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Questions and Answers about the Financial Crisis

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  • Gary B. Gorton

Abstract

All bond prices plummeted (spreads rose) during the financial crisis, not just the prices of subprime- related bonds. These price declines were due to a banking panic in which institutional investors and firms refused to renew sale and repurchase agreements (repo) - short-term, collateralized, agreements that the Fed rightly used to count as money. Collateral for repo was, to a large extent, securitized bonds. Firms were forced to sell assets as a result of the banking panic, reducing bond prices and creating losses. There is nothing mysterious or irrational about the panic. There were genuine fears about the locations of subprime risk concentrations among counterparties. This banking system (the "shadow" or "parallel" banking system) - repo based on securitization - is a genuine banking system, as large as the traditional, regulated and banking system. It is of critical importance to the economy because it is the funding basis for the traditional banking system. Without it, traditional banks will not lend and credit, which is essential for job creation, will not be created.

Suggested Citation

  • Gary B. Gorton, 2010. "Questions and Answers about the Financial Crisis," NBER Working Papers 15787, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:15787
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    References listed on IDEAS

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    1. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    2. Gorton, Gary B., 2010. "Slapped by the Invisible Hand: The Panic of 2007," OUP Catalogue, Oxford University Press, number 9780199734153.
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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services

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