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From complacency to crisis: financial risk taking in the early 21st century

Author

Listed:
  • Danielle DiMartino
  • John V. Duca
  • Harvey Rosenblum

Abstract

During the first half of this decade, the belief that new financial products would adequately shield investors from risk encouraged financial flows to less creditworthy households and businesses. By late 2006, U.S. financial markets were flashing warning signals of a potential financial crisis. ; In a sign that investors had become too complacent, risk premiums had all but vanished in junk bond and emerging-market interest rate spreads. Then, conditions changed abruptly. In the important and usually stable market for asset-backed commercial paper, premiums on three-month paper over Treasury bills jumped from 0.17 percentage point in February 2007 to 2.15 points in August. Meanwhile, rising subprime mortgage defaults led investors to abandon their sanguine beliefs about the risk of many mortgage and nonmortgage products. ; The backdrop for these events was a period of macroeconomic stability that fed complacency about risk. This relatively benign economic environment, when combined with the new, structured financial products, increased financial flows to nonprime mortgage and business borrowers. The result was an overeager acceptance of risk taking that began correcting itself only after mounting subprime mortgage defaults reverberated through the broader financial markets.

Suggested Citation

  • Danielle DiMartino & John V. Duca & Harvey Rosenblum, 2007. "From complacency to crisis: financial risk taking in the early 21st century," Economic Letter, Federal Reserve Bank of Dallas, vol. 2(dec).
  • Handle: RePEc:fip:feddel:y:2007:i:dec:n:v.2no.12
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    File URL: http://dallasfed.org/assets/documents/research/eclett/2007/el0712.pdf
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    Citations

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    Cited by:

    1. Duca, John V. & Muellbauer, John & Murphy, Anthony, 2010. "Housing markets and the financial crisis of 2007-2009: Lessons for the future," Journal of Financial Stability, Elsevier, vol. 6(4), pages 203-217, December.
    2. Orlowski, Lucjan T, 2008. "Stages of the 2007/2008 Global Financial Crisis: Is There a Wandering Asset-Price Bubble?," MPRA Paper 12696, University Library of Munich, Germany.
    3. Lucjan T. Orlowski, 2008. "Stages of the Ongoing Global Financial Crisis: Is There a Wandering Asset-Price Bubble?," CASE Network Studies and Analyses 0372, CASE-Center for Social and Economic Research.
    4. David Luttrell & Harvey Rosenblum & Jackson Thies, 2012. "Understanding the risks inherent in shadow banking: a primer and practical lessons learned," Staff Papers, Federal Reserve Bank of Dallas, issue Nov.
    5. Orlowski, Lucjan T., 2008. "Stages of the Ongoing Global Financial Crisis: Is There a Wandering Asset Bubble?," IWH Discussion Papers 11/2008, Halle Institute for Economic Research (IWH).

    More about this item

    Keywords

    Risk ; Financial markets;

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