Working Paper #674
Anatomy of a Crisis
Bowen H. McCoy
Borrowing Constraints Commercial Brokerage Foreclosures Mortgages Political Risk United States
The financial crisis was a systemic breakdown caused by fraudulent mortgage brokers, fraudulent borrowers, uninformed homebuyers, speculative buyers who owned as many as a dozen homes with no equity and who counted on continually rising prices, overly aggressive Wall Street firms, undisciplined conduits, politically motivated legislators and regulators, politically induced relaxation of mortgage lending standards, overwhelmed and often conflicted rating agencies, and buyers of securitized mortgage debt who did not perform adequate due diligence. The key to a smoothly operating global financial market is trust in the system. The author argues that the current economic crisis is a basic principal/agency problem. When trust evaporates overnight, significant if not major financial firms find it impossible to fund their operations, and are exposed to insolvency.