!VAR HAGENDOORN

The Credit Crisis: Some Preliminary Analyses

For many years to come the current financial crisis will provide material for books, academic papers, PhD theses and special issues of scholarly journals. Since history is still being written, it’s too early for firm conclusions, but some interesting analyses are already starting to appear. If only people would read these papers before forming an opinion or making some policy decisions. As I pointed out earlier there are no simple answers.

The date posted says 11 October, 2008, but I continue updating this post whenever I happen upon an interesting paper such as Money, Liquidity and Monetary Policy by Tobias Adrian and Hyun Song Shin from the Federal Reserve Bank of New York (Staff Report 360, January 2009).

The New York Times now has a special section devoted to the credit crisis to keep up with current events as they unfold.

Historically this is not the first financial crisis and it won’t be the last either. Carmen Reinhardt and Kenneth Rogoff give a panoramic view of eight centuries of financial crises, and no, viewed from a distance, this time is NOT different. I quote “Periods of high international capital mobility have repeatedly produced international banking crises, not only famously as they did in the 1990s, but historically.”

Luc Laeven and Fabian Valencia provide another historical comparison of systemic banking crises based on a new database spanning the period 1970 – 2007. I’m afraid most people will have forgotten about the recent banking crises in Turkey (2000/01) and Argentina (2001) to name but a few.

In a paper titled Information, Liquidity, and the (Ongoing) Panic of 2007 Gary Gorton of the Yale School of Management and NBER discusses how an increase in repo haircuts led to massive deleveraging. Try to read it if you want to understand something about financial markets.

A combination of fiscal, legal and regulatory factors may have increased the likelihood of the U.S. housing boom ending badly. Luci Ellis, The housing meltdown: Why did it happen in the United States? BIS Working Papers No 259, September 2008

Anil Kashyap, Raghuram Rajan of the University of Chicago and Jeremy Stein of Harvard University have also written an interesting paper. I quote: “The proximate cause of the credit crisis (as distinct from the housing crisis) was the interplay between two choices made by banks. First, substantial amounts of mortgage-backed securities with exposure to subprime risk were kept on bank balance sheets even though the ‘originate and distribute’ model of securitization that many banks ostensibly followed was supposed to transfer risk to those institutions better able to bear it, such as unleveraged pension funds. Second, across the board, banks financed these and other risky assets with short-term market borrowing.”

Yuliya Demyanyk of the Federal Reserve Bank of St Louis and Otto Van Hemert of New York University “provide evidence that the rise and fall of the subprime mortgage market follows a classic lending boom-bust scenario, in which unsustainable growth leads to the collapse of the market. Problems could have been detected long before the crisis, but they were masked by high house price appreciation between 2003 and 2005.”

This paper by Günter Franke and Jan Pieter Krahnen of the Center for Financial Studies at the Goethe University Frankfurt "analyzes possible reasons for the breakdown of primary and secondary securitization markets, and argues that misaligned incentives along the value chain are the primary cause of the problems".

In a working paper on The Economics of Structured Finance Joshua Coval and Erik Stafford of Harvard Business School and Jakub Jurek of Princeton University conclude that "at the core of the recent financial market crisis has been the discovery that these securities are actually far riskier than originally advertised." Of course it's the analysis that leads them to this conclusion that is of interest and not the conclusion in itself.

And here is an old, but which we may now term visionary paper by Raghuram G. Rajan: Has Financial Development Made the World Riskier?.