Hellwig Crisis Essay

8100 Words Nov 13th, 2014 33 Pages
Focus

THE CAUSES OF THE FINANCIAL CRISIS1
MARTIN HELLWIG*
Introduction For the media in Germany, the cause of the financial crisis is obvious: Blinded by greed, bank managers thought only about their bonuses and miscalculated badly in betting on American subprime mortgages when the very name of these securities should have alerted them to their risks. If an economist suggests that the matter might be more complicated, he is denounced as a homo exculpans, a person who will excuse anything that managers do.2 If we look at the numbers, however, we see that there is something more to be explained. According to the Global Financial Stability Report of the International Monetary Fund (IMF) of October 2008, losses on non-prime
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2 Frankfurter Allgemeine Zeitung, October 27, 2008.

too large in the sense that it cannot be explained by anticipations of losses in debt service from these securities. According to the IMF’s Global Financial Stability Report, the volume of non-prime mortgages that have been securitized amounts to about 1.1 trillion dollars. Losses of 500 billion dollars would correspond to a loss rate of 45 percent on these mortgages. If the debtor’s down payment amounted to 5 percent, a loss rate of 45 percent on the mortgage would correspond to a depreciation of the property by more than 50 percent. In actual fact, residential-real-estate prices in the United States on average have declined by 19 percent from their peak in the summer of 2006 to the summer of 2008; across metropolitan areas, the maximum for this period was just below 33 percent (Phoenix, Tampa, Miami). To be sure, this “back-of-the-envelope” calculation neglects correlations; it also neglects the possibility that the decline of real-estate prices is still going on. However, this calculation also neglects the fact that, in actual fact, average down payment rates were 6 percent for subprime and 12 percent for “Alt-A”, or near-prime, mortgages, and that about two thirds of these mortgages had been granted before 2006, at times when real-estate prices were significantly below their subsequent peaks. The IMF’s loss estimates are not actually based on projections of debt service on subprime mortgages. They are based on

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