Palgrave Macmillan Studies in Banking and Financial Institutions Series Editor: Professor Philip Molyneux The Palgrave Macmillan Studies in Banking and Financial Institutions are international in orientation and include studies of banking within particular countries or regions, and studies of particular themes such as Corporate Banking, Risk Management, Mergers and Acquisitions, etc The books’ focus is on research and practice, and they include up-to-date and innovative studies on contemporary topics in banking that will have global impact and influence Titles include: Steffen E Andersen THE EVOLUTION OF NORDIC FINANCE Seth Apati THE NIGERIAN BANKING SECTOR REFORMS Power and Politics Caner Bakir BANK BEHAVIOUR AND RESILIENCE The Effect of Structures, Institutions and Agents Dimitris N Chorafas BASEL III, THE DEVIL AND GLOBAL BANKING Dimitris N Chorafas SOVEREIGN DEBT CRISIS The New Normal and the Newly Poor Stefano Cosma and Elisabetta Gualandri (editors) THE ITALIAN BANKING SYSTEM Impact of the Crisis and Future Perspectives Violaine Cousin BANKING IN CHINA Peter Falush and Robert L Carter OBE THE BRITISH INSURANCE INDUSTRY SINCE 1900 The Era of Transformation Juan Fernández de Guevara Radoselovics and José Pastor Monsálvez (editors) CRISIS, RISK AND STABILITY IN FINANCIAL MARKETS Juan Fernández de Guevara Radoselovics and José Pastor Monsálvez (editors) MODERN BANK BEHAVIOUR Franco Fiordelisi and Ornella Ricci (editors) BANCASSURANCE IN EUROPE Past, Present and Future Franco Fiordelisi, Philip Molyneux and Daniele Previati (editors) NEW ISSUES IN FINANCIAL AND CREDIT MARKETS Franco Fiordelisi, Philip Molyneux and Daniele Previati (editors) NEW ISSUES IN FINANCIAL INSTITUTIONS MANAGEMENT Kim Hawtrey AFFORDABLE HOUSING FINANCE Jill M Hendrickson FINANCIAL CRISIS The United States in the Early Twenty-First Century Jill M Hendrickson REGULATION AND INSTABILITY IN U.S COMMERCIAL BANKING A History of Crises Paola Leone and Gianfranco A Vento (editors) CREDIT GUARANTEE INSTITUTIONS AND SME FINANCE Caterina Lucarelli and Gianni Brighetti (editors) RISK TOLERANCE IN FINANCIAL DECISION MAKING Roman Matousek (editor) MONEY, BANKING AND FINANCIAL MARKETS IN CENTRAL AND EASTERN EUROPE 20 Years of Transition Philip Molyneux (editor) BANK PERFORMANCE, RISK AND FIRM FINANCING Philip Molyneux (editor) BANK STRATEGY, GOVERNANCE AND RATINGS Imad A Moosa THE MYTH OF TOO BIG TO FAIL Simon Mouatt and Carl Adams (editors) CORPORATE AND SOCIAL TRANSFORMATION OF MONEY AND BANKING Breaking the Serfdom Victor Murinde (editor) BANK REGULATORY REFORMS IN AFRICA Anders Ögren (editor) THE SWEDISH FINANCIAL REVOLUTION Özlem Olgu EUROPEAN BANKING Enlargement, Structural Changes and Recent Developments Fotios Pasiouras GREEK BANKING From the Pre-Euro Reforms to the Financial Crisis and Beyond Daniela Pỵrvu CORPORATE INCOME TAX HARMONIZATION IN THE EUROPEAN UNION Ramkishen S Rajan EMERGING ASIA Essays on Crises, Capital Flows, FDI and Exchange Rate Allesandro Roselli FINANCIAL STRUCTURES AND REGULATION: A COMPARISON OF CRISES IN THE UK, USA AND ITALY Yasushi Suzuki JAPAN’S FINANCIAL SLUMP Collapse of the Monitoring System under Institutional and Transition Failures Ruth Wandhöfer EU PAYMENTS INTEGRATION The Tale of SEPA, PSD and Other Milestones Along the Road The full list of titles available is on the website: www.palgrave.com/finance/sbfi.asp Palgrave Macmillan Studies in Banking and Financial Institutions Series Standing Order ISBN 978–1–403–94872–4 You can receive future titles in this series as they are published by placing a standing order Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England Financial Crisis The United States in the Early Twenty-First Century Jill M Hendrickson Associate Professor of Economics, University of St Thomas, USA © Jill M Hendrickson 2013 All rights reserved No reproduction, copy or transmission of this publication may be made without written permission No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988 First published 2013 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010 Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries ISBN 978–0–230–36881–1 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin A catalogue record for this book is available from the British Library A catalog record for this book is available from the Library of Congress 10 22 21 20 19 18 17 16 15 14 13 Printed and bound in Great Britain by CPI Antony Rowe, Chippenham and Eastbourne To my family Contents List of Figures and Tables Part I Theories of Financial Crisis Caught Off-Guard by Another Crisis I Why were we surprised? II What about next time? III Aim and scope IV Outline of the book Theories of Financial Crises I Four theories II The Financial Instability Hypothesis III The Austrian Business Cycle Theory IV Speculative Investment V Asymmetric Information VI Summary of the theories Assessment of the Theories I Comparison of the theories II Contrasting the theories III Summary Part II Financial Crisis in the US in the Twenty-First Century Prologue to the Crisis: 2000–2006 I Real sector growth and optimism II Developments in the financial sector III Interaction between the real and financial sectors The Crisis Unfolds I Stages of the crisis II Summary Part III Evaluating Theories Against the Evidence Using Theory to Analyze the Crisis I Analysis of shared theoretical elements II Analysis of common but nonconsensus elements III Summary Theoretically on Guard for Crises I What have we learned? II How is this crisis unique? III Post-crisis IV Conclusions Notes References Index List of Figures and Tables Figures 2.1 Taxonomy of Minky’s Financial Instability Hypothesis 2.2 The Garrison framework 2.3 Monetary policy in the Garrison framework 2.4 Taxonomy of Garrison’s Austrian Business Cycle Theory 2.5 Taxonomy of Kindleberger’s Speculative Investment Theory 2.6 Taxonomy of Mishkin’s Asymmetric Information Theory 4.1 RGDP growth rate: 1930–2010 4.2 RGDP growth rate: 2000–2010 4.3 Mortgage-related security holdings by investor: 2000–2010 4.4 GSE subprime and Alt-A holdings: 2002–2010 4.5 Market share of ARMs and FRMs: 2000–2008 4.6 Loans by category per commercial bank: 2000–2011 4.7 House price index in selected cities: 2000–August 2011 4.8 Federal funds rate: January 2000–October 2011 4.9 Mortgage originations: 1990–2011 4.10 Savings as a percentage of GDP across selected countries: 2000–2011 4.11 Current-account deficit in the US: 2000–2010 4.12 The real trade-weighted exchange rate: 2000–2011 4.13 MBSs issued: 2000–2010 4.14 MBSs issued and held per commercial bank: 2000–2011 4.15 Private-label MBSs issued: 2000–2010 4.16 Mortgage origination by selected product: 1990–2010 4.17 Senior loan officer survey results on C&I loans: 2000–2011 4.18 Senior loan officer survey results on residential mortgage loans: 2000–2011 4.19 Senior loan officer survey results on consumer loans: 2000–2011 4.20 Credit card and individual loans per commercial bank: 2000–2011 30 Ibid.: 117 In the same four days, other well-known money market funds suffered significant withdrawals, including Fidelity, BlackRock and Morgan Stanley (ibid.: 117) However none of these losses was near the level of withdrawals at Reserve Primary Fund 31 Norberg 2009: 69–70 32 Brennermeier 2009 33 Norberg 2009: 90 34 Many have made this same observation and some have even characterized the ban as government protection for financial firms that took on excessive risk (Norberg 2009: 111) 35 Dow Jones Industrial Average data are from http://dowjonesclose.com/2008.html (date accessed October 6, 2012) 36 For additional details on the Washington Mutual failure, see Grind 2009 37 See ibid 38 Special Inspector General 2009: 39 Barth et al 2009 40 Ibid.: 278 41 www.fdic.gov (date accessed October 6, 2012) 42 Senior debt refers to the institution’s debt that will be paid before other debt in the event of failure and typically includes the assets of the institution 43 www.fdic.gov/news/news/press/2008/pr08100.html (date accessed October 6, 2012) 44 Barth et al 2009: 279 45 The Treasury stressed that participation in the CPP was voluntary However, there is evidence to the contrary See Norberg 2009: 121–2 46 Nelson 2008 47 Norberg 2009: 122–3 48 The Economist 2008 49 Real consumption spending data from the Survey of Current Business at www.bea.gov (date accessed October 6, 2012) Note that consumption spending was down 1.8 percent between the second and fourth quarters of 2008 50 Slater 2008 51 Bernanke 2009 52 Soloman et al 2009 53 Enrich et al 2008 54 Ibid 55 Accepted collateral included auto loans, student loans, credit card loans, equipment loans, loans guaranteed by the Small Business Administration, and commercial real estate loans 56 See the St Louis Federal Reserve crisis timeline for TALF updates after November 2008 57 This press release can be found at www.federalreserve.gov/newsevents/press/monetary/20081125b.htm (date accessed October 6, 2012) 58 See www.federalreserve.gov/newsevents/press/monetary/20090318a.htm (date accessed October 6, 2012) 59 Soloman et al 2009 60 The details of this assistance can be found in the press release of the Federal Reserve Board at www.federalreserve.gov/newsevents/press/bcreg/20090116a.htm (date accessed October 6, 2012) 61 The complete press release may be found at the Federal Reserve Board of Governors at www.federalreserve.gov/newsevents/press/bcreg/20090223a.htm (date accessed October 6, 2012) 62 Government Accounting Office 2009a 63 Government Accounting Office 2009b 64 Ibid 65 www.treasury.gov (date accessed October 6, 2012) 66 See FDIC 2009 for more details 67 See www.recovery.gov (date accessed October 6, 2012) for more details 68 See www.treasury.gov/press-center/press-releases/Pages/2009218111 7388144.aspx (date accessed October 6, 2012) for more details 69 White House 2009 70 See www.freddiemac.com/news/archives/investors/2009/2009er-1q09.html (date accessed October 6, 2012) 71 See www.fanniemae.com/ir/pdf/earnings/2008/form10k_022609.pdf (date accessed October 6, 2012) 72 A figure of business confidence is found at http://tradingeconomics.com (date accessed October 6, 2012) 73 Consumption spending data is from the Survey of Current Business at www.bea.gov/iTable/iTable.cfm?ReqID=9&Step=1 (date accessed October 6, 2012) 74 Emmons 2012 Using Theory to Analyze the Crisis This is based on the percentage change in the ten-city Case-Shiller composite index The 20-city composite index did not exist prior to 2000 See Mora 2010 Ibid Mora (ibid.: 44) makes this same point The CPP data in this paragraph comes from www.gao.gov/special.pubs/gao-10-24sp/index.html (date accessed October 6, 2012) A complete list of these banks can be found at www.gao.gov/special.pubs/gao-10-24sp/file1.html (date accessed October 6, 2012) FDIC 2008 Waldrop 2009 Goodwill is the excess of the purchase price of the fair market value of acquired assets minus impairment adjustments Vercelli 2011 10 Silipo 2011 11 A prominent post-Keynesian and Minsky scholar, Paul Davidson (2008) also argues that this crisis did not fit the financial taxonomy created in Minsky Davidson is very clear that hedge, speculative, and Ponzi units require that these borrowers face future dates in which their debt must be either paid or refinanced With the mortgage crisis, these borrowers were not able to roll over their debt or obtain additional debt to cover due mortgages Thus, Davidson argues that this taxonomy was never really an option for subprime borrowers 12 Mishkin (1991) uses the spread between Baa corporate bond rates and long-term Treasury yields In another work (2011), he uses the TED spread and the Baa and Treasury spread 13 Mishkin 2011 14 Interest rates on subprime mortgage loans were about two percent greater than prime mortgage rates and tended to move up or down with the prime rate: Friedman 2009: 137 15 Mishkin 2011 16 Ibid.: 50 17 Ibid.: 52 18 Kindleberger and Aliber 2005: 57 19 Ibid.: 55 20 Garrison 2009b 21 See Callahan and Garrison 2003 22 The reader is encouraged to consider alternative cities and this data is available at www.ffiec.gov/hmda (date accessed October 6, 2012) 23 Sector-specific data, such as employment and the number of establishments in US real estate, can be found at the US Census Bureau, and this data also supports the Garrison perspective that low interest rates attracted funds into financial activities such as mortgage banking and also into construction See also Prassas 2011 24 Ibid 25 Ibid 26 Callahan and Garrison 2003 27 For more on this Austrian perspective, see Howden 2010 28 Silipo 2011 stresses the falling income in the Minsky turning point 29 Mora 2010 makes these same points regarding deposit insurance 30 Mishkin 2011 31 Ibid.: 55 32 E White 2009 33 See L White 2009 for a comprehensive list of the changes to the Federal Reserve’s assets 34 Minsky 1957: 186 35 Minsky 1957 36 Kindleberger and Aliber 2005: 241 37 Ibid.: 14 38 Kindleberger 1997: 31 39 Mishkin (2009) also discusses what he calls valuation risk, which is the information problem during a crisis of not knowing the true value of a security However, he argues that monetary policy cannot help with valuation risk 40 Ibid.: 576 41 Garrison 2009a: 42 Horwitz 2010: 106 Theoretically on Guard for Crises Down payment data in this paragraph are from Humphries 2011 Stein 2003 De Antoni (2010) makes this same argument Garrison is not alone on this position See, for example, Adrian and Shin 2009; Horwitz 2010; and Schwartz 2009, among others Mishkin 2011 See the Mishkin quote on this point in Chapter Indeed, this was the experience in the 1920s real estate boom (E White 2009a) Duca et al 2010 Mishkin 2011 See also Mishkin 2009 10 Kirzner 1984: 631 11 Mishkin 2011 12 See, for example, Dowd 2009 or Samwick 2009 13 For more information on the historical experiences of monetary policy and its ability to add stability, see Hendrickson 2011 14 For an international comparison of this most recent financial crisis, see Reinhart and Rogoff 2008 15 Friedman (2009) makes a compelling case that virtually all market participants and regulators were ignorant to the risks underlying the subprime mortgages and financially engineered products 16 Ibid 17 Prychitko (2010) makes this same observation 18 Gorton and Metrick 2012: 11 19 W White 2008: 308 20 E White 2009 21 Duca et al 2010 22 See, for example, Hendrickson and Nichols 2011 or Samolyk 2004 23 See Demirguc-Kunt and Serven 2009; Dowd 2009; and L White 2009 24 Cochrane 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Market Mutual Fund Liquidity Facility 130 asset-backed securities (ABSs) 64, 71, 74–75, 87, 139 Austrian business cycle theory see Garrison Austrian thought entrepreneur 21 interest rates 21–22 knowledge 20 first-order 20 higher-order 20 prices 21 time 21 auto industry 138, 141–142 Auto Suppliers Support Program 142 Baa corporate yield 174, 184, 223 Basel I 71–74, 76 Bank of America 108–109, 130, 138, 140 Bear Stearns 40, 106–108, 110, 113, 175, 188–190 Bernanke, Ben 5, 137 BNP Paribus 106–107, 115, 185 bond rating agencies 75 bond ratings 75 borrowing cost channel 120–121, 134, 145, 148 bubble bursts 41, 125 Capital Purchase Program (CPP) 128, 132–133, 139, 141, 165, 221–222 capital requirements 62–63, 88, 100, 200, 208, 218 Basel I 71–74, 76 and mortgage-backed securities 74 recourse rule 74, 76, 204 risk weights 71–73 capital-to-asset ratio 71–72 Chicago Fed National Activity Index (CFNAI) 118–119 Chrysler 142 Citigroup 106–107, 137–140 commercial banks C&I loans 73, 92–93, 99, 120–122, 125, 135, 145–146, 152, 155, 163 consumer loans 72–74, 93–95, 135, 153, 156 credit card loans 95–96, 122, 135, 146 deposits 33, 133, 153, 158–162, 168, 186–187, 208 failed 140, 143, 144, 160, 167–168 lending 91–97 loan standards 70, 93–95 mortgage loans 94 problem 143–144 reserves 131 return on equity (ROE) 166–167 stress test 138, 141 commercial paper 5, 90–91, 110, 113–116, 128–130, 132, 134, 145, 160, 163, 169, 174, 187, 189–190, 208–209, 220 Commercial Paper Funding Facility 128, 132, 190 Community Reinvestment Act (CRA) 62–63, 69–71, 88, 100, 200 confidence channel 117–118, 124, 135–136, 142, 146, 148 role of in crisis 5–6, 15, 103, 115, 123, 131–132, 173, 183 conservatorship 125–127, 144, 220 consumer debt 95–97, 171 consumer spending 60, 125 conventional mortgages 97, 168 corporate profit 99–100, 185–186 Countrywide Financial 107–109, 115, 140, 185 credit channel 117–118, 121, 135, 148 credit default swap 129 current account deficit 84–86 debt-to-maturity ratio 120–121, 125, 135, 146 deposit insurance 128, 132 Dillon Read Capital Management 106–107 disposable income 96–97, 100, 124, 170, 186 Dodd-Frank Act 212, 224 Dow Jones Industrial Average 104, 130, 210, 221, 224 Emergency Economic Stabilization Act 127, 131, 141, 162 exchange rates 85–86 channel 117–118, 125, 136, 147 failed banks 140–141, 143–144, 167–168 FDIC 128, 132–133, 139–140 federal funds rate historical 83, 177 target cuts 99, 106–108, 117, 127–128, 133, 143, 172, 188 Federal Housing Administration (FHA) 66–69 federal housing policies 62–63, 82 and homeownership 62, 69, 142, 176, 178, 198, 201, 211–213, 219 Federal Reserve 4, 54–55, 103 balance sheet 189 lender of last resort 107–111, 127–133, 138–140, 143, 176–177, 188, 190–191, 193, 203–204, 209, 212 see also monetary policy finance companies 5, 91, 169 financial crisis history 7, 204 Financial Crisis Inquiry Commission 138, 141–142 financial distress channel 11, 116–118 financial engineering 87, 207 Financial Services Regulatory Relief Act 131 Financial Stability Plan 138, 142 Financial Stress Index 103–105, 115, 134, 137, 145, 147 financing gap 120, 125, 146, 164 Fitch 75 fixed-rate mortgage (FRM) 70–71 flight to liquidity 112–113, 133, 145 flight to quality 109, 112, 117, 125, 129, 133, 136, 169 foreclosure rates 77, 187, 211 foreign savings 84–85 Friedman, Milton Galbraith, John Kenneth 207 Garrison, Roger 10, 12, 18 asset prices 27–28, 45–46, 156–159 Austrian business cycle theory 18–29 boom 24, 27, 29 capital 22–24, 49 consumption 22–24, 29 credit 28, 44–46, 152–156, 158–165, 167 cyclical theory 18–19 entrepreneur 21, 23, 49 exogenous trigger 50, 175–178, 199–201 Hayakian triangle 23, 26, 50 interest rates 21–22, 24, 52–53, 183–185, 201 investment 22–24, 29, 44–46, 152–156, 167 knowledge 20–22, 48, 51, 181–182 loan demand 22, 25 supply 22, 25 loanable funds 22, 24–25 market process 20–21, 49 monetary policy 24, 29, 50, 54–56, 188–195, 203–204 natural rate 24–25, 29–30, 51–56, 176–177, 184 over-consumption 22, 177–179 over-investment 22, 177–179 production possibilities frontier 23, 26 profit 24, 29, 45–46 savings 22 taxonomy 30 time 21–22, 24, 49 turning point 24, 53–54, 185–188, 201–202 uncertainty 21–22, 27, 49 General Motors 142 Goldman Sachs 127, 130 government sponsored enterprises (GSEs) 62–70, 72, 74, 82, 87–89, 100–102, 104, 125–126, 138–139, 144, 175–176, 200, 207–208 Fannie Mae 64–68, 88, 108, 111–113, 126–127, 144 Freddie Mac 64–68, 88, 106–108, 111–112, 126–127, 144 Great Depression 6, 8, 42, 156, 210 Great Moderation 59–60, 100, 102 Great Recession 209 Greenspan, Alan 4, 84 Hayek, Friedrich A 12, 18–19 Hayekian triangle 23, 25, 27, 50 Hazlitt, Henry 18 hedge funds 91, 106–107, 134, 175 Helping Families Save Their Homes Act 2009 138, 142 home equity lines of credit 92, 95–96, 164 home equity loans 78 Homeowner Affordability and Stability Plan 138, 142 homeownership rates 62, 211–212 house prices Case-Shiller index 80–82, 157, 222 during prologue 80–82 peak 103 household debt service ratio 171 Housing and Urban Development (HUD) 64, 66–69, 82, 87–89, 100–101, 176, 200–201, 208 interest-only loans 68, 70, 172 J.P Morgan Chase 160 Keynes, John Maynard 6, 12–14, 18–19, 216 Kindleberger, Charles P 9–10, 13, 29 asset prices 31, 36, 45–46, 156–159 credit 32–33, 35–36, 44–46, 152–156, 158–165, 167 displacement 32 historical examples 32 see also shock euphoria 32–33 exogenous shock 32, 50, 175 interest rates 52–53, 183–185, 201 investments 33, 44–46, 152–156, 167 irrationality 35 knowledge 47, 51, 180–181 liquidity 31, 35 mania 32, 34 monetary policy 54–55, 188–195, 203–204 noncyclical theory 31 profit 32, 45–46 psychology 30, 35, 47 rationality 35, 48 revulsion 32, 35 speculators insiders 31, 33, 47 outsiders 31, 33, 47 speculative investment theory 29–36, 198, 206 taxonomy 30 trigger 199–201 turning point 53–54, 185–188, 201–202 labor force participation rate 211 land use restrictions 61–63, 78–79 leading economic indicator 118–119 Lehman Brothers 40, 125–127, 129–130, 132, 160–161, 175, 186–187, 202 leverage ratio 71 LIBOR 111–112, 220 loan commitment 91, 109, 163 loan growth 158–160, 163 loan standards 70, 93–95 loan-to-value (LTV) 67–68, 70, 93, 101 Minsky, Hyman P 9–10, 12–13 asset prices 18, 45–46, 156–159 credit 15, 18, 44–46, 152–156, 158–165, 167 cyclical theory 14 debt 14–15, 17 endogenous trigger 50, 169–171, 199–201 financial instability hypothesis 12–14, 16–18, 198, 206 hedge 15–16, 47, 55, 91, 170–171, 185, 199, 222 instability 13–14, 50, 206 interest rates 16–18, 52–53, 183–185, 201 investment 14–15, 17, 44–46, 152–156, 167 liquidity 15–17 loan demand 15 supply 18 monetary policy 54–55, 188–195, 203–204 Ponzi 15–16, 47, 55, 91, 170–171, 185, 199, 222 profits 14, 45–46 speculative 15–16, 47, 55, 91, 170–171, 185, 199, 222 systemic fragility 14–16 taxonomy 16 trigger 199–200 turning point 53–54, 185–188, 201–202 uncertainty 14, 51, 182 Mishkin, Frederic S 10, 13, 36 asset prices 41, 45–46, 50, 156–159 asymmetric information adverse selection 37, 39, 48 moral hazard 38–39, 48 Asymmetric Information Theory 36–42, 198, 206 bank balance sheet 41, 50 banking crisis 42 credit 40, 44–46, 152–156, 158–165, 167 debt deflation 42 efficient markets 37, 48 endogenous trigger 50, 172–174, 199–201 interest rates 40, 50, 52–53, 183–185, 201 investment 41–42, 44–46, 152–156, 167 knowledge 51, 181 loan demand 40–41 supply 40–41 monetary policy 54–55, 188–195, 203–204 noncyclical theory 36 real sector 48 taxonomy 38 turning point 53–54, 185–188, 201–202 uncertainty 40, 50–51 Maiden Lane LLC 189–190 Merrill Lynch 130, 140 Mises, Ludwig von 12, 18–19 model failure 6, 9, 19 monetary policy conventional response 137–138, 143, 188, 193–194, 203 nonconventional response 137–138, 143, 193–194 Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility 127, 130 Bear Stearns takeover 108, 110 Commercial Paper Funding Facility (CPFF) 128, 132, 190 lending to GSEs 139 Money Market Investor Funding Facility 128, 132 Primary Dealer Credit Facility 108, 110 Term Asset-Backed Securities Loan Facility (TALF) 138–139, 221 Term Auction Facility 108–109 Term Securities Lending Facility 108, 110 Troubled Asset Relief Program (TARP) 127, 131–132, 138, 140–142, 165 money market mutual funds (MMMF) 90–91, 127–128, 132, 169 Moody’s 75–77, 87 downgrades 88, 107, 131 Morgan Stanley 106–108, 127, 130, 185, 221 mortgage-backed securities (MBSs) 4, 63–69, 72–74, 76–78, 88–91, 100, 106–107, 110, 126, 138–139, 175, 207 at commercial banks 88–89 Federal Reserve purchase of 139 growth in 88 at GSEs 88 private-label 77, 90 mortgage debt 95, 97, 100, 103, 106–107, 164 mortgage delinquency rates 102, 212 mortgage interest deductibility 63, 78 mortgage originations 74, 83–84, 161, 200 NASDAQ 60 nationally recognized statistical rating organizations (NRSRO) 75–76, 78, 218 natural interest rate 22, 24–25, 29–30, 51–53, 55–56, 176–177, 182, 194 net financial inflow 170 net worth 39, 41–42, 117, 163–164, 170–171, 173, 200 net worth channel 118, 122, 135, 146 New Century Financial 106–107 nonbank financial institutions 99, 177–178 nonfinancial business debt 95 nonperforming loans 28, 45, 168, 187 nonrecourse loans 62–63, 79, 219 Northern Rock bank 106–107 open market operations 133, 188 past-due mortgage loans 102, 164–165 Paulson, Henry 4, 141, 215 primary dealer credit facility 108, 110 prime rate 98–99, 184, 223 principal-agent problem 39 real exports 124, 136, 147 real gross domestic product (RGDP) 59–61, 118 real private fixed investment 124, 153 refinancing 17–18, 53, 83, 93 repurchase agreements 91, 110, 169, 174, 199 Reserve Primary Money Fund 127, 129, 161, 175, 221 residential mortgage loans 41, 77, 87, 91, 93–94, 155, 161, 165, 167, 209 restrictive covenants 39–40 return on equity (ROE) 166–167 savings glut 85 savings rate 84–85, 179 Securities and Exchange Commission (SEC) 39, 75–76 ban short sales 130 securitization 87, 90, 175, 200, 207–208 defined 64 of mortgages 68, 82, 87, 91, 176, 198 tranches 87, 219 shadow banking sector 90 short sale 130 stages of crisis 11 defined 103–104 stage one 105–125 stage two 125–136 stage three 136–147 Standard and Poor’s 75–76, 87, 106–107 downgrades 76, 106–107 standby letter of credit 91 stock market 40–41, 54, 103, 108–109, 130, 156, 161, 220 subprime loans 4, 41, 63, 69, 76–77, 87–92, 100, 102, 106–109, 126, 161, 168, 171–173, 175–176, 181, 185, 196, 198–200, 208–209, 223 defined 65–66 subprime borrowers 65–66 technology bubble 32, 60–61, 83 TED spread 111–112, 116, 133, 145, 223 Term Asset-Backed Securities Loan Facility (TALF) 138–139, 221 Term Auction Facility 108–109 Term Securities Lending Facility 108, 110 theory failure 6, Treasury 64, 127–128, 138–142, 221 Troubled Asset Relief Program (TARP) 127, 131–132, 138, 140–142, 165 UBS 106–107 unemployment rates 210 unprofitable banks 166–167 venture capital 39 Wachovia 106–108 Washington Mutual 127, 131–132, 160, 162, 166, 221 Wolfson, Martin H 9–10, 44, 215–217 Zillow Home Value Index 210 ... crisis of the twenty-first century II The Financial Instability Hypothesis The Financial Instability Hypothesis was developed by Hyman P Minsky in the 1970s Born in 1919, Minsky witnessed the incredible... context of the business cycle The first is the Financial Instability Hypothesis of Hyman P Minsky Minsky developed this perspective of financial crises after witnessing increasing financial instability... disturbances in the financial sector In contrast, theories of financial crises explain crisis or turmoil that must include elements of disruption in the financial sector Further, many theories of financial