Working Paper: NBER ID: w14398
Authors: Gary B. Gorton
Abstract: Understanding the ongoing credit crisis or panic requires understanding the designs of a number of interlinked securities, special purpose vehicles, and derivatives, all related to subprime mortgages. I describe the relevant securities, derivatives, and vehicles to show: (1) how the chain of interlinked securities was sensitive to house prices; (2) how asymmetric information was created via complexity; (3) how the risk was spread in an opaque way; and (4) how trade in the ABX indices (linked to subprime bonds) allowed information to be aggregated and revealed. These details are at the heart of the origin of the Panic of 2007. The events of the panic are described.
Keywords: subprime mortgages; financial crisis; ABX indices; securitization; asymmetric information
JEL Codes: G1; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| declining house prices (R31) | increased financial instability (F65) |
| complexity of financial instruments (G19) | panic among investors (E44) |
| ABX indices (C43) | revelation of information about subprime risk (G21) |
| ABX indices (C43) | panic among investors (E44) |
| complexity of financial instruments (G19) | obscured true risks (D81) |