Was the U.S. Crisis a Financial Black-Hole?
AbstractThis paper argues that the U.S. financial crisis is a new type of crisis: a “financial black hole.” Financial black-holes are characterized by the breaking-up of credit market discipline and the large-scale financing of negative net present value projects. In a theoretical model, the paper explains how the interaction of perceived government guarantees and the ability to issue catastrophe-bond-like liabilities generates financial black-holes. The paper then shows that key facts of the recent U.S. crisis can simultaneously be rationalized by the financial black hole equilibrium: Between 2003 and 2006, the origination of catastrophe-loan type mortgages exploded, as well as the issuance of ‘Private Label’ mortgage-backed securities that helped off-load them into the market. During the same period, there was a massive increase in the origination of mortgages to borrowers with limited repayment ability, absent a continuous increase in home prices. While this situation should have led to an upward repricing of the risk associated with Private Label MBS, the contrary occurred and the spread on these securities actually declined. While each of these facts in isolation can be interpreted differently, the strength of the financial black-hole explanation is its ability to account for the combination of these key facts.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Palgrave Macmillan in its journal IMF Economic Review.
Volume (Year): 59 (2011)
Issue (Month): 2 (June)
Contact details of provider:
Web page: http://www.palgrave-journals.com/
Postal: Palgrave Macmillan Journals, Subscription Department, Houndmills, Basingstoke, Hampshire RG21 6XS, UK
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Elizabeth Gale).
If references are entirely missing, you can add them using this form.