Last week, the ECB announced that it would begin purchasing securities backed by bank lending to households and firms. Whereas markets and the media have generally greeted this announcement with enthusiasm, this column identifies reasons for caution. Other central banks’ quantitative easing programmes have involved purchasing fixed amounts of securities according to a published schedule. In contrast, the ECB’s new policy is demand-driven, and will only be effective if it breaks the vicious circle of recession and negative credit growth.
The 4 September announcement by Chairman Mario Draghi has been greeted with enthusiasm by the markets and the media. It has been long awaited, and many believe that the ECB has finally delivered. This is not sure. The ECB intends to buy large amounts of securities backed by bank lending to households (mortgages) and to firms.
Congressional influence as a determinant of subprime lending
Stuart A Gabriel, Matthew E. Kahn, Ryan K Vaughn05 May 2013
A relatively unforeseen implosion in housing markets figured prominently in the 2007 meltdown in capital markets and the subsequent downturn in the global economy. This column presents new research on the political geography of subprime lending. Congressional leaders – as well as other recipients of campaign contributions – may have benefited from gains to trade in the direction, pricing, and sizing of subprime mortgage loans.
An implosion in housing markets figured prominently in the 2007 meltdown in capital markets and the downturn in the global economy. Neither analysts on Wall Street nor regulators in Washington anticipated the depth of the crisis, its geographic and asset-class contagion, or its adverse effects on household balance sheets. What was emblematic was the pervasive failure of subprime mortgages. The loans that were provided substantially eased credit qualification and homeownership opportunity to low credit-quality borrowers.
Ing-Haw Cheng, Sahil Raina, Wei Xiong11 April 2013
The subprime crisis narrative focuses on incentives: ‘they knew it was risky, but didn’t care’. This column argues in favour of a more nuanced explanation, that distorted beliefs also mattered. An analysis of personal home transactions by mid-level managers in the mortgage-securitisation business shows that they increased their personal housing exposure during the boom. ‘Groupthink’ and distorted beliefs in the financial sector is something to take seriously if we want to prevent future crises.
Solving the macroeconomic policy challenge in Europe
Richard Wood19 December 2012
Five years after the subprime bubble burst, the self-correcting nature of business cycles is being questioned and, subsequently, orthodox macroeconomic policy is starting to be challenged. This column introduces a radical rethink of options open to macroeconomic policymakers, suggesting that in order to simultaneously achieve economic stimulus without increasing debt, new money creation should be used to directly finance on-going budget deficits.
Countries in Europe are either slipping into recession or experiencing worsening depression. Economies are headed in the wrong direction, and the malaise is spreading. The current orthodoxies are failing.
Did the mortgage credit boom contribute to the decline in US racial segregation?
Romain Rancière, Amine Ouazad16 March 2012
Did the rise in subprime mortgages – predominantly to black and Hispanic borrowers – lead to a fall in racial segregation as people were able to move to more desirable neighbourhoods? This column looks at extensive data on mortgages and changes in the ethnic mix at local schools. It finds that the credit boom that precipitated the global financial crisis may actually have increased racial segregation.
US Congressional committees are now grilling bankers on the complex instruments that provided subprime mortgages with a veil of security. This column presents new evidence that subprime mortgages had more serious consequences – they were a key factor in the US housing-price boom. When house prices faltered, subprime mortgage holders defaulted en masse, eventually leading to the global crisis.
There once was a decade in US history in which financial innovation led to a sharp rise in the flow of credit to households. Durable goods consumption increased dramatically as household debt climbed to over 100% of GDP. The subsequent economic downturn was tragic, and the severity of the malaise was closely related to the preceding rise in household leverage (see Eichengreen and Michener 2003, Mishkin 1978, and the chart from David Beim at npr.org).
Liquidity risk charges were proposed in February 2009 as a new macro-prudential tool to discourage systemic risk creation by banks. CEPR Policy Insight No. 40 refines this proposal in order to clarify challenging issues surrounding the implementation of liquidity risk charges.
In this new Policy Insight Enrico Perotti and Javier Suarez explain how a liquidity and capital insurance arrangement could provide emergency liquidity (and perhaps capital) and protect the economy against systemic crisis.
Correlated liquidity risks caused subprime mortgage problems to spread widely and sow panic that led to the credit crisis. This column proposes a mandatory liquidity charge to insure against collective bank runs in the future. It argues for charges proportional to securities’ maturity mismatches so as to discourage practices that create systemic risk.
Capital requirements were aimed at absorbing asset losses, not coping with correlated liquidity risk. Securitisation runs around this Maginot line by shifting long-term assets in outside legal boxes funded by short-term markets. Yet banks kept essentially most risk through back-up credit lines, which forced all risk back when subprime mortgages were repriced. Yet the real damage came once panic spread, with losses well beyond what subprime prices would justify. Why?
Carmen Reinhart talks to Romesh Vaitilingam about Vox's first book, which brings together key columns on subprime and the continuing turmoil in financial markets. She recalls Charles Kindleberger, who characterised financial crises as 'a hardy perennial'.