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Robert Shiller: democratizing finance

You have been asked to write a 'briefing' article for The Economist analysing the debate initiated by Robert Shiller about democratising finance and comparing this with the kinds of regulatory measures that have been adopted in the OECD countries in the wake of the recent financial crisis. The issues you need to consider in your article include the following:

1. Are the measures that are currently being taken to regulate the financial system sufficient to avoid another crisis of the kind that began in 2007?
2. If not, should we opt for stronger regulation of the financial system such as limits on financial innovation and the complexity of financial products and should we attempt to reduce the size and significance of finance in the economy?
3. Alternatively, should we follow the approach taken by Shiller in which the problem with finance is seen as a lack of democracy rather than too much complexity?
4. What are the current reforms, their strength and weaknesses?

You should finish with a conclusion setting out what you see as the way forward for the financial system which should be linked to your previous argument.

Solution Preview

1. The measures that are currently being taken to regulate the financial system are not sufficient to avoid another crisis of the kind that began in 2007. In fact Congress has failed to enact adequate regulations that can prevent predatory lending through innovative financial products. Adjustable rate mortgages have not been banned. In 1996 Fannie Mae and Freddie Mae were set goals that at least 42% of the mortgages they purchase should be issued to borrowers whose household income was below the median in their area. These goals were set to attract voters. There is no mechanism in place to prevent future governments from using similar measures.
Currently, there are inadequate measures in place to curb risky consumer/household borrowing, home equity extraction, and housing speculation. There is no law that curbs risky corporate borrowing or controls unreasonable leverage. The current measures in place are inadequate to prevent predatory financial product innovation. Even though the ...

Solution Summary

Democratizing finance is discussed step-by-step in this solution. The response also has the sources used.

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