Dysfunctional Markets: A Spray of Prey Perspective

Olivier Mesly, David W. Shanafelt and Nicolas Huck

Journal of Economic Issues, 2021, vol. 55, issue 3, 797-819

Abstract: We revisit the theory of financial crises using a predator-prey metaphor, highlighting the relationship between greed, risk aversion and debt accumulation and aggregating concepts from economics, finance and psychology. We argue that regulations that are implemented inefficiently, with weak enforcement or at the wrong time can have deleterious effects on the market, worsening the ailment they initially intended to correct and leaving a spray of prey in their wake. To illustrate our hypothesis, we examine the role of regulations in the years leading up to and during the Global Financial Crisis (GFC) in the United States, when the Federal Reserve tried to restrain the over-heated housing market propelled by the predatory mortgage frenzy and the increased use of securitization in risk-hiding financial tools such as Collateralized Debt Obligations (CDOs). Our results indicate that deleterious government interventions may act as a chemotherapy of sorts, causing harm followed by a slow recovery. This understanding can help governments draft better regulations to lower market frictions and better protect investors.

Date: 2021
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DOI: 10.1080/00213624.2021.1948272

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