The Role of Banks in the Subprime Financial Crisis

Michele Fratianni and Francesco Marchionne ()

No 2009-02, Working Papers from Indiana University, Kelley School of Business, Department of Business Economics and Public Policy

Abstract: The ultimate point of origin of the great financial crisis of 2007-2009 can be traced back to an extremely indebted US economy. The collapse of the real estate market in 2006 was the close point of origin of the crisis. The failure rates of subprime mortgages were the first symptom of a credit boom tuned to bust and of a real estate shock. But large default rates on subprime mortgages cannot account for the severity of the crisis. Rather, low-quality mortgages acted as an accelerant to the fire that spread through the entire financial system. The latter had become fragile as a result of several factors that are unique to this crisis: the transfer of assets from the balance sheets of banks to the markets, the creation of complex and opaque assets, the failure of ratings agencies to properly assess the risk of such assets, and the application of fair value accounting. To these novel factors, one must add the now standard failure of regulators and supervisors in spotting and correcting the emerging weaknesses. Accounting data fail to reveal the full extent of the financial maelstrom. Ironically, according to these data, US banks appear to be still adequately capitalized. Yet, bank undercapitalization is the biggest stumbling block to a resolution of the financial crisis.

Keywords: accounting; banks; credit; crisis; fair values; risk aversion; undercapitalization (search for similar items in EconPapers)
JEL-codes: G01 G21 N20 (search for similar items in EconPapers)
Date: 2009-04
New Economics Papers: this item is included in nep-acc, nep-ban, nep-cba, nep-pke, nep-rmg and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Working Paper: The Role of Banks in the Subprime Financial Crisis (2009)
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