As subprime borrowers began to default on their mortgages, the value of assets backed by these loans declined, resulting in substantial losses on the balance sheets of many financial institutions in the United States and across the globe. However, as many have noted, these losses were too small to account for the crisis that followed.2 Therefore, a central challenge in the aftermath has been to understand how relatively small losses within the financial sector could be propagated and amplified to the rest of the economy.
This article appeared in the Fourth Quarter 2013 edition of Business Review. Download and read the full issue.
- For a detailed description of this sequence of events, see the accounts by Gary Gorton or Markus Brunnermeier.
- For example, as Tobias Adrian and Hyun Shin argue, the total value of outstanding adjustable rate subprime mortgages in 2008 was less than $1 trillion. Therefore, even if an unprecedented number of households defaulted on these mortgages, total subprime losses would still have been equal to just a small fraction of the decline in the total market value of publicly traded companies that occurred between October 2007 and March 2009, which was about $30 trillion.