The Subprime/Securitization Market Panic

A Guide for the Perplexed
Larry Peterson

This article is from the November/December 2007 issue of Dollars & Sense: The Magazine of Economic Justice available at http://www.dollarsandsense.org

Subscribe Now
at a 30% discount.

This is a web-only article. For more coverage of the current financial crisis, see the November/December 2007 issue of Dollars & Sense magazine.

Part One: Subprime Origins
I usually consider the lifting of titles of canonical works of philosophy as highly inappropriate, but I get the feeling that there are enough people out there scratching their heads (and glancing nervously at their 401K statements or even job prospects) about the recent market turmoil that I think I can, in good conscience, use Maimonides’ title as starting point for this discussion. After all, what does the swindling of financially benighted, sometimes greedy, and even gullible American homeowners have to do with collateral used by mysterious funds which promise outsized returns to the incredibly wealthy? And how on earth can developments in these markets cause a bank run (Northern Rock) in England, which hadn’t seen anything similar since the 1860s? Moreover, who are those even more shadowy characters lurking on the horizon-Sovereign Wealth Funds and private equity investors to name two-who stand to capitalize on the mess? Having followed the developments closely for the last several months, I shall attempt here to provide some answers to these and related questions.

Let’s start is with the American subprime mortgage market. Not only were developments in this market the ones that, in conjunction with other factors, immediately provoked the crisis; indeed, the methods used by investors and brokers in this sector are good examples of those which have become so prevalent in global finance generally. So, by examining the way subprime mortgages were bought and sold, we will see a pattern which will be, roughly speaking, duplicated in other important markets. In this manner, we will approach the wider phenomenon that has come to be known in the financial press as “securitization.” And we shall see that it is this type of investing that probably had more to do with the crash than the subprime market by itself: it’s arguable that if the US subprime market didn’t set off the crisis, something else would have. And, by extension, it is likely that, if the US or even global economy can manage to dodge this bubble-bursting bullet, the phenomenon of securitization, if unchecked by serious regulatory reform, will lead to the formation of a bigger bubble somewhere else (much as the dot.com bubble-with an obliging Federal Reserve looking on-morphed into the bubble we are dealing with now).

Read more