US policy failures: Who dropped the ball?
US policy failures in the autumn of 2007 were crucial both in letting the financial crisis fester and then spiral out of control, and in a premature, panicky slashing of interest rates that paradoxically aggravated the slowdown severely, writes Charles Dumas.
UNTIL RECENTLY, MOST of us thought financial debt was simply interposed between final borrowers and lenders, and of minor significance in itself. Thus the $2.7 trillion of mortgages (at September 2008 – down from the $3 trillion peak a year earlier) held in vehicles that had issued asset-backed securities were 20% of the 109% of GDP that is financial sector debt.
This seemed like a mere pass-through to the household mortgages held in the ABSs. It was not. The principal chain of potential grief in the banking system has been default on mortgages leading to reduced value of ABSs, knocking on to reduced values of the collateralized debt obligations that are themselves an assemblage of ABSs. Thus from the disastrous 2007 batches of CDOs, triple-A securities are now valued at about 35 cents on the dollar, and triple-B as low as three to four cents. The equity tranche prices are invisible. There are further elaborations of how another recent innovation, credit default swaps, have been written on CDOs and have thus underpinned so-called synthetic CDOs.