lending market and its aftermath reflec

Topics: Subprime mortgage crisis, Mortgage, United States housing bubble Pages: 15 (4741 words) Published: December 12, 2014

lending market and its aftermath reflects K&A paradigm: format should be to explain the KAM model, then identify the initial dislocation triggering the bubble,Describe the Aliber-paradigm. Explain utilizing the housing bubble that has occurred in the past 8 years. Also explain your position on the bubble housing crisis. Describe the stages of the bubble for the aliber-paradigm. Using the paradigm to explain problems in stock market and housing bubble burst.

The Leir Center For Financial Bubble Research

Working Paper #1

THE KINDLEBERGER-ALIBER-MINSKY PARADIGM AND THE GLOBAL SUBPRIME MORTGAGE MELTDOWN William V. Rapp, The New Jersey Institute of Technology, United States, rappw@adm.njit.edu


This paper analyzes the current global financial crisis that originated in the US subprime mortgage market through the lens of the Kindleberger-Aliber-Minsky [KAM] paradigm as set forth in Manias, Panics and Crashes (Kindleberger and Aliber, 2005) to first examine the bubble’s origins in the displacement caused by the Internet collapse, the subsequent US recession, and the aggressive lowering of US interest rates. It shows how these events combined with other technological and regulatory factors resulted in a US housing bubble fueled by the aggressive securitization of mortgages by many large financial institutions, a reduction in their credit standards, and a lack of regulatory oversight. In this way it assesses the prime players in the process in terms motivation and performance.

It then explores how the process peaked and began to unravel as cash flows at the base of the financial pyramid built through securitization slowed. Once the supporting cash flow came under pressure and was questioned several major players went bankrupt or took tremendous losses. It became apparent risk and innovation had been improperly balanced, a prime characteristic of the KAM paradigm. Indeed, greed, innovation, and technology had combined to substantially reduce credit quality and increase leverage, vastly expanding the likelihood of a liquidity crisis and a substantial drop in the value of asset-backed securities. The analysis then examines why this effect had significant global dimensions unlike for example the Japanese real estate and stock market collapse or the US Internet boom and bust. The analysis also shows how market reactions have been in line with what might be expected under the KAM paradigm. It also conforms to what Robert Shiller and Edward Gramlich anticipated and to normal bank behavior in a credit crisis. See Irrational Exuberance (Shiller, 2005) and Subprime Mortgages (Gramlich, 2007).

Finally the paper assesses the policy responses to the crisis and their likely success under a KAM paradigm analysis. The proposed remedies already include the aggressive fiscal and lender of last resort monetary responses typical of the KAM paradigm but regulatory measures too. Further, as KAM notes almost all booms and crashes involve scandals and scams. So not surprisingly there has been growing recourse to the courts seeking criminal and civil remedies. Also typical of such a dramatic boom and bust governments are examining regulatory and legislative actions to address the current difficult economic and credit situation and to make sure similar things do not occur in the future. But politics and a US presidential election are driving significant differences in approach. Under these circumstances what can the lens of KAM paradigm tell us about the actions taken or proposed and what is or is not likely to work.

The paper’s argues the bubble paradigm explained in Manias, Panics and Crashes (Kindleberger and Aliber, 2005) applies to all aspects of the subprime mortgage crisis from development of the bubble through the legal, economic and political aftermath. Indeed any reasonable application of the paradigm should have raised early warnings about the housing...

Citations: Countrywide Financial Corporation, Annual Report 2006, 2007, page 3.
Federal Reserve Bank, 2007 data available at https://www.federalreserve.gov/datadownload/Review, page 2.
Gramlich, Edward, Subprime Mortgage Crisis, Urban Institute Press, Washington, DC, 2007, pages 1, 3 & 5.
Kindleberger, Charles and Robert Aliber, Manias, Panics and Crashes, Wiley, 2005, page 1.
Korngold, Gerald and Paul Goldstein, Real Estate Transactions, Foundation Press (2002), page 2.
Rapp, William, “Civil Causes Of Action And The Sub-Prime Mortgage Meltdown ,” working paper, 2008, available from rappw@adm.njit.edu, page 4.
Rapp, William, Information Technology Strategies, Oxford University Press (2004), page 2.
Shiller, Robert, Irrational Exuberance, Currency Doubleday, NY, 2005, pages 1 & 5.
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