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Ten questions about the subprime crisis

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  • Eichengreen, B.

Abstract

The ongoing credit crunch represents the fi rst crisis of the age of mass securitization. One conclusion sometimes drawn is that the costs of securitization, in the form of risks to fi nancial stability, exceed the benefits. The implication is that we should return to the simpler days when commercial banks originate loans to households and fi rms and hold them on their balance sheets, rather than slicing them, dicing them and selling them off. But this back-to-the-future formula ignores economic realities. Securitization is bound up with the broader deregulation of fi nancial markets and with the information-technology revolution. Policy makers cannot eliminate this process short of reimposing the kind of restrictive regulation to which banking and fi nancial systems were subject half a century ago.liquidity lines provided by financial institutions. Market liquidity depends not only on objective, exogenous factors, but also on endogenous market dynamics. Central banks responsible for systemic stability need to consider how far their traditional responsibility for the health of the banking system needs to be adapted to promote stability in the relevant financial markets. In any case, turning back the clock would not be desirable because the constellation of financial innovations referred to as securitization has real benefits for the economy. Those innovations have allowed the financial system to repackage and spread risk. They have reduced the amount of equity capital that this system requires to absorb that risk. The result has been to lower funding costs for both fi rms and homeowners as a class. In the aftermath of the Great Securitization Crisis of 2007-8, would-be reformers will surely say that financial regulators need to rethink speed limits and rules of the road. In my view, policy makers should focus on the banking system. Banks still play a unique role. They are at the center of the information-impacted segments of the financial system. Their key role and their vulnerability are recognized by the protection they receive via the financial safety net. Re-thinking should start with the role of Basel II, and within Basel II of the role of internal models and bond ratings.

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Bibliographic Info

Article provided by Banque de France in its journal Financial stability review.

Volume (Year): (2008)
Issue (Month): 11 (February)
Pages: 19-28

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Handle: RePEc:bfr:fisrev:2008:11:4

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Cited by:
  1. Fratianni Michele, 2008. "Financial Crises, Safety Nets and Regulation," Rivista italiana degli economisti, Società editrice il Mulino, issue 2, pages 169-208.
  2. repec:rie:review:v:13:y:2008:i:2:n:1 is not listed on IDEAS
  3. Bernd Rudolph & Julia Scholz, 2008. "Driving Factors of the Subprime Crisis and Some Reform Proposals," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, vol. 6(3), pages 14-19, October.
  4. Nikolaou, Kleopatra, 2009. "Liquidity (risk) concepts: definitions and interactions," Working Paper Series 1008, European Central Bank.
  5. Saiful Azhar Rosly, 2010. "Shariah parameters reconsidered," International Journal of Islamic and Middle Eastern Finance and Management, Emerald Group Publishing, vol. 3(2), pages 132-146, June.

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