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1 – 10 of 557Akos Rona-Tas and Stefanie Hiss
Both consumer and corporate credit ratings agencies played a major role in the US subprime mortgage crisis. Equifax, Experian, and TransUnion deployed a formalized scoring system…
Abstract
Both consumer and corporate credit ratings agencies played a major role in the US subprime mortgage crisis. Equifax, Experian, and TransUnion deployed a formalized scoring system to assess individuals in mortgage origination, mortgage pools then were assessed for securitization by Moody's, S&P, and Fitch relying on expert judgment aided by formal models. What can we learn about the limits of formalization from the crisis? We discuss five problems responsible for the rating failures – reactivity, endogeneity, learning, correlated outcomes, and conflict of interest – and compare the way consumer and corporate rating agencies tackled these difficulties. We conclude with some policy lessons.
The concept of state-corporate crime developed during the late 1980s and early 1990s in a series of papers authored by Michalowski and Kramer (Kramer, 1990; Kramer & Michalowski…
Abstract
The concept of state-corporate crime developed during the late 1980s and early 1990s in a series of papers authored by Michalowski and Kramer (Kramer, 1990; Kramer & Michalowski, 1990; Michalowski & Kramer, 1987). They specifically define state-corporate crime as:Illegal or socially injurious actions that result from a mutually reinforcing interaction between (1) policies and/or practices in pursuit of goals of one or more institutions of political governance and (2) policies and/or practices in pursuit of goals of one or more institutions of economic production and distribution. (Michalowski & Kramer, 2006a, 2006b, p. 15)
Donald Palmer and Michael Maher
We use normal accident theory to analyze the financial sector, especially that part of the financial sector that processed home mortgages, and the mortgage meltdown. We maintain…
Abstract
We use normal accident theory to analyze the financial sector, especially that part of the financial sector that processed home mortgages, and the mortgage meltdown. We maintain that the financial sector was highly complex and tightly coupled in the years leading up to the mortgage meltdown. And we argue that the meltdown exhibited characteristics of a system or normal accident; the result of a component failure (unusually high mortgage defaults) that, in the context of unique conditions (which included low interest rates and government policy encouraging home loans to less credit-worthy households), resulted in complex and tightly coupled interactions that financial elites and government officials were ill-equipped to control. We also consider the role that agency and wrongdoing played in the design of the financial system and the unfolding of the mortgage meltdown. We conclude that a fundamental restructuring of the financial system, so as to reduce complexity and coupling, is required to avert future similar financial debacles. But we also conclude that such a restructuring faces significant obstacles, given the interests of powerful actors and the difficulties of labeling those responsible for the meltdown as wrongdoers.
Laura A. Patterson and Cynthia A. Koller
The 2000–2006 housing market bubble conformed to a classic boom–bust scenario that triggered the most serious and costly financial crisis since the Great Depression. The 2008…
Abstract
The 2000–2006 housing market bubble conformed to a classic boom–bust scenario that triggered the most serious and costly financial crisis since the Great Depression. The 2008 subprime mortgage collapse leveraged a financial system that privatizes profits and socializes risks. Several factors converge to set up the subprime mortgage market as an easy target for industry insiders to exploit. Enabling legislation expanded the potential pool of borrowers eligible for subprime mortgages and structured incentives to lenders willing to assume the risks. The securitization of subprime mortgages transformed bundles of high-risk loans into mortgage-backed securities that were in demand by domestic and foreign investors. Pressure to edge out competition produced high-risk loans marketed to unqualified borrowers. The final piece in the setup of the subprime lending crisis was a move from an origination model to a distributive model by many financial institutions in the business of lending. We find that the diffusion and totality of these business practices produced a criminogenic opportunity structure for industry insiders to profit at the expense of homebuyers and later investors.
The chapter studies strategic default using an experimental approach.
Abstract
Purpose
The chapter studies strategic default using an experimental approach.
Design/methodology/approach
The experiment considers a stochastic asset process and a loan with no down-payment. The treatments are two asset volatilities (high and low) and the absence and presence of social interactions via a direct effect on the subject's payoff.
Findings
I demonstrate that (i) people appear to follow the prediction of the strategic default model quite closely in the high asset volatility treatment, and that (ii) incorporating social interactions delays the strategic default beyond what is considered optimal.
Originality/value
The study tests adequately the strategic default using a novel experimental design and analyzes the neighbor's effect on that decision.
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This chapter examines the central role played by credit rating agencies in the production of “knowledge” about financial instruments. That “knowledge,” in the form of credit…
Abstract
This chapter examines the central role played by credit rating agencies in the production of “knowledge” about financial instruments. That “knowledge,” in the form of credit ratings, underpinned disintermediation in mortgage markets by giving investors confidence that they knew the risk-and-return properties of otherwise opaque collateralized debt obligations (CDOs) and mortgage-backed securities. Credit ratings helped to “standardize” structured financial products and create liquid markets. However, this cognitive machinery failed and liquidity collapsed during the current crisis. I use this failure to examine the role of institutionalized cognition in the production of market liquidity.
This chapter analyses the causes and effects of the financial crisis that commenced in 2008, and it examines the dramatic government rescues and reforms. The outcomes of this, the…
Abstract
This chapter analyses the causes and effects of the financial crisis that commenced in 2008, and it examines the dramatic government rescues and reforms. The outcomes of this, the most severe collapse to befall the United States and the global economy for three-quarters of a century, are still unfolding. Banks, homeowners and industries stood to benefit from government intervention, particularly the huge infusion of taxpayer funds, but their future is uncertain. Instead of extending vital credit, banks simply kept the capital to cover other firm needs (including bonuses for executives). Industry in the prevailing slack economy was not actively seeking investment opportunities and credit expansion. The property and job markets languished behind securities market recovery. It all has been disheartening and scary – rage against those in charge fuelled gloom and cynicism. Immense private debt was a precursor, but public debt is the legacy we must resolve in the future.
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Purpose – This chapter asks whether the current economic crisis, precipitated by defaults in subprime mortgages, could have been postponed or perhaps even…
Abstract
Purpose – This chapter asks whether the current economic crisis, precipitated by defaults in subprime mortgages, could have been postponed or perhaps even avoided?
Design/methodology/approach – I begin by exploring an aspect of American culture that I call the moral philosophy of “just deserts.” The term “just deserts” is derived from the title of Alperovitz and Daly's (2008) book, Unjust Deserts: How the Rich Are Taking Our Common Inheritance and Why We Should Take It Back. To argue for greater equity in the distribution of wealth, the authors return to the 17th century writings of John Locke who helped establish the rules of property ownership that determine who is entitled to get what in the way of material goods. Locke's writings, infused with Protestant theology, became the basis of Western law and morality. Economic theory, on which the policies that led up to the latest crash and the responses to it, draws heavily on Locke's ideas.
Findings – Holders of subprime mortgages who have lost their homes, according to this thinking that has become intrinsic to our culture, did not deserve to be given mortgages or to obtain homes. Paying these mortgages for them might have postponed or even prevented the crash and the collapse of the financial system. Rational as this seems, it was not even proposed, because it would have given people something they had not earned and hence were not believed to deserve.
Research limitations/implications – The chapter is based on cultural and historical analysis. It cannot be tested empirically since this would require policy makers to change the assumptions on which its economic programs rest.
Practical implications – The practical implications of the chapter are to stimulate examination and discussion of the cultural value of just deserts and the assumptions on which it is based.
Originality/value – The reintroduction of culture and its assumptions into debates over public policy will improve understanding and enable us to avoid repeating social practices that have had negative effects.
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Financial systemic risk is often assessed by the interconnectedness of financial institutes (FI) in terms of cross-ownership, overlapping investment portfolios, interbank credit…
Abstract
Financial systemic risk is often assessed by the interconnectedness of financial institutes (FI) in terms of cross-ownership, overlapping investment portfolios, interbank credit exposures, etc. Less is known about the interconnectedness between FIs through the lens of consumer credits. Using detailed consumer credit data in Canada, this chapter constructs a novel banking network to measure FIs’ interconnectedness in the consumer credit markets. Results show that FIs on average are more connected to each other over the sample period, with the interconnectedness measure increases by 19% from 2013 Q4 to 2019 Q4. FIs with more diversified portfolios are more connected in the network. Among various types of FIs, secondary FIs have the notable increase in interconnectedness. Domestic Systemically Important Banks and secondary FIs offering a broad range of loan products are more connected to large FIs, while those specialized in single loan types are more connected to their industry peers. FI connectedness is also significantly related to their participation in the mortgage markets.
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