Miraculous Financial Engineering or Toxic Finance? The Genesis of the U.S. Subprime Mortgage Loans Crisis and its Consequences on the Global Financial Markets and Real Economy

Abstract

In the fall of 2008, the U.S. subprime mortgage loans defaults have turned into Wall Street's biggest crisis since the Great Depression. As hundreds of billions in mortgage-related investments went bad, banks became suspicious of one another's potential undisclosed credit losses and preferred to reduce their exposure in the interbank markets, thus causing interbank interest rates and credit default swaps increases, a liquidity shortage problem and a worsened credit crunch condition to consumers and businesses. Massive cash injections into money markets and interest rates reductions have been assured by central banks in an attempt to shore up banks and to restore confidence within the financial system. Even Governments have promoted bail-out deal agreements, protections from bankruptcies, recapitalizations and bank nationalizations in order to rescue banks from disastrous bankruptcies.The credit crisis originated in the previous years when the Federal Reserve sharply lowered interest rates (Fed Funds at 1 %) to limit the economic damage of the stock market decline due to the 2000 dot.com companies' crisis. Lower interest rates made mortgage payments cheaper, and the demand for homes began to rise, sending prices up. In addition, millions of homeowners took advantage of the rate drop to refinance their existing mortgages. As the industry ramped up, the quality of the mortgages went down due to poor credit origination and credit risk assessment. Delinquency and default rates began to rise in 2006 as interest rates rose (Fed Funds at 5,25 %) and poor households across the US struggled to pay off their mortgages. Many of them went bankrupt and lost their homes but the pace of lending did not slow.Banks have transformed much of the high-risk mortgage debt (securitizations) into mortgage-backed securities (MBS) and collateralized debt obligations (CDO), and have sold these assets on the financial markets to investment firms, hedge funds, and insurance companies around the world, transferring to these investors the rights to the mortgage payments and the Pezzuto, I. Miraculous financial engineering or toxic finance? The genesis of the U.S. subprime mortgage loans crisis and its consequences on the global financial markets and real economy [Text] / I. Pezzuto // Міжнародна банківська конкуренція: теорія і практика: матеріали VII Міжнародної наук.-практ. конференції, 24-25 травня 2012 року, Суми. -Суми: УАБС НБУ, 2012. -С. 19-20.

Urban Housing Price Fluctuations and Regional Systemic Financial Risks: Panel Spatial Economic Models in Jiangsu, China

“…Here, we introduce the dependent variable loghp and the independent variables lnltp, lnrdi, lb/gdp, and loghss into Equations (9) and (10) to build an SLM and an SDM, respectively, for the 13 cities in Jiangsu. To compare the difference between South and North Jiangsu, this paper also builds an SLM for South Jiangsu and North Jiangsu.…”

“…After the subprime mortgage crisis in the United States in 2007, scholars started to pay attention to housing price fluctuation for the study of systemic risks. Pezzuto [9] pointed out that low interest rates, high leverage, credit euphoria, and the pursuit of short-term interests caused the housing bubble before the subprime crisis. Acharya et al [10] asserted that the housing bubble burst resulted in a series of losses in the subprime crisis-including a bank credit default loss, associated losses caused by lack of liquidity, the collapse of the stock market, economic recession-and that all of these losses are derived from personal (family) housing loan default problems following the bursting of the housing bubble.…”

Rating Agencies as Gatekeepers to the Capital Market: Practical Implications of 40 Years of Research

“…(1) Regulation of CRAs. Although there is much public discussion on to which degree credit ratings require regulation in light of their failure to prevent the subprime hype (see, e.g., Economist, 2005;Economist, 2008;Storn, 2010), the academic response, although vast, is very much in a developing stage, with many just recently published or still unpublished papers (see, e.g., Coffee, 2010;Yiannaki, 2009;Pezzuto, 2008;Reiss, 2009;Schmudde, 2009;Turnbull, Crouhy, & Jarrow, 2008). This underlines Rom's argument that up to the turn of the millennium, credit ratings presented a reliable and broadly accepted vehicle to the capital market (Rom, 2009).…”

To Basel or not to Basel? Banking crises and contagion

“…For the same purpose, VBanking also employs signalling, as proposed by Kaminsky and Reinhart (1999). Another approach is proposed by Pezzuto (2008), who pinpoints a banking crisis in the reduction of inter-bank debt, a reasonable assumption given the recent bank defaults. Davis and Karim (2008) and Laeven and Valencia (2008) provide a thorough survey of the various Early Warning Systems which are used to predict banking crises.…”