THE CAUSES OF THE FINANCIAL CRISIS1
Introduction For the media in Germany, the cause of the financial crisis is obvious: Blinded by greed, bank managers thought only about their bonuses and miscalculated badly in betting on American subprime mortgages when the very name of these securities should have alerted them to their risks. If an economist suggests that the matter might be more complicated, he is denounced as a homo exculpans, a person who will excuse anything that managers do.2 If we look at the numbers, however, we see that there is something more to be explained. According to the Global Financial Stability Report of the International Monetary Fund (IMF) of ...view middle of the document...
pdf. The Jelle Zijlstra Lecture gives references and sources for all material in this text. 2 Frankfurter Allgemeine Zeitung, October 27, 2008.
too large in the sense that it cannot be explained by anticipations of losses in debt service from these securities. According to the IMF’s Global Financial Stability Report, the volume of non-prime mortgages that have been securitized amounts to about 1.1 trillion dollars. Losses of 500 billion dollars would correspond to a loss rate of 45 percent on these mortgages. If the debtor’s down payment amounted to 5 percent, a loss rate of 45 percent on the mortgage would correspond to a depreciation of the property by more than 50 percent. In actual fact, residential-real-estate prices in the United States on average have declined by 19 percent from their peak in the summer of 2006 to the summer of 2008; across metropolitan areas, the maximum for this period was just below 33 percent (Phoenix, Tampa, Miami). To be sure, this “back-of-the-envelope” calculation neglects correlations; it also neglects the possibility that the decline of real-estate prices is still going on. However, this calculation also neglects the fact that, in actual fact, average down payment rates were 6 percent for subprime and 12 percent for “Alt-A”, or near-prime, mortgages, and that about two thirds of these mortgages had been granted before 2006, at times when real-estate prices were significantly below their subsequent peaks. The IMF’s loss estimates are not actually based on projections of debt service on subprime mortgages. They are based on market prices for mortgagebacked securities. In some cases, where markets are not functioning any more, they are based on guesses as to what market prices might be if the markets were functioning. The IMF itself points out that these prices may not be good indicators of the returns that can be expected if one is willing to hold these securities to maturity. According to the IMF, therefore, market prices at this point are not a good basis for taking for long-term, value-maximising decisions. Under Fair Value Accounting, however, these market prices are used to value the securities in the banks’ books. If, over the past year, banks have forever been “discovering” new losses, the reason is not that bankers are too stupid to know or too devious to reveal what their losses really are. The reason is rather that, week by week and month by month,
CESifo Forum 4/2008
market prices have been going down and the banks’ losses have become ever larger as market participants have become ever less willing to hold these securities – or less able to hold them. The financial crisis is not just a matter of excessive lending in subprime mortgages and excessive securitization. To understand the crisis, we need to look at systemic interdependence, i.e. the mechanisms by which the subprime-mortgage crisis spilled over into the rest of the financial system. live in tents. If we are not willing to...