“Those who made the laws have apparently supposed, that every deficiency of payment is the crime of the debtor. But the truth is, that the creditor always shares the act, and often more than shares the guilt, of improper trust. It seldom happens that any man imprisons another but for debts which he suffered to be contracted in hope of advantage to himself, and for bargains in which proportioned his own profit to his own opinion of the hazard; and there is no reason, why one should punish the other for a contract in which both concurred.”
Johnson: Idler #22 (September 16, 1758)

http://www.charlierose.com/view/interview/9713

Caution: Professional academics are not treated kindly!!!

The issue that economic crisis will be around in one way or ther other. The bigger the economy and complexity the bigger the crisis will be. It was the turn (once again) of the US at this moment to take the hard hit and loosing its conficence as an almighty empire. If the invencible status is maintained after the crisis by the US another crisis could even hit harder. The world pull for a balance sooner or later.

One way to project a snowball systemic problem is to look for unbalance between wealth creation and amount of efforts. It happened with the Internet bubble where people were selling websites with company profiles as IPO without a business plan, or cash flow. And it just happen now with the housing sector.

First, my understanding is that the crisis was primarily a crisis of confidence and not necessarily a crisis of solvency. Due to the lack of transparency, no institution could be sure what financial condition any other institution was in. They all held toxic assets (subprime mortgage backed securities), but they didn’t know to what extent. Under such circumstances, when the confidence ran out, it became impossible for certain firms (Bear Stearns and Lehman Brothers) to do business. No one would do business with them. No one would provide them short term loans. The fear that they were insolvent became a self-fulfilling prophecy.

If this is correct, then it doesn’t matter that subprime and Alt A loans comprise only 20% of the total mortgages. What matters is that many firms held subprime mortgage backed securities and that these mortgages were beginning to default in large numbers. It became impossible to truly know what was the financial condition of firms which were known to have extensive holdings of these securities.

Second, the fact that prime mortgages are now starting to default may well be a result of the collapse of the subprime market. Surely the crisis of confidence caused by extensive defaults in the subprime market have made the ongoing recession much worse than it would have been. The financial crisis and the recession have led to tightening of credit and high unemployment which has started to affect people holding prime mortgages. If you get layed off and have little savings, you can’t pay your mortgage, whether the mortgage is prime or subprime. I don’t think the recession would be this bad or that there would have been a crisis of confidence in the financial markets absent the large issuance of subprime and Alt A mortgages.

Third, the fact that it took a year from the beginning of the subprime crisis for the financial system to go into toxic shock should not necessarily imply that the subprime market was not the prime factor in this result. This may simply have been the extent of time needed for people to realize how bad things were.

I can believe that there would have been a recession without the existence of subprime mortgages. But I have a difficult time accepting that the financial system would have been so negatively affected without these mortgages.