The "Alchemy" behind the Financial Crisis

**Chapter 4**

**Abstract**

Political and Institutional

Asset securitization has been identified as an alchemy that 'really' works. Asset securitization yields a number of benefits to a financial system inter alia by reducing overall interest rates, enhancing liquidity in the banking sector and reducing intermediary costs. Yet, the recent global financial crisis (GFC) questioned the very existence of asset securitization. However, post-GFC literature is not hesitant to identify a list of causes that may have facilitated the GFC including subprime lending, executive compensation, de-regulation, etc. Adopting a lexonomic approach, this discussion deviates from the traditional approach by focusing on identifying political and institutional factors behind the GFC. This chapter will investigate U.S political economic decision and then U.S institutional setup that may

**Keywords:** asset-securitization, global financial crisis, asset-backed-securities

and particularly in residential areas housing concentrations of 'sub-prime'

<sup>1</sup> Often referred as subprime borrowers who, under normal lending criteria, would have been refused

This chapter provides a contextual background to those that follow by describing the GFC and its salient characteristics, and identifying salient causes of the crisis. Once these salient causes have been identified, the thesis proceeds to investigate the extent of the role, if any, that economics and political mechanisms underlying securitization may have had in facilitating the GFC. Financial economists generally trace the beginnings of the GFC to approximately mid-2007, when a number of key mortgage lenders specialising in sub-prime housing loans experienced financial distress. For a number of reasons, banks and other mortgage originators had, in the years preceding the GFC, been able to lend home loans to lowto-mid-income borrowers<sup>1</sup> This practice, and the securitization arrangements based on it, would generally not have proved problematic if house prices throughout the United States had continued to appreciate as they had under speculative boom conditions. Problems arose, however, when the U.S. housing boom burst in 2006,

Dynamics of the Global

Financial Crisis

have facilitated the stage for a GFC.

**1. Introduction**

borrowers.

**57**

loans (eg. because of poor credit histories).

*Shanuka Senarath*
