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Systemic Risk in the Financial Sector: An Analysis of the Subprime-Mortgage Financial Crisis

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Author Info
Martin Hellwig () (Max Planck Institute for Research on Collective Goods, Bonn)

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Abstract

The paper analyses the causes of the current crisis of the global financial system, with particular emphasis on the systemic elements that turned the crisis of subprime mortgage-backed securities in the United States, a small part of the overall system, into a worldwide crisis. The first half of the paper explains the role of mortgage securitization as a mechanism for allocating risks from real estate investments and discusses what has gone wrong and why in the implementation of this mechanism in the United States. The second half of the paper discusses the incidence of systemic risk in the crisis. Two elements of systemic risk are identified. First, there was excessive maturity transformation through conduits and structured-investment vehicles (SIVs); when this broke down in August 2007, the overhang of asset-backed securities that had been held by these vehicles put significant additional downward pressure on securities prices. Second, as the financial system adjusted to the recognition of delinquencies and defaults in US mortgages and to the breakdown of maturity transformation of conduits and SIVs, the interplay of market malfunctioning or even breakdown, fair value accounting and the insufficiency of equity capital at financial institutions, and, finally, systemic effects of prudential regulation created a detrimental downward spiral in the overall financial system. The paper argues that these developments have not only been caused by identifiably faulty decisions, but also by flaws in financial system architecture. In thinking about regulatory reform, one must therefore go beyond considerations of individual incentives and supervision and pay attention to issues of systemic interdependence and transparency.

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Paper provided by Max Planck Institute for Research on Collective Goods in its series Working Paper Series of the Max Planck Institute for Research on Collective Goods with number 2008_43.

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Date of creation: Nov 2008
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Handle: RePEc:mpg:wpaper:2008_43

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Related research
Keywords: Mortgage Securitization; Subprime-Mortgage Financial Crisis; Systemic Risk; Banking Regulation; Capital Requirements;

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Find related papers by JEL classification:
G01 - Financial Economics - - General - - - Financial Crises
G29 - Financial Economics - - Financial Institutions and Services - - - Other
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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:
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    Other versions:
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    Other versions:
  20. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June. [Downloadable!] (restricted)
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    Other versions:
  25. Martin Hellwig, 1996. "Capital Adequacy Rules as Instruments for the Regulation of Banks," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 132(IV), pages 609-612, December. [Downloadable!]
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  30. Martin Hellwig, 2007. "Switzerland and Euroland: European Monetary Union, Monetary Stability and Financial Stability," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2007_9, Max Planck Institute for Research on Collective Goods. [Downloadable!]
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    Other versions:
  35. Hellwig, Martin, 1998. "Systemische Risiken im Finanzsektor," Sonderforschungsbereich 504 Publications 98-30, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
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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. Helmut Gründl & Thomas Post, 2009. "Transparency through Financial Claims with Fingerprints – A Free Market Mechanism for Preventing Mortgage Securitization Induced Financial Crises," SFB 649 Discussion Papers SFB649DP2009-018, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
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