Abstract

http://ssrn.com/abstract=1514984
 
 

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Causes of the Financial Crisis


Viral V. Acharya


New York University - Leonard N. Stern School of Business; Centre for International Finance and Regulation (CIFR); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Matthew P. Richardson


New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

May 1, 2009

Critical Review, Vol. 21, Nos. 2 & 3, pp. 195-210, 2009

Abstract:     
Why did the popping of the housing bubble bring the financial system - rather than just the housing sector of the economy - to its knees? The answer lies in two methods by which banks had evaded regulatory capital requirements. First, they had temporarily placed assets - such as securitized mortgages - in off-balance-sheet entities, so that they did not have to hold significant capital buffers against them. Second, the capital regulations also allowed banks to reduce the amount of capital they held against assets that remained on their balance sheets - if those assets took the form of AAA-rated tranches of securitized mortgages. Thus, by repackaging mortgages into mortgage-backed securities, whether held on or off their balance sheets, banks reduced the amount of capital required against their loans, increasing their ability to make loans many-fold. The principal effect of this regulatory arbitrage, however, was to concentrate the risk of mortgage defaults in the banks and render them insolvent when the housing bubble popped.

Number of Pages in PDF File: 16

Keywords: Subprime crisis, capital requirements, regulatory arbitrage, mortgage-backed securities, housing bubble

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Date posted: November 30, 2009  

Suggested Citation

Acharya, Viral V. and Richardson, Matthew P., Causes of the Financial Crisis (May 1, 2009). Critical Review, Vol. 21, Nos. 2 & 3, pp. 195-210, 2009. Available at SSRN: http://ssrn.com/abstract=1514984

Contact Information

Viral V. Acharya (Contact Author)
New York University - Leonard N. Stern School of Business ( email )
44 West 4th Street
New York, NY NY 10012
United States
HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm
Centre for International Finance and Regulation (CIFR) ( email )
Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
New York University (NYU) - Department of Finance
Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
Matthew P. Richardson
New York University (NYU) - Department of Finance ( email )
44 West 4th Street
Suite 9-190
New York, NY 10012-1126
United States
212-998-0349 (Phone)
212-995-4233 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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