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An Asset-Based Framework of Credit Creation (applied to the Global Financial Crisis)

Susanne von der Becke () and Sornette Didier ()
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Sornette Didier: ETH Zurich, D-MTEC - Chair of Entrepreneurial Risks, Scheuchzerstrasse 7, 8092Zurich, Switzerland

Accounting, Economics, and Law: A Convivium, 2019, vol. 9, issue 2, 21

Abstract: We develop a conceptual asset-based framework of credit creation based on three leading variables: (i) the amount of assets acceptable as collateral, (ii) the level of leverage and (iii) the level of trust. As credit expands along these dimensions in a non-linear dynamic, the financial system becomes more liquid. At the same time, it becomes more prone to endogenous feedbacks and vulnerable to internally generated instabilities manifested as booms and busts. Applying this framework to the global financial crisis, we show that the subprime crisis was both a signature and only one possible trigger in an increasingly unstable financial system. Using historical data, we demonstrate a significant shift in the components of US bank balance sheets and a decoupling of bank assets from deposits since the mid-1980s, marking the rise of “securitized-fractional reserve banking”. The subsequent decades were a period of growing leverage, with debt-securities assuming money-like functions and serving as collateral for further credit creation. As trust began to recede, the high levels of leverage were no more viable, precipitating a reduction of the amount of assets acceptable as collateral, and leading to a contraction in credit and to liquidity spirals. We discuss the potential general applicability of this framework of credit creation and define extensions in future research.

Keywords: credit creation; financial crises; leverage; liquidity; confidence (search for similar items in EconPapers)
JEL-codes: B53 E12 E13 E51 G01 (search for similar items in EconPapers)
Date: 2019
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Accounting, Economics, and Law: A Convivium is currently edited by Reuven S. Avi-Yonah, Yuri Biondi and Shyam Sunder

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