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The Subprime Panic

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  • Gary B. Gorton

Abstract

Understanding the ongoing credit crisis or panic requires understanding the designs of a number of interlinked securities, special purpose vehicles, and derivatives, all related to subprime mortgages. I describe the relevant securities, derivatives, and vehicles to show: (1) how the chain of interlinked securities was sensitive to house prices; (2) how asymmetric information was created via complexity; (3) how the risk was spread in an opaque way; and (4) how trade in the ABX indices (linked to subprime bonds) allowed information to be aggregated and revealed. These details are at the heart of the origin of the Panic of 2007. The events of the panic are described.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14398.

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Date of creation: Oct 2008
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Publication status: published as Gary Gorton, 2009. "The Subprime Panic," European Financial Management, Blackwell Publishing Ltd, vol. 15(1), pages 10-46.
Handle: RePEc:nbr:nberwo:14398

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References

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  1. Gary B. Gorton & Nicholas S. Souleles, 2007. "Special Purpose Vehicles and Securitization," NBER Chapters, in: The Risks of Financial Institutions, pages 549-602 National Bureau of Economic Research, Inc.
  2. Gary Gorton & Richard Rosen, 1995. "Banks and derivatives," Working Papers 95-12, Federal Reserve Bank of Philadelphia.
    • Gary Gorton & Richard Rosen, 1995. "Banks and Derivatives," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 299-349 National Bureau of Economic Research, Inc.
  3. Calomiris, Charles W & Mason, Joseph R, 1997. "Contagion and Bank Failures during the Great Depression: The June 1932 Chicago Banking Panic," American Economic Review, American Economic Association, vol. 87(5), pages 863-83, December.
  4. Gorton, Gary & Mullineaux, Donald J, 1987. "The Joint Production of Confidence: Endogenous Regulation and Nineteenth Century Commercial-Bank Clearinghouses," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(4), pages 457-68, November.
  5. Gary Gorton, 2008. "The Panic of 2007," Yale School of Management Working Papers amz2372, Yale School of Management.
  6. Gary Richardson & William Troost, 2006. "Monetary Intervention Mitigated Banking Panics During the Great Depression: Quasi-Experimental Evidence from the Federal Reserve District Border in Mississippi, 1929 to 1933," NBER Working Papers 12591, National Bureau of Economic Research, Inc.
  7. Pagano, Marco, 1989. "Endogenous Market Thinness and Stock Price Volatility," Review of Economic Studies, Wiley Blackwell, vol. 56(2), pages 269-87, April.
  8. David B. Gross, 2002. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 319-347, March.
  9. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  10. Gorton, Gary, 1994. "Bank Regulation When 'Banks' and 'Banking' Are Not the Same," Oxford Review of Economic Policy, Oxford University Press, vol. 10(4), pages 106-19, Winter.
  11. Gary Gorton & George Pennacchi, . "Are Loan Sales Really Off-Balance Sheet," Rodney L. White Center for Financial Research Working Papers 18-88, Wharton School Rodney L. White Center for Financial Research.
  12. Gr da, Cormac & White, Eugene N., 2003. "The Panics of 1854 and 1857: A View from the Emigrant Industrial Savings Bank," The Journal of Economic History, Cambridge University Press, vol. 63(01), pages 213-240, March.
  13. Gary Richardson, 2006. "Bank Distress During the Great Contraction, 1929 to 1933, New Data from the Archives of the Board of Governors," NBER Working Papers 12590, National Bureau of Economic Research, Inc.
  14. Bank for International Settlements, 1999. "Implications of repo markets for central banks," CGFS Papers, Bank for International Settlements, number 10, January.
  15. Charles W. Calomiris & Gary Gorton, 1991. "The Origins of Banking Panics: Models, Facts, and Bank Regulation," NBER Chapters, in: Financial Markets and Financial Crises, pages 109-174 National Bureau of Economic Research, Inc.
  16. Charles Calomiris & Joseph Mason, 2004. "Credit Card Securitization and Regulatory Arbitrage," Journal of Financial Services Research, Springer, vol. 26(1), pages 5-27, August.
  17. Moen, Jon & Tallman, Ellis W., 1992. "The Bank Panic of 1907: The Role of Trust Companies," The Journal of Economic History, Cambridge University Press, vol. 52(03), pages 611-630, September.
  18. Gorton, Gary B. & Pennacchi, George G., 1995. "Banks and loan sales Marketing nonmarketable assets," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 389-411, June.
  19. Englund, Peter, 1999. "The Swedish Banking Crisis: Roots and Consequences," Oxford Review of Economic Policy, Oxford University Press, vol. 15(3), pages 80-97, Autumn.
  20. Calomiris, Charles W. & Schweikart, Larry, 1991. "The Panic of 1857: Origins, Transmission, and Containment," The Journal of Economic History, Cambridge University Press, vol. 51(04), pages 807-834, December.
  21. Cormac O Grada & Morgan Kelly, 2000. "Market Contagion: Evidence from the Panics of 1854 and 1857," American Economic Review, American Economic Association, vol. 90(5), pages 1110-1124, December.
  22. Adrian D'Silva & Brian Gordon, 2008. "Hedges in the warehouse: the banks get trimmed," Chicago Fed Letter, Federal Reserve Bank of Chicago, issue Apr.
  23. Bhardwaj, Geetesh & Sengupta, Rajdeep, 2012. "Subprime mortgage design," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1503-1519.
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