The Panic of 2007

…they are linked to house price appre­ci­a­tion. The secu­ri­ti­za­tion of sub­prime mort­gages is also unique. Because sub­prime mort­gages are financed through a chain of secu­ri­ties and struc­tures, investors could not eas­i­ly deter­mine the loca­tion and extent of the risk. Infor­ma­tion was lost. The house price declines led to a fear of loss­es that could not be mea­sured because the sub­prime risk had been spread around the globe opaque­ly. The avail­able infor­ma­tion was on the side of the mar­ket that pro­duced the chain of struc­tures; out­side investors know much less. The prob­lem is that the mag­ni­tude of the struc­tures, and their impen­e­tra­bil­i­ty by out­siders, was not com­plete­ly under­stood; it was not com­mon knowl­edge. The intro­duc­tion of the ABX indices cre­at­ed a set of mar­ket prices that aggre­gat­ed and revealed that sub­prime-relat­ed secu­ri­ties were worth a lot less than had been thought. The abil­i­ty to short sub­prime risk may have burst the bub­ble and, in any case, result­ed in the mar­ket crowd­ing on the short side to hedge, dri­ving ABX prices very low. The pan­ic was then on.” Gary Gor­ton The Pan­ic of 2007

No Comments

Leave a Reply

Your email is never shared.Required fields are marked *