Okay so here is a summary of what has happened over 20 years to make the current banking mess.
There are a great number of economic theorists, but public policy in the West is dominated by two school of thought about how wealth is created. On one side some people believe people spending money drives business, on the other side some people believe companies Capital produces wealth.
As idiotic and simple as this chicken and egg discussion might seem it has real impacts on policy. If you believe consumer make wealth you will want to promote the economy either through direct payments too consumers or tax cuts to consumers, and care little about regulation and tax on companies. If you believe Capital makes wealth you will want to reduce regulation and provide tax cuts to the rich.
In the 1950s the consumer wealth production model held sway, but then a crisis in the 1970s due to high energy cost caused a re-think. But one problem with the Capital theory of wealth production is that it did not offer a control to stimulate the economy or stop infation. Then monetary policy was applied to economic thinking, by controlling the supply of money inflation and economic growth could be regulated.
In the early 1980s central banks used the money supply to crush inflation of the 1980s, or so they believed. Maybe energy prices just went down. Whatever the true cause over the 1990s and this Century governments looked to regulate their economies by interest rates.
The problem was the fact Central Banks could never be independent from the governments and business of the economy. In 1980 when everyone wanted reduced inflation, including labour, higher interest rates were politically easy. But what about 2003, when the Iraq war turns out to not go so great, do you pump money in to the economy via credit?
To keep the economy booming more and more and more credit was pumped in to the economy. Now my theory of why this was too much was where it was put. If the credit was used to buy computers or start new IT departments and train new staff that might not have been a problem, but what happened was people started to buy more and more property in the United States.
The issue with US property market is that it is not limited. America is an empty country, wood is plentiful and even inside major cities there are large underveloped areas. The housing boom drove more and more builders to make more and more houses, and lends to get more and more people in to houses. Supply rose to meet demand and overshot it.
Energy prices rose again leading to inflation, and just as the economies of the 1970s were overexposed by government debt the US and UK private sector was over exposed and now we see that private/public sector itself is something of a myth. If in the 1980s business felt they had been harmed by extensive spending and regulation of the State today the banks can look to Washington for 1% prime in the years before the 2004 election, when everyone the Fed Chair meet was a Bush supporter, but it was their own greed in using the money, their own belief in the idea that they were smarter than other humans because they were rich, which caused the problem.
What to do? All that can be done is the public WILL have to pay. Regulation will expand. Will we have a period of "regulation" and "liberal neo-liberalism"? Obama would do this in the US, hard to see how it will happen in the UK.
But we must point to Capitalism basic strength, comparing this to the Soviety collapse.
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