What Caused the Crisis

Bank Exposure to Commercial Real Estate
by Yuliya Demyanyk and Kent Cherny
in Federal Reserve Bank of Cleveland Economic Trends, August 2009

As rising home foreclosures and delinquencies continue to undermine a financial and economic recovery, an increasing amount of attention is being paid to another corner of the property market: commercial real estate. This article discusses bank exposure to the commercial real estate market.

Beyond the Crisis: Reflections on the Challenges
by Terrence J. Checki
in Federal Reserve Bank of New York Speech, December 2009

A discussion of the challenges facing the financial system and reform.

Booms and Busts: The Case of Subprime Mortgages
by Edward M. Gramlich
in Federal Reserve Bank of Kansas City Economic Review, September 2007

Booms and busts have played a prominent role in American economic history. In the 19th century, the United States benefited from the canal boom, the railroad boom, the minerals boom, and a financial boom. The 20th century brought another financial boom, a postwar boom, and a dot-com boom. The details differed, but each of these cases featured init...  

Central Bank Tools and Liquidity Shortages
by Stephen G. Cecchetti and Piti Disyatat
in Federarl Reserve Bank of New York Economic Policy Review, October 2009

The global financial crisis that began in mid-2007 has renewed concerns about financial instability and focused attention on the fundamental role of central banks in preventing and managing systemic crises. In response to the turmoil, central banks have made extensive use of both new and existing tools for supplying central bank money to financial ...  

Changes in the U.S. Financial System and the Subprime Crisis
by Jan Kregel
in Levy Economics Institute Working Paper, April 2008

The paper provides a background to the forces that have produced the present system of residential housing finance, the reasons for the current crisis in mortgage financing, and the impact of the crisis on the overall financial system.

The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis
by Atif R. Mian, Amir Sufi
in SSRN Working Paper, December 2008

We conduct a within-county analysis using detailed zip code level data to document new findings regarding the origins of the biggest financial crisis since the Great Depression. The recent sharp increase in mortgage defaults is significantly amplified in subprime zip codes, or zip codes with a disproportionately large share of subprime borrowers as...  

Counterparty Risk in the Over-The-Counter Derivatives Market
by Miguel A. Segoviano and Manmohan Singh
in IMF Working Paper, November 2008

The financial market turmoil of recent months has highlighted the importance of counterparty risk. Here, we discuss counterparty risk that may stem from the OTC derivatives markets and attempt to assess the scope of potential cascade effects. This risk is measured by losses to the financial system that may result via the OTC derivative contracts fr...  

The Credit Crisis and Cycle Proof Regulation
by Raghuram G. Rajan
in Federal Reserve Bank of St. Louis Review, September 2009

Rajan offers what he called "cycle proof regulation" to help head off a future crisis. Among other things, he proposed: -Highly leveraged financial institutions would be required to buy fully collateralized insurance. This insurance would inject contingent capital into those institutions when they're in trouble. -Financial institutions considered...  

The Credit Crisis: Conjectures about Causes and Remedies
by Douglas W. Diamond and Raghuram G. Rajan
in AEA Presentation Paper, December 2008

What caused the financial crisis that is sweeping across the world? What keeps asset prices and lending depressed? What can be done to remedy matters? While it is too early to arrive at definite answers to these questions, the focus of this paper is to offer offer informed conjectures.

Did Credit Scores Predict the Subprime Crisis?
by Yuliya Demyanyk
in Federal Reserve Bank of St. Louis Regional Economist, October 2008

One might expect to find a connection between borrowers' FICO scores and the incidence of default and foreclosure during the current crisis. The data don't show such a cause and effect, however.

Did Prepayments Sustain the Subprime Market?
by Geetesh Bhardwaj and Rajdeep Sengupta
in Federal Reserve Bank of St. Louis Working Paper, October 2008

This paper demonstrates that the reason for widespread default of mortgages in the subprime market was a sudden reversal in the house price appreciation of the early 2000's. Using loan-level data on subprime mortgages, we observe that the majority of subprime loans were hybrid adjustable rate mortgages, designed to impose substantial financial ...  

Factors Affecting Efforts to Limit Payments to AIG Counterparties
by Thomas C. Baxter Jr.
in Federal Reserve Bank of New York, February 2010

Testimony before the Committee on Government Oversight and Reform, U.S. House of Representatives

The Fed's Expanded Balance Sheet
by Brian P. Sack
in Federal Reserve Bank of New York Speech, December 2009

The Fed’s balance sheet has moved to the forefront of its policy efforts. Accordingly, to understand the policy choices that lie ahead for the Federal Reserve, one has to understand how the balance sheet got to where it is and what effects it has had on financial markets.

The Federal Reserve's Balance Sheet: An Update
by Ben S. Bernanke
in Speech, Board of Governors, October 2009

Bernanke reviews the most important elements of the Federal Reserve's balance sheet, as well as some aspects of their evolution over time. With this, he explains the steps the Federal Reserve has taken, beyond conventional interest rate reductions, to mitigate the financial crisis and the recession, as well as how those actions will be reversed as ...  

Financial Crises and Economic Activity
by Stephen G. Cecchetti, Marion Kohler and Christian Upper
in Federal Reserve Bank of Kansas City Symposium, August 2009

The authors use historical data to examine past systemic banking crises and compare them to the current crisis. They also look at the long-term effects of a crisis on economic output.

The Financial Crisis and the Policy Response: An Empirical Analysis of What Went Wrong
by John B. Taylor
in Stanford University Working Paper, November 2008

This paper is an empirical investigation of the role of government actions and interventions in the financial crisis that flared up in August 2007.

Financial Reform or Financial Dementia?
by Richard W. Fisher
in Federal Reserve Bank of Dallas Speech, June 2010

Remarks at the SW Graduate School of Banking 53rd Annual Keynote Address and Banquet

Fixing Finance: A Roadmap for Reform
by Robert E. Litan and Martin N. Baily
in Brookings Institution, February 2009

This paper suggests a roadmap for reform of the financial system. The authors suggest that the guiding principles should be market discipline and sound regulation, and provide a detailed outline for changes in financial policy.

A Framework for Assessing the Systemic Risk of Major Financial Institutions
by Xin Huang, Hao Zhou, and Haibin Zhu
in Federal Reserve Board, Finance and Economics Discussion Series, September 2009

In this paper the authors propose a framework for measuring and stress testing the systemic risk of a group of major financial institutions. The systemic risk is measured by the price of insurance against financial distress, which is based on ex ante measures of default probabilities of individual banks and forecasted asset return correlations. Imp...  

Has Financial Development Made the World Riskier?
by Raghuram G. Rajan
in Federal Reserve Bank of Kansas City's Symposium: The Greenspan Era: Lessons for the Future, August 2005

This paper (written pre-crisis in 2005) examines the revolutionary changes in financial systems around the world, such as greater borrowing at lower rates, the multitude of investment options catering to every possible profile of risk and return, and the ability to share risks with strangers from across the globe. The author questions the costs of...  

Has the Recent Real Estate Bubble Biased the Output Gap?
by Chanont Banternghansa and Adrian Peralta-Alva
in Federal Reserve Bank of St. Louis Economic Synopses, December 2009

The authors offer a word of caution to policymakers: Policies based on point estimates of the output gap may not rest on solid ground.

Hedge Funds, Systemic Risk, and the Financial Crisis of 2007-2008
by Andrew W. Lo
in U.S. House Committee on Oversight and Government Reform, November 2008

This article is the written testimony of Andrew Lo on the role of hedge funds in the U.S. financial system and their regulation. For the preliminary transcript, see http://oversight.house.gov/documents/20081114143312.pdf

The Information Value of the Stress Test and Bank Opacity
by Stavros Peristiani, Donald P. Morgan, and Vanessa Savino
in Federal Reserve Bank of New York Staff Reports, no. 460, July 2010

We investigate whether the “stress test,” the extraordinary examination of the nineteen largest U.S. bank holding companies conducted by federal bank supervisors in 2009, produced information demanded by the market. Using standard event study techniques, we find that the market had largely deciphered on its own which banks would have capital ga...  

Is the Financial Crisis Over? A Yield Spread Perspective
by Massimo Guidolin and Yu Man Tam
in Federal Reserve Bank of St. Louis Economic Synopses, September 2009

Our finding is consistent with some recent, substantial volatility in the U.S. corporate bond market and leaves open a possibility that additional, future shocks to default premia may have long-lived effects.

Lessons for the Future from the Financial Crisis
by Eric S. Rosengren
in Speech before Massachusetts Newspaper Publishers Association Annual Meeting, December 2009

In a storytelling format, Rosengren explains why it was necessary to “bail out” certain firms – like AIG – and what this story teaches us about avoiding such necessities in the future. Also, why the Federal Reserve took such aggressive action to dramatically expand its balance sheet to address the crisis – and what implications and effects we expe...  

Lessons Learned from the Financial Crisis
by William C. Dudley
in Speech, June 2009

In assessing the lessons of the past two years, Dudley focuses on five broad themes that are interrelated: Interconnectedness of the financial system; System dynamics—How does the system respond to shocks?; Incentives—Can we improve outcomes by changing incentives?; Transparency; How should central banks respond to asset bubbles?

Liquidity Risk, Credit Risk, and the Federal Reserve’s Responses to the Crisis
by Asani Sarkar
in Federal Reserve Bank of New York Staff Reports, September 2009

In responding to the severity and broad scope of the financial crisis that began in 2007, the Federal Reserve has made aggressive use of both traditional monetary policy instruments and innovative tools in an effort to provide liquidity. In this paper, the author examines the Fed’s actions in light of the underlying financial amplification mechanis...  

The Longer-Term Challenges Ahead
by William C. Dudley
in Federal Reserve Bank of New York Speech, March 2010

Remarks at the Council of Society Business Economists Annual Dinner, London, United Kingdom

Making Sense of the Subprime Crisis
by Kristopher S. Gerardi, Andreas Lehnert, Shane M. Sherland, and Paul S. Willen
in Federal Reserve Bank of Boston Working Paper, December 2008

This paper explores the question of whether market participants could have or should have anticipated the large increase in foreclosures that occurred in 2007 and 2008. Most of these foreclosures stem from loans originated in 2005 and 2006, leading many to suspect that lenders originated a large volume of extremely risky loans during this period. ...  

Monetary Policy and the Housing Bubble
by Ben S. Bernanke
in Board of Governors Speech, January 2010

Speech given at the Annual Meeting of the American Economic Association, Atlanta, Georgia

Preparing for a Smooth (Eventual) Exit
by Brian P. Sack
in Federal Reseve Bank of New York, March 2010

Remarks at the National Association for Business Economics Policy Conference, Arlington, Virginia

Quantitative Easing: Entrance and Exit Strategies
by Alan S. Blinder
in Federal Reseve Bank of St. Louis Homer Jones Memorial Lecture, April 2010

Blinder discussed the concept of quantitative easing, the Fed's entrance strategy, the Fed's exit strategy, and its implications for central bank independence.

Quick Exits of Subprime Mortgages
by Yuliya S. Demyanyk
in Federal Reserve Bank of St. Louis Review, March 2009

All holders of mortgage contracts, regardless of type, have three options: keep their payments current, prepay (usually through refinancing), or default on the loan. The latter two options terminate the loan. The termination rates of subprime mortgages that originated each year from 2001 through 2006 are surprisingly similar: about 20, 50, and 8...  

Regulation and Its Discontents
by Kevin Warsh
in Board of Governors Speech, February 2010

At the New York Association for Business Economics, New York, New York

Rethinking Capital Regulation
by Anil K. Kashyap, Raghuram G. Rajan and Jeremy C. Stein
in Federal Reserve Bank of Kansas City's Symposium: Maintaining Stability in a Changing Financial System, September 2008

Recent estimates suggest that U.S. banks and investment banks may lose up to $250 billion from their exposure to residential mortgages securities. The resulting depletion of capital has led to unprecedented disruptions in the market for interbank funds and to sharp contractions in credit supply, with adverse consequences for the larger economy. A n...  

The Rise in Mortgage Defaults
by Chris Mayer, Karen Pence and Shane M. Sherlund
in Federal Reserve Board Finance and Economics Discussion Series, November 2008

The main factors underlying the rise in mortgage defaults appear to be declines in house prices and deteriorated underwriting standards, in particular an increase in loan-to-value ratios and in the share of mortgages with little or no documentation of income.

The Subprime Crisis: Cause, Effect and Consequences
by R. Christopher Whalen
in SSRN Working Paper, June 2008

Despite the considerable media attention given to the collapse of the market for complex structured assets that contain subprime mortgages, there has been too little discussion of why this crisis occurred. The Subprime Crisis: Cause, Effect and Consequences argues that three basic issues are at the root of the problem, the first of which is an odio...  

Subprime Facts: What (We Think) We Know about the Subprime Crisis and What We Don't
by Christopher L. Foote, Kristopher Gerardi, Lorenz Goette and Paul S. Willen
in Federal Reserve Bank of Boston Public Policy Discussion Paper, May 2008

Using a variety of datasets, the authors document some basic facts about the current subprime crisis. Many of these facts are applicable to the crisis at a national level, while some illustrate problems relevant only to Massachusetts and New England. The authors conclude by discussing some outstanding questions about which the data, which they beli...  

Subprime Lending and Real Estate Markets
by Susan M. Wachter, Andrey D. Pavlov, and Zoltan Pozsar
in SSRN Working Paper, December 2008

The recent credit crunch, and liquidity deterioration, in the mortgage market have led to falling house prices and foreclosure levels unprecedented since the Great Depression. A critical factor in the post-2003 house price bubble was the interaction of financial engineering and the deteriorating lending standards in real estate markets, which fed o...  

Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures
by Kristopher Gerardi, Adam Hale Shapiro and Paul S. Willen
in Federal Reserve Bank of Boston Working Paper, May 2008

This paper provides the first rigorous assessment of the homeownership experiences of subprime borrowers. We consider homeowners who used subprime mortgages to buy their homes, and estimate how often these borrowers end up in foreclosure. In order to evaluate these issues, we analyze homeownership experiences in Massachusetts over the 1989–2007 per...  

The Subprime Turmoil: What's Old, What's New, and What's Next
by Charles W. Calomiris
in Federal Reserve Bank of Kansas City's Symposium: Maintaining Stability in a Changing Financial System", October 2008

We are currently experiencing a major shock to the financial system, initiated by problems in the subprime market, which spread to securitization products and credit markets more generally. Banks are being asked to increase the amount of risk that they absorb (by moving off-balance sheet assets onto their balance sheets), but losses that the banks...  

Toward an Effective Resolution Regime for Large Financial Institutions
by Daniel K. Tarullo
in Board of Governors Speech, March 2010

At the Symposium on Building the Financial System of the 21st Century, Armonk, New York

U.S. Monetary Policy and the Financial Crisis
by James R. Lothian
in Federal Reserve Bank of Atlanta CenFIS Working Paper, December 2009

This paper reviews U.S. Federal Reserve policy prior to and during the course of the recession that began in December 2007. It compares those policies to monetary policy during the Great Depression of the 1930s, with which this recession has been likened. The paper then discusses what policymakers will need to do to in future to avoid a surge in in...  

Understanding the Securitization of Subprime Mortgage Credit
by Adam B. Ashcraft and Til Schuermann
in Federal Reserve Bank of New York Staff Reports, March 2008

In this paper, the authors provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. They discuss the ways that market participants work to minimize these frictions and speculate on how this process broke down. They continue with a complete picture of the subprime borrower and the subp...  

Understanding the Subprime Mortgage Crisis
by Yuliya Demyanyk and Otto Van Hemert
in SSRN Working Paper, December 2008

In this paper the authors 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.

What to Do about Systemically Important Financial Institutions
by James B. Thomson
in Federal Reserve Bank of Cleveland, August 2009

The Federal Reserve Bank of Cleveland is proposing a three-tiered system for regulating systemically important financial institutions. Tier one would include high-risk institutions, such as large, interstate banks and multi-state insurance companies. Tier two would include moderately complex financial institutions, such as larger regional banks. An...  

Where's the Smoking Gun? A Study of Underwriting Standards for US Subprime Mortgages
by Geetesh Bhardwaj and Rajdeep Sengupta
in Federal Reserve Bank of St. Louis Working Paper, October 2008

The dominant explanation for the meltdown in the US subprime mortgage market is that lending standards dramatically weakened after 2004. Using loan-level data, Bhardwaj and Sengupta examine underwriting standards on the subprime mortgage originations from 1998 to 2007. Contrary to popular belief, the authors find no evidence of a dramatic weakening...