Chapter

Dynamics of the Financial Crisis

Thomas H. Stanton

in Why Some Firms Thrive While Others Fail

Published in print July 2012 | ISBN: 9780199915996
Published online September 2012 | e-ISBN: 9780199950324 | DOI: http://dx.doi.org/10.1093/acprof:oso/9780199915996.003.0002
Dynamics of the Financial Crisis

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Chapter 2 provides background on the financial crisis and how it evolved. There was an inflow of funds into the United States that compressed returns on investments. This made more risky investments attractive, such as subprime mortgages, on which borrowers paid higher interest rates than prime borrowers. The chapter describes the financial crisis as a two-step process. When housing prices began to decline and losses appeared in securities labelled AAA, and in derivative securities based on them, this threatened major firms that had greatly increased their leverage over the period. Firms became uncertain about their solvency and also about the solvency of counterparties that held these securities. The result was panic and an unwillingness of financial firms to provide credit to one another. Only massive government intervention saved the economy from another Great Depression.

Keywords: government intervention; risky investments; housing prices; subprime mortgages; mortgage securities; counterparties

Chapter.  9913 words.  Illustrated.

Subjects: Financial Markets

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