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Structured finance and the financial turmoil of 2007-2008: and introductory overview

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  • Sarai Criado

    ()
    (Banco de España)

  • Adrian van Rixtel

    ()
    (Banco de España)

Abstract

This paper provides an overview of the most important structured finance instruments in the context of the development of the financial turmoil that started in the third quarter of 2007 and continued into 2008. These financial market tensions were triggered by concerns about exposures of financial institutions to the most risky segment of the US mortgage markets -the so-called subprime mortgage market- and related financial instruments, which predominantly were related to structured finance. As structured finance has developed very fast in recent years and often involves highly complex financial instruments and techniques, which may not be understood completely beyond a small circle of financial market experts, the aim of this paper is to provide an introduction to these instruments that may serve to better understand the specific characteristics of the financial turmoil. In this context, the paper proposes a specific classification of structured finance and discusses both securitizations and credit derivatives with the aim of explaining their specific contributions to the development of the financial turmoil. To this extent, the paper differentiates between two main categories of structured finance instruments. The first one played an important role in the initiation and propagation of the turmoil and includes mortgage-backed securities (MBS), asset backed commercial paper (ABCP) and collateralized debt obligations (CDOs), both cash flow and synthetic. The second category of structured finance instruments involves those that have been more instrumental in monitoring the crisis, both for market participants and policymakers. The main instruments here are credit default swaps (CDS), of which examples are presented for both single name and index contracts. Finally, the paper provides an overview of the specific contagion channels involving various structured finance instruments. This will be conducted on the basis of examples for hypothetical financial institutions that are nevertheless representative for real world developments such as they occurred in the course of 2007 and 2008.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosOcasionales/08/Fic/do0808e.pdf
File Function: First version, August 2008
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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Occasional Papers with number 0808.

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Length: 43 pages
Date of creation: Aug 2008
Date of revision:
Handle: RePEc:bde:opaper:0808

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Keywords: financial turmoil; financial markets; financial institutions; structured finance; securitization; credit derivatives;

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References

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  1. Antonio Di Cesare, 2006. "Do market-based indicators anticipate rating agencies? Evidence for international banks," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 593, Bank of Italy, Economic Research and International Relations Area.
  2. repec:sae:ecolab:v:16:y:2006:i:2:p:1-2 is not listed on IDEAS
  3. Klaus Düllmann & Agnieszka Sosinska, 2007. "Credit default swap prices as risk indicators of listed German banks," Financial Markets and Portfolio Management, Springer, Springer, vol. 21(3), pages 269-292, September.
  4. Cousseran, O. & Rahmouni, I., 2005. "The CDO market Functioning and implications in terms of financial stability," Financial Stability Review, Banque de France, issue 6, pages 43-62, June.
  5. Adam B. Ashcraft & Til Schuermann, 2008. "Understanding the securitization of subprime mortgage credit," Staff Reports 318, Federal Reserve Bank of New York.
  6. Ronel Elul, 2005. "The economics of asset securitization," Business Review, Federal Reserve Bank of Philadelphia, issue Q3, pages 16-25.
  7. Gary Gorton & Nicholas Souleles, 2005. "Special Purpose Vehicles and Securitization," NBER Working Papers 11190, National Bureau of Economic Research, Inc.
  8. Frank Fabozzi & Vinod Kothari, 2007. "Securitization: The Tool of Financial Transformation," Yale School of Management Working Papers, Yale School of Management amz2495, Yale School of Management, revised 01 Jul 2007.
  9. Scheicher, Martin, 2008. "How has CDO market pricing changed during the turmoil? Evidence from CDS index tranches," Working Paper Series, European Central Bank 0910, European Central Bank.
  10. Adrian Blundell-Wignall, 2007. "An Overview of Hedge Funds and Structured Products: Issues in Leverage and Risk," Financial Market Trends, OECD Publishing, vol. 2007(1), pages 37-57.
  11. Paul S. Mills & John Kiff, 2007. "Money for Nothing and Checks for Free," IMF Working Papers 07/188, International Monetary Fund.
  12. Claudio Borio, 2008. "The financial turmoil of 2007-?: a preliminary assessment and some policy considerations," BIS Working Papers 251, Bank for International Settlements.
  13. Douglas Lucas & Laurie Goodman & Frank Fabozzi, 2007. "Collateralized Debt Obligations and Credit Risk Transfer," Yale School of Management Working Papers, Yale School of Management amz2503, Yale School of Management.
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Cited by:
  1. Sonsoles Gallego & Sándor Gardó & Reiner Martin & Luis Molina & José María Serena, 2010. "The Impact of the Global Economic and Financial Crisis on Central Eastern and SouthEastern Europe (CESEE) and Latin America," Banco de Espa�a Occasional Papers 1002, Banco de Espa�a.
  2. Juan Carlos Berganza, 2011. "Fiscal rules in Latin America: a survey," Banco de Espa�a Occasional Papers 1108, Banco de Espa�a.
  3. Pablo Hernández de Cos & Mario Izquierdo & Alberto Urtasun, 2011. "An estimate of the potential growth of the Spanish economy," Banco de Espa�a Occasional Papers 1104, Banco de Espa�a.
  4. Adrian Van Rixtel & Gabriele Gasperini, 2013. "Financial crises and bank funding: recent experience in the euro area," BIS Working Papers 406, Bank for International Settlements.
  5. Hatemi-J, Abdulnasser & Roca, Eduardo, 2011. "How globally contagious was the recent US real estate market crisis? Evidence based on a new contagion test," Economic Modelling, Elsevier, vol. 28(6), pages 2560-2565.
  6. João Pinto & Manuel Marques & William Megginson, 2013. "A Comparative Analysis Of Ex Ante Credit Spreads: Structured Finance Versus Straight Debt Finance," Working Papers de Economia (Economics Working Papers), Faculdade de Economia e Gestão, Universidade Católica Portuguesa (Porto) 05, Faculdade de Economia e Gestão, Universidade Católica Portuguesa (Porto).
  7. Galo Nuño & Cristina Pulido & Rubén Segura-Cayuela, 2012. "Long-run growth and demographic prospects in advanced economies," Banco de Espa�a Occasional Papers 1206, Banco de Espa�a.
  8. Klaus Schmidt-Hebbel, 2011. "Central banking in Latin America: changes, achievements, challenges," Banco de Espa�a Occasional Papers 1102, Banco de Espa�a.
  9. Abdulnasser Hatemi-J & Eduardo Roca, 2010. "The Impact of the US Real Estate Market on Other Major Markets During Normal and Crisis Periods," Discussion Papers in Finance finance:201003, Griffith University, Department of Accounting, Finance and Economics.
  10. João Pinto, 2014. "The Economics of Securitization: Evidence from the European Markets," Working Papers de Economia (Economics Working Papers), Faculdade de Economia e Gestão, Universidade Católica Portuguesa (Porto) 02, Faculdade de Economia e Gestão, Universidade Católica Portuguesa (Porto).
  11. Dorrucci, Ettore & Pula, Gabor & Santabárbara, Daniel, 2013. "China's economic growth and rebalancing," Occasional Paper Series 142, European Central Bank.
  12. Pablo Hernández de Cos & Juan F. Jimeno, 2013. "Fiscal policy and external imbalances in a debt crisis: the Spanish case," Banco de Espa�a Occasional Papers 1303, Banco de Espa�a.
  13. María J. Nieto, 2012. "What role, if any, can market discipline play in supporting macroprudential policy?," Banco de Espa�a Occasional Papers 1202, Banco de Espa�a.
  14. Eloísa Ortega & Juan Peñalosa, 2012. "The Spanish economic crisis: key factors and growth challenges in the euro area," Banco de Espa�a Occasional Papers 1201, Banco de Espa�a.
  15. BAICU, Claudia Gabriela, 2010. "Basel Iii – A New Approach To Improve International Financial Stability," Annals of Spiru Haret University, Economic Series, Universitatea Spiru Haret, vol. 1(3), pages 117-123.

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