The subprime debacle

Monthly Review

Volumn 60, Issue 1, 2008, Pages 27-44

  Beitel, Karl ^a  

^a Service Employees International Union   (United States)

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EID: 44349134989     PISSN: 00270520     EISSN: None     Source Type: Journal    
DOI: 10.14452/MR-060-01-2008-05_3     Document Type: Review

References (24)

1. For useful accounts of the U.S housing finance system, see Michael E. Stone, "Pernicious Problems of Housing Finance," in Chester Hartman, Rachael Bratt, and Michael Stone, eds., A Right to Housing (Philadelphia, Temple University Press, 2006), 82-104;
2. and Michael E. Stone, Shelter Poverty (Philadelphia, Temple University Press, 1993).
3. Collateralized debt obligations, or CDOs, are investment trusts backed by mortgage pools in which investors can acquire positions in various "tranches" that differ in terms of their risk profile and rate of return. Underwriters (arrangers) of CDOs aggregate large pools of subprime mortgages against which various subclasses of securities are issued that offer varying levels of protection from losses due to default. In a typical CDO, the first tranche, referred to as the equity tranche, will absorb all losses due to default and foreclosure until its principal is exhausted. Losses will then be applied to the second tranche, typically with a BB grade credit rating, and so on, up the ascending "mezzanine" of tranches until the senior tranche is reached. The higher the credit rating of a given tranche, the lower the rate of return. The senior tranche, which carries an AAA grade credit rating, generally composes about 70-80 percent of the total principal in the trust. High-quality credit ratings given to the senior tranche were based on a credit rating agency's estimates of the likelihood of losses based on past default rates. Purchasers of these assets-hedge funds, insurance companies, and the SIV's set up by the banks-assumed they were protected by the lower grade, or "subordinate" tranches, that would provide a sufficient cushion against losses due to default.
4. Gillian Tett and Paul J. Davies, "Out of the Shadows," Financial Times, December 17, 2007.
5. Saskia Scholtes, "On Wall Street," Financial Times, March 30, 2007.
6. See also "Cracks in the Façade," Economist, March 24, 2007, 79-81.
7. See Robert Shiller, Irrational Exuberance, 2nd ed., (New York Doubleday, 2006).
8. See Karl Beitel "Did Overzealous Activists Destroy Housing Affordability in San Francisco?" Urban Affairs Review 42, no. 5, 741-56.
9. For example, "Home $weet Home," Time, June 13, 2005; "A Word of Advice During a Housing Slump: Rent," New York Times, April 11, 2007.
10. See John Bellamy Foster, "The Household Debt Bubble," Monthly Review 58, no.l, 1-11, on the rise in household debt.
11. "CSI: Credit Crunch," Economist, October 19, 2007.
12. Gillian Tett, "Sense of Crisis Growing over Interbank Deals," Financial Times, September 5, 2007.
13. The term "revulsion" (also referred to as distress) comes from the work of Kindelberger, and refers to the stage of the credit cycle after the repayments crisis has erupted and lenders are engaged in a frantic rush to hoard funds and build up liquid reserves in anticipation of further bad news. This leads to a refusal to grant new loans, even to creditworthy borrowers. "Crash and Panic" is the final stage of the credit cycle for Kindelberger and is self-explanatory. Charles P. Kindelberger, Manias, Panics, and Crashes (New York: Basic Books, 1987).
14. The two primary tools through which the Federal Reserve has historically fulfilled its function as provider of liquidity and "lender of last resort" are injections and withdrawals of reserves to and from the banking system to maintain the interbank loan rate (e.g., the rate at which banks borrow or lend short-term funds from one another on the wholesale capital market) at the target rate set by the Federal Reserve Open Market Committee, and by making short-term loans available to temporarily overextended banks through the Fed's "discount window."
15. Martin Wolf, "Helicopters Start Dropping Bundles of Cash," Financial Times, December 13, 2007.
16. "The Week That Shook Wall Street," Wall Street Journal, March 18, 2008.
17. The central bank has a balance sheet analogous to that of any other bank, with positions in assets - primarily government issued securities or loans to the private banks - matched on the liability side of its balance sheet by obligations to the private banks to honor their demand for reserves.
18. See "U.S. Housing Market Conditions, 4th Quarter, 2007," Department of Housing and Urban Development, February 2008, http:/www.huduser. org/org/periodicals/ushmc/winter07_1/index.html.
19. "The Subprime Lending Crisis," Report and Recommendation by the Majority Staff of the joint Economic Committee, October, 2007.
20. Carter Dougherty, "U.S. subprime losses may hit $300 billion, OECD estimates," International Herald Tribune, November 22, 2007, http//:www.iht.com;
21. and Martin Wolf, "Going, Going, Gone," Financial Times, March 12, 2008.
22. Vikas Bajaj and Ford Fessenden, "What's Behind the Race Gap?" New York Times, November 11, 2007.
23. Marc Lavioe, "A Primer on Endogenous Credit Money," in Studies in the Modern Theories of Money, Loius-Phillippe Rochon and Sergio Rossi, eds., (Amherst, MA: Edward Elgar, 2004).
24. This statement comes with a critical caveat, namely that if the profit rate in the nonfinancial sector begins to fall, as it appears to have done in the last year, then all bets are off.