Credit Crisis 101

Edward Gottesman

World Economics, 2008, vol. 9, issue 3, pages 47-72

Abstract: Subprime mortgage loans were the catalyst, not the cause, of the crisis. Policy errors in both the public and private sectors stretch back nearly 40 years. Inflation, monetary policy and lax regulation all played a role in allowing individual greed and irrational risk-taking to flourish. The paper provides background to the mania that generated an alphabet-soup of derivative “obligations†with uncertain—possibly unknowable-values. The growth of derivatives and the failure of Fannie Mae and Freddie Mac are linked to the tenfold growth of median house prices in the United States, which ballooned from $11,900 in 1960 to $120,000 in 2000. Residential properties became trading inventory for speculators rather than fixed assets for homeowners. Turmoil, the author suggests, will continue as long as financial instruments are manufactured and sold through “fantastically complex†statistical models and mathematical strategies that bear little relationship to fair market values of real assets.

Date: 2008

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