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The Subprime Panic

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  • Gary 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 Yale School of Management in its series Yale School of Management Working Papers with number amz2504.

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Date of creation: 01 Sep 2008
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Handle: RePEc:ysm:somwrk:amz2504

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Web page: http://icf.som.yale.edu/
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Keywords: Banking panic; securitization; off-balance sheet vehicles; ABX index;

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References

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  1. Gary Gorton & Richard Rosen, 1995. "Banks and Derivatives," NBER Working Papers 5100, National Bureau of Economic Research, Inc.
    • 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.
  2. 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.
  3. Bhardwaj, Geetesh & Sengupta, Rajdeep, 2012. "Subprime mortgage design," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1503-1519.
  4. David B. Gross & Nicholas S. Souleles, 1999. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Center for Financial Institutions Working Papers 98-28, Wharton School Center for Financial Institutions, University of Pennsylvania.
  5. 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.
  6. Charles W. Calomiris & Gary Gorton, . "The Origins of Banking Panics: Models, Facts, and Bank Regulation," Rodney L. White Center for Financial Research Working Papers 11-90, Wharton School Rodney L. White Center for Financial Research.
  7. Charles W. Calomiris & Joseph R. Mason, 2003. "Credit card securitization and regulatory arbitrage," Working Papers 03-7, Federal Reserve Bank of Philadelphia.
  8. 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.
  9. 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.
  10. 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.
  11. Pagano, Marco, 1986. "Endogenous Market Thinness and Stock Price Volatility," CEPR Discussion Papers 146, C.E.P.R. Discussion Papers.
  12. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  13. Bank for International Settlements, 1999. "Implications of repo markets for central banks," CGFS Papers, Bank for International Settlements, number 10, January.
  14. 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.
  15. 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.
  16. 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.
  17. 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.
  18. Adrian D'Silva & Brian Gordon, 2008. "Hedges in the warehouse: the banks get trimmed," Chicago Fed Letter, Federal Reserve Bank of Chicago, issue Apr.
  19. 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.
  20. Gary Gorton & Nicholas S. Souleles, 2005. "Special purpose vehicles and securitization," Working Papers 05-21, Federal Reserve Bank of Philadelphia.
  21. 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.
  22. Gary Gorton, 2008. "The Panic of 2007," Yale School of Management Working Papers amz2372, Yale School of Management.
  23. 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.
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