Credit Crises: From Tainted Loans to a Global Economic Meltdown

The subprime crisis marked the end of an almost five-year long period of prosperity in financial markets. At the beginning of the crisis, the majority of market participants believed in a geographically limited impact on some specific segments; during the course of 2007 it became obvious that the subprime turmoil would reach the status of a fully fledged credit crisis. This put one of the most challenging topics back on the agenda of investors and monetary authorities, as well as academics: what are the transmission mechanisms during crises, how high are the related costs, and the question of whether crises are cyclical phenomena that hit the market from time to time. The authors try to find answers to these questions and show that there are many similarities between the credit crises that financial markets have experienced in the past. However, there are also some specific elements which occur during a crisis. In this book, the characteristics of the subprime crisis are described in detail to show the mechanism behind credit crises in general, especially the transmission mechanisms of so-called second-and third-round effects.

The book includes a comprehensive overview of the players in the credit market and the strategies implemented by these players, with a focus on the establishment of new vehicles (like Special Investment Vehicles (SIVs)) and innovative instruments, primarily out of the structured credit and credit derivatives universe. The book also includes an overview of historical credit crises, as this analysis is necessary to understand the basic mechanism behind crises, which is a prerequisite to discussing potential solutions. This brings us to a key wisdom with respect to financial market distortions: the question of how to avoid credit crises in the future.