Questions and Answers About the Financial Crisis - Prepared for the U.S. Financial Crisis Inquiry Commission

17 Pages Posted: 23 Feb 2010 Last revised: 16 Mar 2010

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: February 20, 2010

Abstract

All bond prices plummeted (spreads rose) during the financial crisis, not just the prices of subprime related bonds. These price declines were due to a banking panic in which institutional investors and firms refused to renew sale and repurchase agreements (repo) - short‐term, collateralized, agreements that the Fed rightly used to count as money. Collateral for repo was, to a large extent, securitized bonds. Firms were forced to sell assets as a result of the banking panic, reducing bond prices and creating losses. There is nothing mysterious or irrational about the panic. There were genuine fears about the locations of subprime risk concentrations among counterparties. This banking system (the “shadow” or “parallel” banking system) ‐ repo based on securitization ‐ is a genuine banking system, as large as the traditional, regulated and banking system. It is of critical importance to the economy because it is the funding basis for the traditional banking system. Without it, traditional banks will not lend and credit, which is essential for job creation, will not be created.

Suggested Citation

Gorton, Gary B., Questions and Answers About the Financial Crisis - Prepared for the U.S. Financial Crisis Inquiry Commission (February 20, 2010). Available at SSRN: https://ssrn.com/abstract=1557279 or http://dx.doi.org/10.2139/ssrn.1557279

Gary B. Gorton (Contact Author)

Yale School of Management ( email )

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P.O. Box 208200
New haven, CT 06511
United States

HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml

National Bureau of Economic Research (NBER)

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