Political Bubbles

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Behind every financial crisis lies a political bubble—policy biases that encourage market behaviors leading to instability. Instead of curbing risky actions, these political bubbles, formed from a mix of beliefs, institutions, and interests, support and magnify risk. The authors illustrate how political bubbles contributed to the real estate-driven financial bubble and the 2008 crisis, arguing that government oversights after the crisis weakened Washington's response to the fallout. This pattern has recurred throughout US history. Just as financial bubbles stem from flawed beliefs, market imperfections, and greed, political bubbles arise from rigid ideologies, ineffective institutions, and special interests. Innovations in financial markets, such as adjustable-rate mortgages and credit default swaps, face regulatory leniency, leading to dangerous practices. The authors highlight the political blindness that prevents regulators from recognizing economic vulnerabilities that foster bubbles and propose straightforward rules to help avert future crises. This comprehensive analysis of how politics leads to financial disruptions offers crucial insights that all sectors should consider.