adopting a neoliberal financial paradigm based in place of a Keynesian model based financial paradigm, America selfishly and foolishly created extremely fragile economic bubbles capable of pulling down the entire financial system. “ The recent global financial boom and crisis might not have occurred if perverse incentives had not induced credit rating agencies to give absurdly high ratings to illiquid, non-transparent, structured financial products." The deregulation in through the neoliberal regime promoted high risk taking, perverse incentives, and created a system put inflation as their primary policy concern that failed to observe its possible catastrophic consequences. As a result, the American economy plummeted and thus the Global Economic Crisis of 2007 embarked.