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

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