- Starting in the late 1990s, there was a broad credit bubble in the U.S. and Europe;
- and a sustained housing bubble in the U.S.
- Excess liquidity, combined with rising house prices and an ineffectively regulated primary mortgage market, led to an increase in nontraditional mortgages that were in some cases deceptive, in many cases confusing, and often beyond borrowers' ability to pay.
- Failures in credit-rating and securitization transformed bad mortgages into toxic financial assets.
- Managers of many large and midsize financial institutions amassed enormous concentrations of highly correlated housing risk;
- and they amplified this risk by holding too little capital relative to the risks and funded these exposures with short-term debt.
- These risks within highly leveraged, short-funded financial firms with concentrated exposure to a collapsing asset class led to a cascade of firm failures. The losses spread in two ways. Some firms had large counterparty credit risk exposures, and the sudden and disorderly failure of one firm risked triggering losses elsewhere. We call this the risk of contagion.
- In other cases, the problem was a common shock.
- A rapid succession of 10 firm failures, mergers and restructurings in September 2008 caused a financial shock and panic
- Confidence and trust in the financial system evaporated, as the health of almost every large and midsize financial institution in the U.S. and Europe was questioned. The financial shock and panic caused a severe contraction in the real economy
Monday, January 31, 2011
What caused the financial crisis?
Doug Holtz-Eakin of the Crisis Commission identifies ten things: