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Sucker Punched by the Invisible Hand

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  • Fligstein, Neil
  • Goldstein, Adam
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    Abstract

    The worldwide financial crisis of 2007-2010 was set off by the collapse of the subprime mortgage market in the U.S. This crisis caused widespread banking failure in the U.S. and forced the federal government to provide a massive bailout to the financial sector. The crisis simultaneously reverberated to banks around the world, and eventually brought about a worldwide recession. This paper documents why Western European countries were so susceptible to the housing price downturn. We explore various mechanisms by which the financial crisis might have spread including the existence of similar regulatory schemes, government deficits and current account imbalances, export connectedness, and the presence of a housing bubble. We present a surprising result: European banks went down because they had joined the market in the U.S. for mortgage backed securities and funded them by borrowing in the asset backed commercial paper market. They were pursuing the same strategies to make profit as the American banks, and when the housing market turned down, they suffered the same fate as their U.S. counterparts. Our study makes a broader theoretical point suggesting that subsequent studies of global finance and financial markets need to know something about the identities and strategies of the banks that structure the main markets for different products. This insight has implications for the literatures on financialization, globalization, and the sociology of finance.

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    Bibliographic Info

    Paper provided by Institute of Industrial Relations, UC Berkeley in its series Institute for Research on Labor and Employment, Working Paper Series with number qt1754s7tz.

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    Date of creation: 03 Sep 2012
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    Handle: RePEc:cdl:indrel:qt1754s7tz

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    Keywords: Social and Behavioral Sciences; Worldwide Financial Crisis of 2007-2010;

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    References

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    1. Acharya, Viral V. & Schnabl, Philipp & Suarez, Gustavo, 2013. "Securitization without risk transfer," Journal of Financial Economics, Elsevier, vol. 107(3), pages 515-536.
    2. Andrew K. Rose & Mark M. Spiegel, 2010. "Cross-Country Causes and Consequences of the Crisis: An Update," NBER Working Papers 16243, National Bureau of Economic Research, Inc.
    3. Tobias Adrian & Brian Begalle & Adam Copeland & Antoine Martin, 2012. "Repo and securities lending," Staff Reports 529, Federal Reserve Bank of New York.
      • Tobias Adrian & Brian Begalle & Adam Copeland & Antoine Martin, 2013. "Repo and Securities Lending," NBER Chapters, in: Risk Topography: Systemic Risk and Macro Modeling, pages 131-148 National Bureau of Economic Research, Inc.
    4. Fligstein, Neil & Goldstein, Adam, 2010. "The Anatomy of the Mortgage Securitization Crisis," Institute for Research on Labor and Employment, Working Paper Series qt9bh786v2, Institute of Industrial Relations, UC Berkeley.
    5. Fabian Valencia & Luc Laeven, 2008. "Systemic Banking Crises," IMF Working Papers 08/224, International Monetary Fund.
    6. Moser, Thomas, 2003. "What Is International Financial Contagion?," International Finance, Wiley Blackwell, vol. 6(2), pages 157-78, Summer.
    7. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153, October.
    8. Frieden, Jeffry A., 1991. "Invested interests: the politics of national economic policies in a world of global finance," International Organization, Cambridge University Press, vol. 45(04), pages 425-451, September.
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