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A primer on the subprime crisis

Listed author(s):
  • Clerc, L.

The catalyst of the current financial turmoil has been the losses on the subprime mortgage market. However, the low quality of these partly collateralised housing loans was known for a while and the default on subprime mortgages largely expected. Therefore, how to account for the fact that an expected shock on a small segment of the US mortgage market turned into a major financial crisis, causing the near-collapse of the Commercial Paper and of the interbank lending markets, that is to say of two of the most liquid financial markets? Banks have transferred risks to special entities, the so-called “conduits”, SIV (Special Investment Vehicles) and SPV (Special Purpose Vehicles). Such a practice gave the false impression that credit risk was transferred from banks outside the financial system. This was indeed not the case. The funding needs associated in particular with backup lines of credit for off-balance sheet vehicles generated pressures on the the interbank markets and led central banks to massively intervene. The roots of the current turmoil are therefore of a deeper and structural nature. For that reason, it is necessary to assess, from a longer term perspective, what are the main consequences of the recent structural changes on financial markets in order to have a good grasp on the current financial market dynamics and clarify what is meant nowadays by liquidity.

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Paper provided by Banque de France in its series Occasional papers with number 4.

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Length: 7 pages
Date of creation: 2008
Handle: RePEc:bfr:opaper:4
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