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Shadow Banks and the Financial Crisis of 2007-2008

In 'THE BANKING CRISIS HANDBOOK', Chapter 3, pp. 39-56, Greg Gregoriou, ed., CRC Press, 2009

Posted: 20 Mar 2010 Last revised: 29 Dec 2016

Jason C. Hsu

Rayliant Global Advisors; Research Affiliates, LLC; University of California, Los Angeles - Anderson School of Business

Max Moroz

Research Affiliates, LLC

Date Written: November 2, 2010

Abstract

This paper argues that bank runs on the shadow banking system was a significant factor in the spread of subprime losses to the overall financial system. Highly leveraged shadow banks with illiquid assets suffered from the loss spiral effect whereby they were forced to deleverage due to higher margin requirements and falling asset prices. This deleveraging increased margin requirements and reduced asset valuations, thus fueling the next round of the loss spiral. We also show that informational problems, agency issues, the reliance on historical data to estimate future risks, and the lack of a multilateral settlement mechanism contributed to the spread of the financial crisis.

Keywords: Shadow Banking, Financial Crisis, Subprime Crisis

JEL Classification: G10, G14, G20

Suggested Citation

Hsu, Jason C. and Moroz, Max, Shadow Banks and the Financial Crisis of 2007-2008 (November 2, 2010). In 'THE BANKING CRISIS HANDBOOK', Chapter 3, pp. 39-56, Greg Gregoriou, ed., CRC Press, 2009. Available at SSRN: https://ssrn.com/abstract=1574970

Jason C. Hsu (Contact Author)

Rayliant Global Advisors ( email )

Hong Kong

Research Affiliates, LLC ( email )

620 Newport Center Dr
Suite 900
Newport Beach, CA 92660
United States

HOME PAGE: http://www.jasonhsu.org

University of California, Los Angeles - Anderson School of Business

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Max Moroz

Research Affiliates, LLC ( email )

620 Newport Center Drive
Suite 900
Newport Beach, CA 92660
United States

HOME PAGE: http://researchaffiliates.com/index.htm

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