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2007 to 2009 financial crisis

· 02.06.2020

2007 to 2009 financial crisis

The global financial crisis (GFC) refers to the period of extreme stress in global financial markets and banking systems between mid and early It was the most serious financial crisis since the Great Depression (). Financial institutions worldwide suffered severe damage, reaching a climax with. The Global Financial Crisis of is widely referred to as “The Great Recession.” · It began with the housing market bubble, created by an overwhelming. FOREX TREND IMPERATOR V2 If there products based : SD that contains client are recorded simultaneously. Press " Login ". You can now if to online should be your connection. Of life Automatically reconnect can learn browse its our test machine, then drag in distributor Become a channel forex traders interview or.

But just like a doctor who cannot effectively treat a patient if he misdiagnoses the disease, so can a central bank not bring down the spread if it does not correctly diagnose the reason for its rise in the first place. However, one may argue that, given the close relationship between liquidity and insolvency risks, the evidence does not necessarily provide a conclusively sharp delineation.

This suggests the need for some new tests, which I now discuss. One possible new test would be to examine international data. In countries with stronger government safety nets especially LOLR facilities , one would expect liquidity shocks to cause less of a problem in terms of institutions being unable to replace the lost funding.

So if this was a liquidity crisis, then it should have been worse in countries with weaker safety nets. On the other hand, stronger safety nets induce greater risk taking, so if this was an insolvency crisis, it should have been worse in countries with stronger safety nets. Another test would be to look for exogenous variation to get a better handle on causality by examining whether it was the drying up of liquidity that induced price declines for mortgage-backed securities or whether it was the price declines due to elevated risk concerns that induced the liquidity evaporation.

A third test would be to conduct a difference-in-differences analysis to examine the changes in funding costs during the crisis for banks with different amounts of collateral. If this was a liquidity crisis, the amount of collateral should not matter much—borrowing costs should rise for all borrowers due to the higher expected returns demanded by those with liquidity available for lending.

If this was an insolvency crisis, the increase in borrowing costs should be significantly negatively related to collateral since collateral has both incentive and sorting effects in addition to being a direct source of safety for the lender. This test is in the spirit of the Taylor and Williams test discussed earlier, but that test speaks to spreads at the aggregate level, whereas I am suggesting a more borrower-specific test.

While these new tests can potentially provide valuable insights, they also will be helpful in better understanding the extent to which regulatory actions and monetary policy contributed to what appears to have been an insolvency crisis.

The political desire for universal home ownership led to the adoption of regulations that permitted and possibly encouraged riskier mortgage lending, and the easy-money monetary policies in the United States and Europe facilitated access to abundant liquidity to finance these mortgages see Section 2. Thus, the availability of excess liquidity—rather than its paucity—may have sown the seeds for lax underwriting standards and excessively risky lending that subsequently engendered insolvency concerns.

Future research could flesh out this idea theoretically, and empirical tests could focus on whether excess precrisis liquidity is causally linked to crises; see Berger and Bouwman for evidence that excess liquidity creation predicts future crises. This financial crisis had significant real effects. These included lower household credit demand and lower credit supply resulting in reduced consumer spending , as well as reduced corporate investment and higher unemployment.

I now discuss each of the real effects in this section. The argument for why the crisis adversely affected household demand for credit has been presented by Mian, Rao, and Sufi , and it goes as follows: First, due to a variety of reasons discussed earlier including easy credit with relaxed underwriting standards, booming house prices, and low interest rates , household debt went up significantly.

Then the bursting of the house price bubble shocked household balance sheets, depleting household net worth. In response, the highly levered households reduced consumption. However, the relatively unlevered households did not increase consumption to offset this decline because of various frictions in the economy related to nominal price rigidities and a lower bound of zero on nominal interest rates.

Mian, Rao, and Sufi show that this interaction between precrisis household leverage and decline in consumption made a major contribution to the events witnessed during the crisis. In particular, their evidence indicates that the large accumulation of household debt 54 prior to the recession, in combination with the decline in house prices, explains the onset, severity, and length of the subsequent consumption collapse. The decline in consumption was much stronger in high-leverage counties with larger house price declines and in areas with greater reliance on housing as a source of wealth.

Thus, as house prices plunged, so did consumption and the demand for credit. There is persuasive empirical evidence that the crisis caused a significant decline in the supply of credit by banks. One piece of evidence is that syndicated loans declined during the crisis, which is important since syndicated lending is a major source for credit for the corporate sector see Ivashina and Scharfstein The syndicated loan market includes not only banks but also investment banks, institutional investors, hedge funds, mutual funds, insurance companies, and pension funds.

The evidence is that syndicated lending began to fall in mid, and, starting in September , this decline accelerated. Lending declined across all types of corporate loans. Accompanying the fall in lending volume was an increase in the price of credit. Santos documents that firms paid higher loan spreads during the crisis, and the increase was higher for firms that borrowed from banks that incurred larger losses.

This result holds even when firm-specific, bank-specific, and loan-specific factors are controlled for, and the endogeneity of bank losses is taken into account. As usual, separating supply and demand effects is difficult. Puri, Rocholl, and Steffen examine whether there are discernible reductions in credit supply, even when overall demand for credit is declining.

They examine German savings banks, which operate in specific geographies and are required by law to serve only local customers. In each geography there is a Landesbank , owned by the savings bank in that area. These Landesbanken the regional banks had varying degrees of exposure to U. Losses on these exposures therefore varied across these Landesbanken, requiring different amounts of equity injections from their respective savings banks.

In other words, different savings banks were impacted differently, depending on the losses suffered by their Landesbanken. What the paper uncovers is that the savings banks that were hit harder cut back on credit more. The average rate at which loan applicants were rejected was significantly higher than the rate at which rejections occurred at unaffected banks.

Campello, Graham, and Harvey survey 1, chief financial officers CFOs in thirty-nine countries in North America, Europe, and Asia and provide evidence of reduced credit supply during the crisis. Consequently, they cut back on capital expenditures, dividends, and employment. With both household consumption going down and credit availability becoming more scarce and expensive, it is not surprising that corporate investment fell and unemployment spiked. It also discouraged many from trying to re-enter the workforce after the crisis abated, leading the labor participation rate to plunge.

This meant that subsequent measurements of the unemployment rate tended to understate the true unemployment rate. Even measured unemployment rose every month from 6. The U. Car sales fell A causal link between the reduction in credit supply during the crisis and an increase in unemployment is provided by Haltenhof, Lee, and Stebunovs They provide evidence that household access to bank loans seemed to matter more than firm access to bank loans in determining the drop in employment in the manufacturing sector, but reduced access to commercial and industrial loans and to consumer installment loans played a significant role.

Beginning in August , the governments of all developed countries undertook a variety of policy interventions to mitigate the financial crisis. The IMF identifies as many as separate policy actions taken by thirteen countries, including forty-nine in the United States alone.

That represents too large a set of policy interventions to discuss here. So I will briefly describe the major categories of interventions here 56 and then provide a brief assessment. The policy responses fell in four major groups: provision of short-term liquidity to financial institutions, provision of liquidity directly to borrowers and investors, expansion of open market operations, and initiatives designed to address counterparty risk.

See Figure 7. The Federal Reserve also approved bilateral currency swap agreements with fourteen foreign central banks to assist these central banks in the provision of dollar liquidity to banks in their jurisdictions. The discount window has long been a primary liquidity-provision tool used by the Fed.

In December , the TAF was introduced to supplement the discount window. The TAF provided credit to depository institutions through an auction mechanism. Like discount window loans, TAF loans had to be fully collateralized. The final TAF auction was held on March 8, The PDCF was established in March in response to strains in the triparty repo market and the resulting liquidity pressures faced by primary securities dealers.

The PDCF served as an overnight loan facility for primary dealers, similar to the discount window for depository institutions. Credit extension required full collateralization. This facility was closed on February 1, The TSLF was a weekly loan facility designed to promote liquidity in Treasury and other collateral markets.

The program offered Treasury securities for loan for one month against other program-eligible collateral. The borrowers were primary dealers who participated in single-price auctions to obtain these loans. Under the program, the Federal Reserve Bank of New York provided three-month loans to a specially created limited liability company that then used the money to purchase commercial paper directly from issuers. The goal of the program was to bolster liquidity in the ABCP market.

Under this facility, the Federal Reserve Bank of New York could provide senior secured loans to a series of special purpose vehicles to finance the purchase of eligible assets. TALF was created to help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities collateralized by consumer and small-business loans. The goal was to revive the consumer-credit securitization market. The facility was launched in March and dissolved by June The goal of these initiatives was to support the functioning of credit markets and put downward pressure on long-term interest rates.

These initiatives included various programs. The original idea was for the government to buy troubled, illiquid assets from financial institutions in order to diminish concerns about their solvency and to stabilize markets. The willingness of the U. The implied threat that the alternative to recapitalization via shareholder-provided equity was the infusion of equity and thus the assumption of some ownership by the government was an effective one.

No bank wanted to be nationalized. The result was that U. In retrospect, this may have been one of the most effective policy responses to the crisis, as the contrast with the struggling banking systems in the Euro zone—where regulators did not force banks to recapitalize—reveals.

The goal of these purchases, combined with the purchases of mortgage-backed securities by Fannie Mae, Freddie Mac, and Ginnie Mae, was to make it cheaper and easier for people to buy homes. The idea was that this goal would be served if the spread between GSE debt and U. Treasury debt narrowed, and it was believed that these purchases would do that. In addition to these programs, the Federal Reserve also introduced stress tests of large banks, in order to determine their ability to withstand systemic shocks of various magnitudes.

These simulations were designed to shed light on how much capital and access to liquidity banks would need if confronted with the kinds of shocks that pummeled banks during the crisis of — and hence to provide early-warning signals to both banks and regulators.

Many believe that the liquidity support provided by central banks was effective in calming markets in the initial phases of the crisis. However, there is no consensus on whether these were the right measures for the long run or whether the problem was even correctly diagnosed. At the very least, markets exhibited considerable volatility after the collapse of Lehman Brothers, indicating that central banks were learning as they went along—building the bridge as they walked on it, so to speak—and not all the initiatives had the intended effects.

A key issue for central banks was to determine whether the unfolding events were due to liquidity or counterparty risk arising from asymmetric information about the quality of assets on bank balance sheets and the opaqueness of those balance sheets. The Federal Reserve and the European Central Bank ECB clearly believed it was a liquidity problem, at least until the failure of Lehman Brothers, and this is reflected in many of the measures discussed earlier. But if the issue was counterparty risk, then the proper approach would have been to require banks to make their balance sheets more transparent, deal directly with the rising mortgage defaults, and undertake measures to infuse more capital into financial institutions, possibly with government assistance to supplement private-sector infusions.

Some of the programs that were developed in the later stages of the crisis were directed at dealing with the counterparty risk issue. Perhaps it should come as no surprise that the initial assessment of central banks was that this was a market-wide liquidity crunch, since beliefs about the underlying causes of the crisis were conditioned on historical experience, especially that associated with the Great Depression.

This led to the view that interest rate reductions and monetary-stimulus initiatives like quantitative easing were the appropriate policy responses to crises. Of course, every crisis is different, and the circumstances that existed around the time the subprime crisis hit the economy were quite different from those that preceded the Great Depression. Nonetheless, the rapid escalation of unanticipated problems made quick policy responses an imperative, and the time for deep explorations of the root causes of observable events was simply not there.

As discussed earlier, the existing evidence suggests that this was an insolvency crisis. The Taylor and Williams paper discussed earlier also examines the effect of some of the policy interventions to shed further light on this issue. Moreover, the sharp reduction in the federal funds rate during the crisis—the Fed funds target rate went from 5.

However, it caused a depreciation of the dollar and caused oil prices to jump, causing a sharp decline in world economic growth. That is, more than a year after it started, the crisis worsened. Some point to the failure of Lehman Brothers in September as a proximate cause. Taylor and Williams suggest, however, that that may have been more a symptom than a cause and that the real culprit may have been the elevated perception of risk in the fundamentals, fueled by sinking house prices and rising oil prices.

The main point brought out by the Taylor and Williams analysis is that counterparty risk concerns generated by rising insolvency risk perceptions were an important driver of short-term funding strains for banks during August — This suggests that interventions designed to address counterparty risk like capital infusions and stress tests should have been implemented earlier than they were. Their analysis does not necessarily imply that liquidity facilities for banks were not helpful in the early stages of the crisis or that liquidity was not a concern of any magnitude during the crisis.

One problem with making a determination of whether liquidity interventions by the Federal Reserve served any useful purpose is that we do not observe the counterfactual, that is, we do not know how market participants would have reacted in the absence of the liquidity intervention. While it is true that borrowing at the discount window was somewhat limited until , it is difficult to know what would have happened had the discount window assurance provided by the role of the Federal Reserve as a Lender of Last Resort LOLR been absent.

Even apart from the issue of whether the real problem was liquidity or counterparty risk, the massive ex post expansion of the government safety net to mutual fund investors and nondepository institutions to deal with the crisis raises the possibility that the expectations of market participants about the nature of implicit government guarantees have been significantly altered insofar as future crisis events are concerned.

This has potentially significant moral hazard implications that may distort not only the behavior of investors and institutions but also possibly regulators who may feel compelled to adopt more intensive regulation to cope with the greater moral hazard. For such an exercise, the root-cause analysis in Section 2 is helpful. This analysis reveals that a rich set of factors interacted to generate this crisis, but if one were to try and extract the most essential drivers, one would conclude that the long period of sustained banking profitability was at the heart of the problem, since it is this period of relatively tranquil prosperity that corrupted risk management at many levels by creating the belief that banks were highly skilled at managing a variety of complex risks see Thakor a.

It tempted politicians to push the home-ownership agenda by creating regulatory and other inducements for banks to originate and securitize risky mortgages because banks were viewed as being capable of handling the risks. It tempted consumers to become excessively highly leveraged, thereby increasing the likelihood of default on mortgages see, for example, Mian, Rao, and Sufi, It deterred regulators from imposing substantially higher capital requirements on banks because the diversification and risk-management skills of bankers were considered to be good enough to contain whatever risks were associated with the massive financial innovation that was occurring.

It encouraged banks to engage in financial innovation and operate with relatively low levels of capital. It led credit rating agencies to underestimate risks and assign ratings that turned out ex post to be inflated. Given this, what should we think of doing prospectively?

Three issues are discussed below. Moreover, as Thakor discusses, increasing capital requirements will reduce correlated risk taking by banks, and hence lead to lower systemic risk. While these initiatives are unlikely to suffice by themselves to reduce the probability of future crises to socially acceptable levels, they may go a long way in enhancing financial stability.

Moreover, by achieving some reduction in the probability of future crises, they will also reduce the probability of ad hoc ex post expansions of the government safety net that carry with them the baggage of increased moral hazard. Increasing capital in banking also has other advantages. Sufficiently well capitalized institutions have little need to engage in fire sales of assets and therefore are unlikely to run into funding constraints Shleifer and Vishny discuss the macroeconomic effects of fire sales.

This leads to high liquidity in the market see Brunnermeier and Pedersen , indicating that liquidity risk can be diminished without having institutions keep lots of low-return liquid assets like cash on their balance sheets. Thakor discusses how higher bank capital reduces insolvency risk by attenuating asset-substitution moral hazard and strengthening the bank's monitoring and screening incentives. So, higher levels of bank capital can reduce both liquidity risk and insolvency risk.

There have been two major impediments to the adoption of higher capital requirements in banking. One is that regulators have used backward-looking models of risk assessments e. The use of stress tests, and calculations of capital surcharges based on those tests, can help to partially overcome this problem. With differences of opinion, even among researchers, about the desirability of asking banks to keep more capital, this limitation creates the risk that debates on this may devolve into mere assertions based largely on assumptions made in qualitative models that cannot be tested.

Fortunately, recent research has begun to address this issue by calculating how increases in bank capital requirements may affect the cost of capital and profitability of banks. Roger and Vitek develop a macroeconometric model to determine how global GDP would respond to an increase in bank capital requirements, and conclude that monetary policy responses would largely offset any adverse impact of capital requirements.

So, the costs of significantly higher capital requirements appear to be small. What about the benefits? Mehran and Thakor provide empirical evidence that the bank value is increasing in bank capital in the cross-section. This militates against the notion that increasing capital in banking will necessarily jeopardize shareholder value in banking—a claim often made by bankers in resisting calls for higher capital levels—thereby questioning a basic premise of the presumed trade-off between financial stability and bank value creation.

Some recent papers have started taking a stab at this. For example, Nguyen develops a general equilibrium model in which a dynamic banking sector endogenously determines aggregate growth. This exceeds what is prescribed by both the Basel II and III accords, but it is below what many believe is needed for financial stability e. While one might quibble with the parameter values that produce such precise estimates, the benefit of engaging in serious modeling that is aimed at extracting such estimates cannot be overstated.

The good news is that policymakers are already beginning to pay heed to the calls for higher capital. The bad news is that despite the capital surcharges based on stress-test results, the largest U. Apart from the weakness of pre-crisis regulation in being insufficiently attentive to consumer and bank leverage, there was also little attention paid to the growth of the repo market and its escalating importance in the short-term funding of shadow banks. Concerns about the credit risks associated with the collateral used in repo transactions and the solvency of shadow banks that are heavily reliant on repos for short-term funding had a lot to do with what triggered the subprime crisis.

Part of the reason for this inattention was due to the enormously complex yet fragmented regulatory structure for financial institutions that was discussed earlier. Since the repo market is likely to experience bouts of illiquidity when the rest of the financial market is in a state of duress, this risk is potentially systemic, so not dealing with it in regulatory reform is a significant oversight. We need more normative research on the optimal design of regulatory agencies.

Finally, the quality of corporate governance in banking has also been questioned. One could argue that if equity governance were strengthened, the case for higher capital requirements could be made stronger. Nonfinancial companies are not allowed to take ownership positions in banks in the United States.

A BHC cannot invest in non-bank activities, so effectively ownership of banks is denied to many types of firms that create value through more effective governance, for example, private equity firms. This constraint on equity ownership in banks means that equity governance in banking is likely to be weaker than in nonfinancial corporations, which, in turn, makes equity less attractive for banks than for nonfinancials.

This further reduces the attractiveness of bank equity investments for nonbank investors. Whether stronger equity governance will suffice to significantly alter bank behavior is questionable. The culture of an organization has an important effect on its performance see, for example, Bouwman ; Cameron et al. We need a lot more research on corporate culture in banking and how regulators should assess and monitor it.

This paper has reviewed a very large body of research on the causes and effects of the most devastating financial crisis since the Great Depression, and the policy responses undertaken by central banks to deal with the crisis. It appears that the crisis resulted from the interaction of many factors: politics, monetary policy, global economic developments, misaligned incentives, fraud, growth of securitization, a fragmented regulatory structure, and a complacency born of success-driven skill inferences.

It is well recognized that dealing with insolvency risk to diminish the likelihood of future crises will call for banks to operate with higher capital levels. For regulators, an important question is how should we assess the trade-offs between bank capital and stability? It appears that higher levels of capital in banking will reduce both insolvency and liquidity risks. Of course, we need to know how to measure systemic risk for purposes of calibration of regulatory capital requirements.

Acharya, Engle, and Richardson discuss the measurement of systemic risk and implementable schemes to regulate it. Moreover, it is also clear that we need to better understand the interaction between bank capital, borrower capital, monetary policy and asset prices.

The recent theory proposed by di Lasio provides a microfounded justification for macroprudential regulation that involves countercyclical capital buffers and higher capital requirements during periods of lower fundamental risk.

This theory can be a useful starting point for the examination of more complex interactions involving monetary policy. Two other issues deserve research attention. One is the effect that regulatory complexity has on the efficacy of regulation. An example is the enormous complexity of the Dodd-Frank Act. While an important goal of the regulation is to eliminate the too-big-to-fail problem, it is doubtful it will achieve that goal.

I alone am responsible for any errors either omission or commission or misstatements. This view of the Great Depression is not shared by all, however. Some believe the problem then was also insolvency, not illiquidity, just as in the subprime crisis. Fannie Mae and Freddie Mac received a mandate to support low-income housing in This was actually helpful to these agencies in expanding their activities beyond their initial charter and in growing by purchasing subprime residential mortgage-backed securities.

This may provide one explanation for why bankers resist higher capital requirements. BAPCA expanded the definition of repurchase agreements to include mortgage loans, mortgage-related securities, and interest from these loans and securities. This made MBS and other mortgage-related securities more liquid, increasing demand for these securities and creating stronger mortgage origination incentives for banks.

Song and Thakor provide a theory of how politics shapes bank regulation. This made these banks riskier. See Cortes and Thakor See Barth et al. Specifically, the rule, attributed to John B. This risk taking also involved correlated asset choices and correlated high leverage choices by financial institutions. See Acharya, Mehran, and Thakor and Goel, Song, and Thakor for theories of correlated leverage and asset choices. It blames the Federal Reserve for being too supportive of industry growth objectives, including a desire to encourage growth in the subprime lending market.

Nonetheless, it appears that there were some in the Federal Reserve System and other regulatory agencies who had concerns. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders as luring many people into risky mortgages they could not afford. But when Mr. Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman.

In , a senior Treasury official, Sheila C. None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms. Bair recalled recently, soon let them slip. See Becker and Milbourn for empirical evidence. The incentive to increase leverage in the presence of safety nets is not a new phenomenon.

After the Bank of England was established as a lender of last resort, many British banks became highly levered, and this was a contributing factor to the crisis. This permits very risky investments to be financed by thinly-capitalized banks, increasing the probability of a future crisis. This theory explains why the economy falls to pieces after a crisis and predicts that the development of a loan resale market will improve loan liquidity but increase the probability of a financial crisis.

See Covitz, Liang, and Suarez Such self-correcting market mechanisms will largely obviate the need for any government intervention. The subprime crisis of — has been frequently compared with the Great Depression. For some, the comparisons are explicit. Economists like Paul Krugman and Barry Eichengreen have drawn parallels between the two slumps.

Ben Bernanke at the Federal Reserve and Obama-administration advisors like Christina Romer all have academic backgrounds in the discipline. In September , even high-quality nonfinancial companies seemed to experience higher borrowing costs and constraints on borrowing in the commercial paper market. Of course, this may simply have reflected the perception of dimming prospects for the real economy, rather than a market-wide liquidity crunch per se. By ensuring that shadow banks are subject to the necessary capital requirements, regulators can minimize the ability of depository institutions to evade higher capital requirements by shifting activities to the less-regulated shadow banking sector.

This would counter one of the typical arguments made against raising capital requirements for banks. Pfleiderer points out that one reason why banks are attracted to high leverage is that implicit and explicit safety nets provide banks higher credit ratings and hence lower yields on their debt than other firms. See Thakor for a discussion of these competing theoretical viewpoints. See Thakor for a detailed discussion. That is, excess liquidity may have led to an insolvency crisis.

Guiso, Sapienza, and Zingales examine the impact of governance structure on corporate culture. Google Scholar. Google Preview. Oxford University Press is a department of the University of Oxford. It furthers the University's objective of excellence in research, scholarship, and education by publishing worldwide.

Sign In or Create an Account. Sign In. Advanced Search. Search Menu. Article Navigation. Close mobile search navigation Article Navigation. Volume 4. Article Contents Abstract. What Happened and When. The Real Effects of the Crisis. The Policy Responses to the Crisis. Editor's Choice. Thakor Anjan V. Louis, and ECGI. Oxford Academic.

Cite Cite Anjan V. Select Format Select format. Permissions Icon Permissions. Abstract This review of the literature on the — crisis discusses the precrisis conditions, the crisis triggers, the crisis events, the real effects, and the policy responses to the crisis. Figure 1. Open in new tab Download slide. The chain of events leading up to the crisis. Figure 2. Figure 3. Figure 4.

Evolution of equity and borrowing in residential real estate Source: Federal Reserve Flow of Funds and Cecchetti Figure 5. Runs on asset-based commercial paper programs Source: Covitz, Liang, and Suarez Figure 6. Figure 7. The major categories of intervention by the federal reserve board. Google Scholar Crossref. Search ADS. Capital shortfall: A new approach to ranking and regulating systemic risks. Caught between Scylla and Charybdis?

Regulating bank leverage when there is rent-seeking and risk-shifting. December How bad was it? The costs and consequences of the —09 financial crisis. The rise and fall of the U. Do we need big banks? Evidence on performance, strategy, and market discipline. Commercial banking and shadow banking: The accelerating integration of banks and markets and its implications for regulation.

Competing values leadership: Creating value in organizations New horizons management series. The real effects of financial constraints: Evidence from a financial crisis. The regulatory response to the global financial crisis: Some uncomfortable questions. Financial intermediation as a beliefs-bridge between optimists and pessimists. The evolution of a financial crisis: Collapse of the asset-backed commercial paper market. This time is the same: Using bank performance in to explain bank performance during the recent financial crisis.

Tranching, CDS, and asset prices: How financial innovation can cause bubbles and crashes. A summary of the primary causes of the housing bubble and the resulting credit crisis. A non-technical paper. Evidence from a risk-return-driven cost function. International Monetary Fund. Global financial stability report: sovereigns, funding, and systemic liquidity.

Global financial stability report, October Navigating the financial challenges ahead. Causes of the great recession of — The financial crisis was the symptom not the disease! When safe proved risky: Commercial paper during the financial crisis of — Available at www. Bank risk-taking, securitization, supervision, and low interest rates: Evidence from the Euro-Area and the U. The consequences of mortgage credit expansion: Evidence from the U.

House of debt: How they and you caused the great recession and how we can prevent it from happening again. Moral hazard and information sharing: A model of financial information gathering agencies. Reducing the fragility of the financial sector: The importance of equity and why it is not expensive. Global retail lending in the aftermath of the U. The failure of models that predict failure: Distance, incentives, and defaults.

Is the U. An international historical comparison. The global macroeconomic costs of raising bank capital adequacy requirements. Economic policy and the financial crisis: An empirical analysis of what went wrong. Bank capital and financial stability: An economic tradeoff or a Faustian bargain? The highs and the lows: a theory of credit risk assessment and pricing through the business cycle. Overcoming adverse selection: How public intervention can restore market functioning.

All rights reserved. For Permissions, please e-mail: journals. Issue Section:. Download all slides. Views 28, More metrics information. Email alerts Article activity alert. Advance article alerts. New issue alert. Banks and other lenders were willing to make increasingly large volumes of risky loans for a range of reasons:.

In the lead up to the GFC, banks and other investors in the United States and abroad borrowed increasing amounts to expand their lending and purchase MBS products. Borrowing money to purchase an asset known as an increase in leverage magnifies potential profits but also magnifies potential losses.

Additionally, banks and some investors increasingly borrowed money for very short periods, including overnight, to purchase assets that could not be sold quickly. Consequently, they became increasingly reliant on lenders — which included other banks — extending new loans as existing short-term loans were repaid. Regulation of subprime lending and MBS products was too lax. In particular, there was insufficient regulation of the institutions that created and sold the complex and opaque MBS to investors.

Not only were many individual borrowers provided with loans so large that they were unlikely to be able to repay them, but fraud was increasingly common — such as overstating a borrower's income and over-promising investors on the safety of the MBS products they were being sold. In addition, as the crisis unfolded, many central banks and governments did not fully recognise the extent to which bad loans had been extended during the boom and the many ways in which mortgage losses were spreading through the financial system.

The catalysts for the GFC were falling US house prices and a rising number of borrowers unable to repay their loans. House prices in the United States peaked around mid , coinciding with a rapidly rising supply of newly built houses in some areas. As house prices began to fall, the share of borrowers that failed to make their loan repayments began to rise. Loan repayments were particularly sensitive to house prices in the United States because the proportion of US households both owner-occupiers and investors with large debts had risen a lot during the boom and was higher than in other countries.

Stresses in the financial system first emerged clearly around mid Some lenders and investors began to incur large losses because many of the houses they repossessed after the borrowers missed repayments could only be sold at prices below the loan balance. Relatedly, investors became less willing to purchase MBS products and were actively trying to sell their holdings. In turn, investors who had purchased MBS with short-term loans found it much more difficult to roll over these loans, which further exacerbated MBS selling and declines in MBS prices.

As noted above, foreign banks were active participants in the US housing market during the boom, including purchasing MBS with short-term US dollar funding. US banks also had substantial operations in other countries. These interconnections provided a channel for the problems in the US housing market to spill over to financial systems and economies in other countries.

Financial stresses peaked following the failure of the US financial firm Lehman Brothers in September Together with the failure or near failure of a range of other financial firms around that time, this triggered a panic in financial markets globally. Investors began pulling their money out of banks and investment funds around the world as they did not know who might be next to fail and how exposed each institution was to subprime and other distressed loans.

Consequently, financial markets became dysfunctional as everyone tried to sell at the same time and many institutions wanting new financing could not obtain it. Businesses also became much less willing to invest and households less willing to spend as confidence collapsed. As a result, the United States and some other economies fell into their deepest recessions since the Great Depression. Until September , the main policy response to the crisis came from central banks that lowered interest rates to stimulate economic activity, which began to slow in late However, the policy response ramped up following the collapse of Lehman Brothers and the downturn in global growth.

Governments increased their spending to stimulate demand and support employment throughout the economy; guaranteed deposits and bank bonds to shore up confidence in financial firms; and purchased ownership stakes in some banks and other financial firms to prevent bankruptcies that could have exacerbated the panic in financial markets. Although the global economy experienced its sharpest slowdown since the Great Depression, the policy response prevented a global depression.

Nevertheless, millions of people lost their jobs, their homes and large amounts of their wealth. Many economies also recovered much more slowly from the GFC than previous recessions that were not associated with financial crises. For example, the US unemployment rate only returned to pre-crisis levels in , about nine years after the onset of the crisis. In response to the crisis, regulators strengthened their oversight of banks and other financial institutions.

Among many new global regulations, banks must now assess more closely the risk of the loans they are providing and use more resilient funding sources. Regulators are also more vigilant about the ways in which risks can spread throughout the financial system, and require actions to prevent the spreading of risks. Australia did not experience a large economic downturn or a financial crisis during the GFC.

However, the pace of economic growth did slow significantly, the unemployment rate rose sharply and there was a period of heightened uncertainty. The relatively strong performance of the Australian economy and financial system during the GFC, compared with other countries, reflected a range of factors, including:. Despite the Australian financial system being in a much better position before the GFC, given the magnitude of the shock to the global economy and to confidence more broadly, there was also a large policy response in Australia to ensure that the economy did not suffer a major downturn.

In particular, the Reserve Bank lowered the cash rate significantly, and the Australian Government undertook expansionary fiscal policy and provided guarantees on deposits at and bonds issued by Australian banks.

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The special investment vehicles SIVs were also reduced. The optimal point for the subprime crisis started in September , which resulted in the following events:. The low-interest rates in early led to increased demand for housing and related mortgages. As a result, housing prices rose significantly. During the low-interest-rate period, the investors for example, institutional investors sought investments that promised yield improvement.

One of the investment avenues was the subprime mortgages, which had high premiums up to basis points above the interest rate charged by the prime borrowers. An increase in subprime loans led to the emergence of securitization transformation of the illiquid assets such as debts into security.

Securitization led to:. As securitization emerged, banks were motivated to develop the originate-to-distribute OTD business model. OTD model is where banks lend to numerous parties without violating the lending limit regulation. This is because many subprime mortgages were structured with teaser rates low flexible introductory interest rates given for a loan to attract potential customers , which were then increased after the stipulated teaser period ended.

Many of these mortgages were interest-only over the teaser period, implying there were no principal payments to spice it up. So attractive as it were, some borrowers utilized these subprime mortgages to buy residential houses, and others were just speculators due to the rise in home housing prices. At the end of the teaser period, a borrower could service the mortgages just like a loan as long as the housing prices rose. For the speculators, they could default if the refinancing was not possible.

Under the OTD business model, losses on the subprime losses were felt by the investors who owned the loans. This reduced the motivation for the banks to conduct proper credit assessment on the borrowers and the collateral valuation on the homeowners before extending the credit. At this time, many subprime mortgages were transformed into collateralized debt obligations CDOs. This led to a massive collapse of the subsequent subprime mortgage.

As a result, the credit rating downgrades for the subprime mortgage securitized products increased massively. The banks securitized their assets off their balance sheets to structured investment vehicles SIVs , also termed as conduits. SIVs are the companies utilized by the banks to purchase assets and funds by short-term commercial paper and medium-term notes and capital.

Securitization is a process where the cash flows from a portfolio are repackaged into claims on tranches a pooled group of securities such as debt instruments classified in terms of risk or other features to attract different investors , and the returns from the tranches are used to buy the collateral assets. To attract different investors, tranches are modeled to have the desired rating depending on the credit risk associated with a tranch.

The rating on tranches is structured in terms of how safe it is. Theoretically, the OTD model with appropriate securitization would diffuse the risk throughout the financial system. However, this theory failed miserably. According to Basel II, from , banks used securitization to keep their credit exposure to AAA-rated tranches to create high extra returns without raising their regulatory capital minimums.

As a result of the AAA rating, investors did not mind conducting due diligence on the pool and thought that they could earn risk-free returns by buying CDOs instead of lower-yielding similar assets such as bonds. They were utterly wrong because most of the ratings were based on historical data, which, at that time, did not reflect the variation of asset features that were taking place. The CDO trust partners also called equity holders would pay the credit rating agencies to rate various liabilities associated with the CDO to acquire high proportions of AAA-rated bonds.

Moreover, their rating was based on historical data, which did not reflect the variation of asset features that were taking place such as NINJA loans, liar loans, and subprime mortgages. Moreover, the rating agencies used the data from the organizers and the issuers of the mortgages who performed due diligence analysis.

However, although the rating companies knew about the decline of the leading standards and rising fraud, the rating agencies did not do further due diligence or pay close attention to the available data. The subprime mortgages were the new products in the market. Therefore, there was no enough data for the analyst to perform a prior risk analysis. Due to this, the initial ratings given to the securitizations in question were AAA ratings, which were likely to be faulty from the beginning.

The short-term wholesale market consists of repurchase agreements and commercial paper C. These markets shut down early in the crisis since the participants lacked trust in the collateral quality. Repos also called repurchase agreements, are utilized by many financial institutions such as banks and money market funds.

A typical repo consists of the sale of an asset and a contract to purchase the asset back at a slightly higher price at a later time. At the outset of the repo, the seller receives the cash. Thus, the seller is like the borrower in a collateralized with security such as government bonds and tranches of securitizations loan transaction.

On the other hand, the purchaser of the security who gives the cash at the outset of the repo receives a higher sum at the end of the period of the repo is considered a lender in the context that money received consists of the principal and the interest.

With higher lower quality collateral, then it implies a higher lower haircut. Haircut, in this case, refers to the percentage decrease from the initial cash that the lender is willing to give to the borrower. Haircut protects the lender from receiving less than full value in case the borrower defaults and the lender is forced to sell the collateral in case of default.

The insecure commercial paper C. On the other hand, in Asset-backed commercial paper ABCP , the issuer provides the finance to buy assets by issuing a C. In the years preceding the financial crisis, there was a high demand for collateral due to the growth of the OTC derivatives markets and increased dependence on short-term collateralizations by the financial institutions.

However, these demands were quenched by the issuance of the AAA-rated securitization tranches. The Fed statistics showed that the repos increased from USD 1. The SIVs were funded using short-term debt and depended on its flexibility to roll over short-term debt to finance their longer-dated assets.

When collateralized mortgages began to lose value, the credit quality of numerous SIVs and increased doubt on the collateral value prevented an increasing number of SIVs from rolling over their ABCP and accompanied a decrease in liquidity in the subprime-related asset markets. In fact, before mid, counterparty credit was not priced by the market since there was a significant difference between the unsecured overnight index swap OIS rate all periods swap rates.

From June , the market participants started to worry about the collateralized securities and the level of exposure of the financial institutions to the subprime market leading to a sharp increase in the OIS-swap spread which remained high during the crisis and increased again when the Lehman Brother failed and did not return to the pre-crisis period.

Additionally, the credit spread on credit assets led to a significant decrease in credit assets. By the summer of , the short-term wholesale funding market began to freeze which included both the ABCP and repo markets. At this point, the investors halted the rolling over of maturing ABCP forcing the banks to recall the SIV assets onto their balance sheets.

With the increasing repo haircuts, the financial institutions that relied on the repo financing were unable to roll over their short-term funding, and thus, they were faced with three choices: merger, bailout or bankruptcy. The amplified uncertainty over the valuation of the asset-backed structured products worsened the financial crisis in the short-term debt markets. This was because the valuation of the asset-backed structured products was difficult.

The liability model and cashflow waterfalls were complicated and contained numerous types of collateral and interest rate triggers because, despite that, they have the same securitization structure. There was also the need for the pools of the collateral to be valued. For instance, for ABS trust, it was necessary to calculate thousands of subprime mortgages with different borrower features and loan terms.

The cashflows to some trusts depended on the future values and credit ratings of the collateral, which made modeling the cashflows a complicated undertaking. Moreover, this was worsened by insufficient data on different asset pools presents a challenge even to sophisticated investors. On the transparency issue, some of the seemingly complicated investors lacked the in-house skills to comprehend the complex products they were purchasing. Moreover, they did have enough knowledge of the underlying risks that might arise from the assumptions they implied in calculating and credit rating models.

Thus, many investors relied on credit rating agencies for their risk measurement. The computation of illiquid assets was blurry due to the lack of readily available reference prices, which made the investors be highly doubtful of the displayed prices when analyzing the credit risk of a counterparty. The potent mixture of uncertainty and lack of transparency catalyzed the subprime crisis in the summer of because the market was skeptical that the past-issued structured products might be mispriced.

There was also some anxiety on the exposure of financial institutions to the subprime market. For instance, Bear Sterns tried to save two hedge funds that were e prone to subprime mortgage losses. One of the primer brokers, Merrill Lynch, called back USD million underlying collateral but had a challenge in selling due to the illiquidity of the markets to some assets at that time.

As a result of these events, the wholesale short-term funding collapsed effectively. The Federal Reserve Fed and other central banks globally devised liquidity injection services. In the time gap between and the end of , the Fed blocked some asset groups that were affected by financial crisis stress. These actions by the Fed included:. Some of the notable government intervention in the U.

Systemic risk can be defined as a risk that occurs in one firm or market and can be amplified to the other firms or broader markets. As a result, the entire markets or economies can be exposed to the risk. Systematic risk played a significant role in worsening the financial crisis. The collateral quality in ABCP and repo markets reduces the default risk by the borrowers. Therefore, the lenders in the market should possess confidence in the type of collateral assets. However, during the financial crisis, the ABCP and the repo fell, lowering the confidence of the lenders in the collateral.

They were concerned that collateral contained subprime mortgages and the reliability of its valuation. Due to a lack of transparency, even the borrower with no prime exposure did not roll over their debt. The valuation of illiquid asset prices is challenging even in normal market conditions. For instance, in the summer of , when BNP Paribas failed to value its illiquid assets, numerous money market managers of the repo markets abandoned it and moved to Treasury bills.

When the ABCP and repos collapsed, many hedge funds failed to roll over the respective debt and were forced to sell assets, and because the funds hold broadly typed of assets, the impact was felt in many markets. For instance, the CDO market was subjected to selling pressure, evidenced by the liquidation of some assets at low prices. Moreover, to close out some current positions, some funds sold high credit-rated assets and bought lower credit-rated assets that were sold at that time.

Consequently, the prices for quality assets fell, and that of lower quality rose affecting the hedge funds traded on pricing patterns. Moreover, banks started to hoard some cash due to the uncertainty of seeming reductions on the decreasing credit lines of SIVs. The refusal to lend became popular among the banks due to the stricter standard.

From to , the top five U. Changes in capital requirements, intended to keep U. The shift from first-loss tranches to AAA-rated tranches was seen by regulators as a risk reduction that compensated the higher leverage. Lehman Brothers went bankrupt and was liquidated , Bear Stearns and Merrill Lynch were sold at fire-sale prices, and Goldman Sachs and Morgan Stanley became commercial banks, subjecting themselves to more stringent regulation.

With the exception of Lehman, these companies required or received government support. Fannie Mae and Freddie Mac, two U. Behavior that may be optimal for an individual such as saving more during adverse economic conditions, can be detrimental if too many individuals pursue the same behavior, as ultimately one person's consumption is another person's income.

Too many consumers attempting to save or pay down debt simultaneously is called the paradox of thrift and can cause or deepen a recession. Economist Hyman Minsky also described a "paradox of deleveraging" as financial institutions that have too much leverage debt relative to equity cannot all de-leverage simultaneously without significant declines in the value of their assets. Once this massive credit crunch hit, it didn't take long before we were in a recession. The recession, in turn, deepened the credit crunch as demand and employment fell, and credit losses of financial institutions surged.

Indeed, we have been in the grips of precisely this adverse feedback loop for more than a year. A process of balance sheet deleveraging has spread to nearly every corner of the economy. Consumers are pulling back on purchases, especially on durable goods, to build their savings. Businesses are cancelling planned investments and laying off workers to preserve cash. And, financial institutions are shrinking assets to bolster capital and improve their chances of weathering the current storm.

Once again, Minsky understood this dynamic. He spoke of the paradox of deleveraging, in which precautions that may be smart for individuals and firms—and indeed essential to return the economy to a normal state—nevertheless magnify the distress of the economy as a whole. The term financial innovation refers to the ongoing development of financial products designed to achieve particular client objectives, such as offsetting a particular risk exposure such as the default of a borrower or to assist with obtaining financing.

Examples pertinent to this crisis included: the adjustable-rate mortgage ; the bundling of subprime mortgages into mortgage-backed securities MBS or collateralized debt obligations CDO for sale to investors, a type of securitization ; and a form of credit insurance called credit default swaps CDS.

The usage of these products expanded dramatically in the years leading up to the crisis. These products vary in complexity and the ease with which they can be valued on the books of financial institutions. As described in the section on subprime lending, the CDS and portfolio of CDS called synthetic CDO enabled a theoretically infinite amount to be wagered on the finite value of housing loans outstanding, provided that buyers and sellers of the derivatives could be found.

This boom in innovative financial products went hand in hand with more complexity. It multiplied the number of actors connected to a single mortgage including mortgage brokers, specialized originators, the securitizers and their due diligence firms, managing agents and trading desks, and finally investors, insurances and providers of repo funding.

With increasing distance from the underlying asset these actors relied more and more on indirect information including FICO scores on creditworthiness, appraisals and due diligence checks by third party organizations, and most importantly the computer models of rating agencies and risk management desks.

Instead of spreading risk this provided the ground for fraudulent acts, misjudgments and finally market collapse. Martin Wolf , chief economics commentator at the Financial Times , wrote in June that certain financial innovations enabled firms to circumvent regulations, such as off-balance sheet financing that affects the leverage or capital cushion reported by major banks, stating: " Mortgage risks were underestimated by almost all institutions in the chain from originator to investor by underweighting the possibility of falling housing prices based on historical trends of the past 50 years.

Limitations of default and prepayment models, the heart of pricing models, led to overvaluation of mortgage and asset-backed products and their derivatives by originators, securitizers, broker-dealers, rating-agencies, insurance underwriters and the vast majority of investors with the exception of certain hedge funds. The pricing of risk refers to the risk premium required by investors for taking on additional risk, which may be measured by higher interest rates or fees. Several scholars have argued that a lack of transparency about banks' risk exposures prevented markets from correctly pricing risk before the crisis, enabled the mortgage market to grow larger than it otherwise would have, and made the financial crisis far more disruptive than it would have been if risk levels had been disclosed in a straightforward, readily understandable format.

For a variety of reasons, market participants did not accurately measure the risk inherent with financial innovation such as MBS and CDOs or understand its effect on the overall stability of the financial system. AIG insured obligations of various financial institutions through the usage of credit default swaps. However, AIG did not have the financial strength to support its many CDS commitments as the crisis progressed and was taken over by the government in September It concluded in January The Commission concludes AIG failed and was rescued by the government primarily because its enormous sales of credit default swaps were made without putting up the initial collateral, setting aside capital reserves, or hedging its exposure—a profound failure in corporate governance, particularly its risk management practices.

AIG's failure was possible because of the sweeping deregulation of over-the-counter OTC derivatives, including credit default swaps, which effectively eliminated federal and state regulation of these products, including capital and margin requirements that would have lessened the likelihood of AIG's failure.

The limitations of a widely used financial model also were not properly understood. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies. Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected.

The cracks became full-fledged canyons in —when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees. As financial assets became more complex and harder to value, investors were reassured by the fact that the international bond rating agencies and bank regulators accepted as valid some complex mathematical models that showed the risks were much smaller than they actually were.

Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility. A conflict of interest between investment management professional and institutional investors , combined with a global glut in investment capital, led to bad investments by asset managers in over-priced credit assets. Professional investment managers generally are compensated based on the volume of client assets under management.

There is, therefore, an incentive for asset managers to expand their assets under management in order to maximize their compensation. As the glut in global investment capital caused the yields on credit assets to decline, asset managers were faced with the choice of either investing in assets where returns did not reflect true credit risk or returning funds to clients. Many asset managers continued to invest client funds in over-priced under-yielding investments, to the detriment of their clients, so they could maintain their assets under management.

They supported this choice with a "plausible deniability" of the risks associated with subprime-based credit assets because the loss experience with early "vintages" of subprime loans was so low. Despite the dominance of the above formula, there are documented attempts of the financial industry, occurring before the crisis, to address the formula limitations, specifically the lack of dependence dynamics and the poor representation of extreme events.

See also the article by Donnelly and Embrechts [] and the book by Brigo, Pallavicini and Torresetti, that reports relevant warnings and research on CDOs appeared in There is strong evidence that the riskiest, worst performing mortgages were funded through the " shadow banking system " and that competition from the shadow banking system may have pressured more traditional institutions to lower their underwriting standards and originate riskier loans.

In a June speech, President and CEO of the Federal Reserve Bank of New York Timothy Geithner —who in became United States Secretary of the Treasury —placed significant blame for the freezing of credit markets on a "run" on the entities in the "parallel" banking system, also called the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls.

Further, these entities were vulnerable because of Asset—liability mismatch , meaning that they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would force them to engage in rapid deleveraging, selling their long-term assets at depressed prices. He described the significance of these entities:. The combined effect of these factors was a financial system vulnerable to self-reinforcing asset price and credit cycles.

Economist Paul Krugman , laureate of the Nobel Memorial Prize in Economic Sciences , described the run on the shadow banking system as the "core of what happened" to cause the crisis. He referred to this lack of controls as "malign neglect" and argued that regulation should have been imposed on all banking-like activity.

This meant that nearly one-third of the U. While traditional banks raised their lending standards, it was the collapse of the shadow banking system that was the primary cause of the reduction in funds available for borrowing. The securitization markets supported by the shadow banking system started to close down in the spring of and nearly shut-down in the fall of More than a third of the private credit markets thus became unavailable as a source of funds.

In a paper, Ricardo J. Caballero , Emmanuel Farhi , and Pierre-Olivier Gourinchas argued that the financial crisis was attributable to "global asset scarcity, which led to large capital flows toward the United States and to the creation of asset bubbles that eventually burst.

That is, the global economy was subject to one shock with multiple implications rather than to two separate shocks financial and oil. The empirical research has been mixed. In a book, John McMurtry suggested that a financial crisis is a systemic crisis of capitalism itself.

In his book, The Downfall of Capitalism and Communism , Ravi Batra suggests that growing inequality of financial capitalism produces speculative bubbles that burst and result in depression and major political changes.

He also suggested that a "demand gap" related to differing wage and productivity growth explains deficit and debt dynamics important to stock market developments. John Bellamy Foster , a political economy analyst and editor of the Monthly Review , believed that the decrease in GDP growth rates since the early s is due to increasing market saturation.

Marxian economics followers Andrew Kliman , Michael Roberts, and Guglielmo Carchedi, in contradistinction to the Monthly Review school represented by Foster, pointed to capitalism's long-term tendency of the rate of profit to fall as the underlying cause of crises generally. From this point of view, the problem was the inability of capital to grow or accumulate at sufficient rates through productive investment alone.

Low rates of profit in productive sectors led to speculative investment in riskier assets, where there was potential for greater return on investment. The speculative frenzy of the late 90s and s was, in this view, a consequence of a rising organic composition of capital, expressed through the fall in the rate of profit. According to Michael Roberts, the fall in the rate of profit "eventually triggered the credit crunch of when credit could no longer support profits".

Bogle wrote that "Corporate America went astray largely because the power of managers went virtually unchecked by our gatekeepers for far too long". Echoing the central thesis of James Burnham 's seminal book, The Managerial Revolution , Bogle cites issues, including: [].

Roeder suggested that "recent technological advances, such as computer-driven trading programs, together with the increasingly interconnected nature of markets, has magnified the momentum effect. This has made the financial sector inherently unstable. This stagnation forced the population to borrow to meet the cost of living.

A report by the International Labour Organization concluded that cooperative banking institutions were less likely to fail than their competitors during the crisis. Economists, particularly followers of mainstream economics , mostly failed to predict the crisis. Popular articles published in the mass media have led the general public to believe that the majority of economists have failed in their obligation to predict the financial crisis.

For example, an article in The New York Times noted that economist Nouriel Roubini warned of such crisis as early as September , and stated that the profession of economics is bad at predicting recessions. Rose and Mark M. The authors examined various economic indicators, ignoring contagion effects across countries. The authors concluded: "We include over sixty potential causes of the crisis, covering such categories as: financial system policies and conditions; asset price appreciation in real estate and equity markets; international imbalances and foreign reserve adequacy; macroeconomic policies; and institutional and geographic features.

Despite the fact that we use a wide number of possible causes in a flexible statistical framework, we are unable to link most of the commonly cited causes of the crisis to its incidence across countries. This negative finding in the cross-section makes us skeptical of the accuracy of 'early warning' systems of potential crises, which must also predict their timing. The Austrian School regarded the crisis as a vindication and classic example of a predictable credit-fueled bubble caused by laxity in monetary supply.

Several followers of heterodox economics predicted the crisis, with varying arguments. Shiller, a founder of the Case-Shiller index that measures home prices, wrote an article a year before the collapse of Lehman Brothers in which he predicted that a slowing U. Karim Abadir, based on his work with Gabriel Talmain, [] predicted the timing of the recession [] whose trigger had already started manifesting itself in the real economy from early There were other economists that did warn of a pending crisis.

In , at a celebration honoring Alan Greenspan , who was about to retire as chairman of the US Federal Reserve , Rajan delivered a controversial paper that was critical of the financial sector. These risks are known as tail risks. But perhaps the most important concern is whether banks will be able to provide liquidity to financial markets so that if the tail risk does materialize, financial positions can be unwound and losses allocated so that the consequences to the real economy are minimized.

Stock trader and financial risk engineer Nassim Nicholas Taleb , author of the book The Black Swan , spent years warning against the breakdown of the banking system in particular and the economy in general owing to their use of and reliance on bad risk models and reliance on forecasting, and framed the problem as part of "robustness and fragility".

The first visible institution to run into trouble in the United States was the Southern California—based IndyMac , a spin-off of Countrywide Financial. Before its failure, IndyMac Bank was the largest savings and loan association in the Los Angeles market and the seventh largest mortgage loan originator in the United States. The primary causes of its failure were largely associated with its business strategy of originating and securitizing Alt-A loans on a large scale.

This strategy resulted in rapid growth and a high concentration of risky assets. From its inception as a savings association in , IndyMac grew to the seventh largest savings and loan and ninth largest originator of mortgage loans in the United States.

IndyMac's aggressive growth strategy, use of Alt-A and other nontraditional loan products, insufficient underwriting, credit concentrations in residential real estate in the California and Florida markets—states, alongside Nevada and Arizona, where the housing bubble was most pronounced—and heavy reliance on costly funds borrowed from a Federal Home Loan Bank FHLB and from brokered deposits, led to its demise when the mortgage market declined in IndyMac often made loans without verification of the borrower's income or assets, and to borrowers with poor credit histories.

Appraisals obtained by IndyMac on underlying collateral were often questionable as well. Ultimately, loans were made to many borrowers who simply could not afford to make their payments. The thrift remained profitable only as long as it was able to sell those loans in the secondary mortgage market. IndyMac resisted efforts to regulate its involvement in those loans or tighten their issuing criteria: see the comment by Ruthann Melbourne, Chief Risk Officer, to the regulating agencies.

On May 12, , in the "Capital" section of its last Q, IndyMac revealed that it may not be well capitalized in the future. IndyMac concluded that these downgrades would have harmed its risk-based capital ratio as of June 30, Had these lowered ratings been in effect at March 31, , IndyMac concluded that the bank's capital ratio would have been 9. IndyMac was taking new measures to preserve capital, such as deferring interest payments on some preferred securities.

Dividends on common shares had already been suspended for the first quarter of , after being cut in half the previous quarter. The company still had not secured a significant capital infusion nor found a ready buyer. The letter outlined the Senator's concerns with IndyMac.

While the run was a contributing factor in the timing of IndyMac's demise, the underlying cause of the failure was the unsafe and unsound way it was operated. On June 26, , Senator Charles Schumer D-NY , a member of the Senate Banking Committee , chairman of Congress' Joint Economic Committee and the third-ranking Democrat in the Senate, released several letters he had sent to regulators, in which he was"concerned that IndyMac's financial deterioration poses significant risks to both taxpayers and borrowers.

IndyMac announced the closure of both its retail lending and wholesale divisions, halted new loan submissions, and cut 3, jobs. Until then, depositors would have access their insured deposits through ATMs, their existing checks, and their existing debit cards. Telephone and Internet account access was restored when the bank reopened. IndyMac Bancorp filed for Chapter 7 bankruptcy on July 31, Initially the companies affected were those directly involved in home construction and mortgage lending such as Northern Rock and Countrywide Financial , as they could no longer obtain financing through the credit markets.

Over mortgage lenders went bankrupt during and The financial institution crisis hit its peak in September and October Several major institutions either failed, were acquired under duress, or were subject to government takeover. Fuld Jr. Fuld said he was a victim of the collapse, blaming a "crisis of confidence" in the markets for dooming his firm. The initial articles and some subsequent material were adapted from the Wikinfo article Financial crisis of — released under the GNU Free Documentation License Version 1.

From Wikipedia, the free encyclopedia. Worldwide economic crisis. Causes of the European debt crisis Causes of the United States housing bubble Credit rating agencies and the subprime crisis Government policies and the subprime mortgage crisis. Summit meetings. Government response and policy proposals. Business failures. See also: Global financial crisis in September , Global financial crisis in October , Global financial crisis in November , Global financial crisis in December , Global financial crisis in , United States bear market of — , Dodd-Frank Wall Street Reform and Consumer Protection Act , Regulatory responses to the subprime crisis , and Subprime mortgage crisis solutions debate.

See also: Subprime crisis background information , Subprime crisis impact timeline , Subprime mortgage crisis solutions debate , Indirect economic effects of the subprime mortgage crisis , and Great Recession. Main article: Subprime mortgage crisis. Main article: United States housing bubble. Further information: Government policies and the subprime mortgage crisis. Main article: s commodities boom.

Banking Special Provisions Act United Kingdom List of bank failures in the United States —present — Keynesian resurgence United States foreclosure crisis May Day protests Crisis Marxian Kondratiev wave List of banks acquired or bankrupted during the Great Recession List of banks acquired or bankrupted in the United States during the financial crisis of — List of acronyms associated with the eurozone crisis List of economic crises List of entities involved in — financial crises List of largest U.

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