Structured Finance and the Financial Turmoil of 2007-2008: An Introductory Overview

43 Pages Posted: 2 Sep 2008

See all articles by Sarai Criado

Sarai Criado

Banco de España - Department of International Economics & International Relations

Adrian Van Rixtel

Banco de España - Department of International Economics & International Relations

Date Written: August, 29 2008

Abstract

This paper provides an overview of the most important structured finance instruments in the context of the development of the financial turmoil that started in the third quarter of 2007 and continued into 2008. These financial market tensions were triggered by concerns about exposures of financial institutions to the most risky segment of the US mortgage markets - the so-called subprime mortgage market - and related financial instruments, which predominantly were related to structured finance. As structured finance has developed very fast in recent years and often involves highly complex financial instruments and techniques, which may not be understood completely beyond a small circle of financial market experts, the aim of this paper is to provide an introduction to these instruments that may serve to better understand the specific characteristics of the financial turmoil. In this context, the paper proposes a specific classification of structured finance and discusses both securitizations and credit derivatives with the aim of explaining their specific contributions to the development of the financial turmoil. To this extent, the paper differentiates between two main categories of structured finance instruments. The first one played an important role in the initiation and propagation of the turmoil and includes mortgage-backed securities (MBS), asset backed commercial paper (ABCP) and collateralized debt obligations (CDOs), both cash flow and synthetic. The second category of structured finance instruments involves those that have been more instrumental in monitoring the crisis, both for market participants and policymakers. The main instruments here are credit default swaps (CDS), of which examples are presented for both single name and index contracts. Finally, the paper provides an overview of the specific contagion channels involving various structured finance instruments. This will be conducted on the basis of examples for hypothetical financial institutions that are nevertheless representative for real world developments such as they occurred in the course of 2007 and 2008.

Keywords: financial turmoil, financial markets, financial institutions, structured finance, securitization, credit derivatives

JEL Classification: G10, G15, G21, G24

Suggested Citation

Criado, Sarai and Rixtel, Adrian Van, Structured Finance and the Financial Turmoil of 2007-2008: An Introductory Overview (August, 29 2008). Banco de Espana Occasional Paper No. 0808, Available at SSRN: https://ssrn.com/abstract=1260748 or http://dx.doi.org/10.2139/ssrn.1260748

Sarai Criado (Contact Author)

Banco de España - Department of International Economics & International Relations ( email )

Alcala 50
Madrid, 28014
Spain

Adrian Van Rixtel

Banco de España - Department of International Economics & International Relations ( email )

Alcala 50
Madrid, 28014
Spain

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