In the past nine months the global credit market
saw a “flight from uncertainty” that dislocated market liquidity,
caused enormous writedowns across asset classes and geographies, panic
interest rate cuts in the US, and the fall of Bear Stearns, the once
fifth-largest US investment bank.
The speed, severity, and magnitude of the turmoil
that has swept through the financial markets in the past nine months has
taken many market participants by surprise. What started as a US subprime
mortgage crisis has turned into a global credit crunch. The turn of events
was breathtaking. In a new report, Pathology of the US Mortgage Crisis,
Celent attempts to explain how the US subprime crisis precipitated a major
global economic downturn by providing answers to the following questions:
- What actually happened?
- Why did it happen?
- How will the US mortgage industry change?
At the core of the recent turmoil is an altered
mortgage business model. With the remarkable growth in securitization, the
simple “originate and hold” model has evolved to incorporate an
alternative and more complex “originate to distribute” model. The
incentives in this model have encouraged large-scale production of low
quality mortgages. Diffuse distribution of risk followed in this context,
as credit risk was removed from the originating institutions and dispersed
via the capital markets in the form of risk-bearing securities. The
fragility of this system became evident as the drop in US house prices
precipitated high default levels among over-leveraged borrowers, Exposure
to the these losses was transmitted partly via the securitization market
to financial institutions around the world.
