Deciphering the Liquidity and Credit Crunch 2007–2008

Deciphering the Liquidity and Credit Crunch 2007–2008 Abstract The financial market turmoil in 2007 and 2008 has led to the most severe financial crisis since the Great Depression and threatens to have large repercussions on the real economy. The bursting of the housing bubble forced banks to write down several hundred billion dollars in bad loans caused by mortgage delinquencies. At the same time, the stock market capitalization of the major banks declined by more than twice as much. While the overall mortgage losses are large on an absolute scale, they are still relatively modest compared to the $8 trillion of U.S. stock market wealth lost between October 2007, when the stock market reached an all-time high, and October 2008. This paper attempts to explain the economic mechanisms that caused losses in the mortgage market to amplify into such large dislocations and turmoil in the financial markets, and describes common economic threads that explain the plethora of market declines, liquidity dry-ups, defaults, and bailouts that occurred after the crisis broke in summer 2007. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Economic Perspectives American Economic Association

Deciphering the Liquidity and Credit Crunch 2007–2008

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Publisher
American Economic Association
Copyright
Copyright © 2009 by the American Economic Association
Subject
Symposia
ISSN
0895-3309
DOI
10.1257/jep.23.1.77
Publisher site
See Article on Publisher Site

Abstract

Abstract The financial market turmoil in 2007 and 2008 has led to the most severe financial crisis since the Great Depression and threatens to have large repercussions on the real economy. The bursting of the housing bubble forced banks to write down several hundred billion dollars in bad loans caused by mortgage delinquencies. At the same time, the stock market capitalization of the major banks declined by more than twice as much. While the overall mortgage losses are large on an absolute scale, they are still relatively modest compared to the $8 trillion of U.S. stock market wealth lost between October 2007, when the stock market reached an all-time high, and October 2008. This paper attempts to explain the economic mechanisms that caused losses in the mortgage market to amplify into such large dislocations and turmoil in the financial markets, and describes common economic threads that explain the plethora of market declines, liquidity dry-ups, defaults, and bailouts that occurred after the crisis broke in summer 2007.

Journal

Journal of Economic PerspectivesAmerican Economic Association

Published: Feb 1, 2009

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