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Deciphering the Liquidity and Credit Crunch 2007-2008

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Author Info
Markus K. Brunnermeier

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Abstract

The financial market turmoil in 2007 and 2008 has led to the most severe financial crisis since the Great Depression and threatens to have large repercussions on the real economy. The bursting of the housing bubble forced banks to write down several hundred billion dollars in bad loans caused by mortgage delinquencies. At the same time, the stock market capitalization of the major banks declined by more than twice as much. While the overall mortgage losses are large on an absolute scale, they are still relatively modest compared to the $8 trillion of U.S. stock market wealth lost between October 2007, when the stock market reached an all-time high, and October 2008. This paper attempts to explain the economic mechanisms that caused losses in the mortgage market to amplify into such large dislocations and turmoil in the financial markets, and describes common economic threads that explain the plethora of market declines, liquidity dry-ups, defaults, and bailouts that occurred after the crisis broke in summer 2007.

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Publisher Info
Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 23 (2009)
Issue (Month): 1 (Winter)
Pages: 77-100
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Handle: RePEc:aea:jecper:v:23:y:2009:i:1:p:77-100

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
  3. Dilip Abreu & Markus K. Brunnermeier, 2003. "Bubbles and Crashes," Econometrica, Econometric Society, vol. 71(1), pages 173-204, January. [Downloadable!] (restricted)
    Other versions:
  4. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June. [Downloadable!] (restricted)
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  7. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
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  8. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports 328, Federal Reserve Bank of New York. [Downloadable!]
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  10. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September. [Downloadable!] (restricted)
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  12. Markus K. Brunnermeier & Lasse Heje Pedersen, 2005. "Predatory Trading," Journal of Finance, American Finance Association, vol. 60(4), pages 1825-1863, 08. [Downloadable!] (restricted)
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  13. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February. [Downloadable!] (restricted)
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  14. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March. [Downloadable!] (restricted)
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  15. Abreu, Dilip & Brunnermeier, Markus K., 2002. "Synchronization risk and delayed arbitrage," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 341-360. [Downloadable!] (restricted)
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  18. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
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  19. Bernanke, Ben & Gertler, Mark & Gilchrist, Simon, 1996. "The Financial Accelerator and the Flight to Quality," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 1-15, February. [Downloadable!] (restricted)
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  20. Ricardo J. Caballero & Arvind Krishnamurthy, 2008. "Collective Risk Management in a Flight to Quality Episode," Journal of Finance, American Finance Association, vol. 63(5), pages 2195-2230, October. [Downloadable!] (restricted)
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  21. Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 361-407. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2008. "Financial Crash, Commodity Prices and Global Imbalances," NBER Working Papers 14521, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Amir E. Khandani & Andrew W. Lo & Robert C. Merton, 2009. "Systemic Risk and the Refinancing Ratchet Effect," NBER Working Papers 15362, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Guillermo A. Calvo, 2009. "FINANCIAL CRISES AND LIQUIDITY SHOCKS: A Bank-Run Perspective," NBER Working Papers 15425, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Argandoña, Antonio, 2009. "Can corporate social responsibility help us understand the credit crisis?," IESE Research Papers D/790, IESE Business School. [Downloadable!]
  5. Andrea Beltratti & René M. Stulz, 2009. "Why Did Some Banks Perform Better During the Credit Crisis? A Cross-Country Study of the Impact of Governance and Regulation," NBER Working Papers 15180, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Andrew K. Rose & Mark M. Spiegel, 2009. "Cross-country causes and consequences of the 2008 crisis: early warning," Working Paper Series 2009-17, Federal Reserve Bank of San Francisco. [Downloadable!]
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  7. Marco Pagano & Paolo Volpin, 2008. "Securitization, Transparency and Liquidity," CSEF Working Papers 210, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 25 Jan 2010. [Downloadable!]
    Other versions:
  8. Damien Besancenot & Radu Vranceanu, 2009. "Banks Risk Race: A Signaling Explanation," Working Papers halshs-00424214_v1, HAL. [Downloadable!]
    Other versions:
  9. Aikaterini Karadimitropoulou & Miguel A. León-Ledesma, 2009. "Sources of Current Account Fluctuations in Industrialized Countries," Studies in Economics 0910, Department of Economics, University of Kent. [Downloadable!]
  10. Paul Mizen, 2008. "The credit crunch of 2007-2008: a discussion of the background, market reactions, and policy responses," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 531-568. [Downloadable!]
  11. Patrick Honohan, 2008. "Bank Failures: The Limitations of Risk Modelling," The Institute for International Integration Studies Discussion Paper Series iiisdp263, IIIS. [Downloadable!]
  12. Schich, Sebastian T., 2009. "Challenges Associated with the Expansion of Deposit Insurance Coverage during Fall 2008," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 3(20), pages 1-23. [Downloadable!]
  13. Itai Agur, 2009. "Regulatory Competition and Bank Risk Taking," DNB Working Papers 213, Netherlands Central Bank, Research Department. [Downloadable!]
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  14. Cahuc, Pierre & Challe, Edouard, 2009. "Produce or Speculate? Asset Bubbles, Occupational Choice and Efficiency," IZA Discussion Papers 4630, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  15. James Crotty, 2008. "Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’," Working Papers 2008-14, University of Massachusetts Amherst, Department of Economics. [Downloadable!]
    Other versions:
  16. Florian Heider & Marie Hoerova, 2009. "Interbank Lending, Credit-Risk Premia, and Collateral," International Journal of Central Banking, International Journal of Central Banking, vol. 5(4), pages 5-43, December. [Downloadable!]
    Other versions:
  17. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2009. "Crises and Liquidity in Over-the-Counter Markets," NBER Working Papers 15414, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  18. Gara M. Afonso & Hyun Song Shin, 2008. "Systemic risk and liquidity in payment systems," Staff Reports 352, Federal Reserve Bank of New York. [Downloadable!]
  19. Andrei Shleifer & Robert W. Vishny, 2009. "Unstable Banking," NBER Working Papers 14943, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  20. Tobias Adrian & Hyun Song Shin, 2008. "Financial intermediary leverage and value at risk," Staff Reports 338, Federal Reserve Bank of New York. [Downloadable!]
  21. Daniel M. Covitz & Nellie Liang & Gustavo A. Suarez, 2009. "The evolution of a financial crisis: panic in the asset-backed commercial paper market," Finance and Economics Discussion Series 2009-36, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  22. Mark Mink & Jochen Mierau, 2009. "Measuring Stock Market Contagion with an Application to the Sub-prime Crisis," DNB Working Papers 217, Netherlands Central Bank, Research Department. [Downloadable!]
  23. Marian NASTASE & Alina Stefania CRETU & Roberta STANEF, 2009. "Effects of Global Financial Crisis," REVISTA DE MANAGEMENT COMPARAT INTERNATIONAL/REVIEW OF INTERNATIONAL COMPARATIVE MANAGEMENT, Faculty of Management, Academy of Economic Studies, Bucharest, Romania, vol. 10(4), pages 691-699, October. [Downloadable!]
  24. David B. Brown & Bruce Ian Carlin & Miguel Sousa Lobo, 2009. "On the Scholes Liquidation Problem," NBER Working Papers 15381, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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