Working Paper: NBER ID: w15787
Authors: Gary B. Gorton
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.
Keywords: No keywords provided
JEL Codes: G01; G1; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banking panic starting in August 2007 (G21) | significant decline in bond prices across various asset classes (G10) |
| banking panic (G21) | forced asset sales by firms (G32) |
| forced asset sales by firms (G32) | fire sales that further depressed bond prices (G10) |
| banking panic (G21) | refusal to renew repo agreements (E49) |
| refusal to renew repo agreements (E49) | liquidity crisis in the banking system (F65) |