On Pol­icy Re­forms

The Economic Times - - The Edit Page - TI­MOTHY GEI­TH­NER

Bor­row­ers with “no-doc loans” (with­out proof of in­come) and “liar loans” (with in­flated claims about in­come) and “NINJA loans” (No In­come, No Job, No As­sets) were de­fault­ing in droves. The sec­ond-largest sub­prime lender, New Century Fi­nan­cial, went bank­rupt, while the largest, Coun­try­wide Fi­nan­cial, re­vealed that it was run­ning short on cash. Mean­while, the price of in­sur­ing bonds backed by sub­prime mort­gages against de­fault soared, prompt­ing the rat­ing agency Stan­dard & Poor’s to warn that hun­dreds of those bonds could be down­graded. And two big hedge funds fi­nanced by Bear Stearns — in­clud­ing one called, in­cred­i­bly, the En­hanced Lever­age Fund — col­lapsed af­ter their sub­prime in­vest­ments tanked. The over­heated sub­prime mar­ket was over­due for a cool­ing…. The risk pre­mi­ums that were ris­ing across the sys­tem had been too low for too long, en­cour­ag­ing too much reach­ing for yield. It was an ab­surd sign of the times that “en­hanced lever­age” had be­come a sell­ing point for an in­vest­ment ve­hi­cle, in­stead of a warn­ing; it was like nam­ing a new car model af­ter its faulty brakes. At the Fed’s rate-set­ting meet­ing on Au­gust 7, 2007, I de­scribed the tur­moil in sub­prime as “a nec­es­sary ad­just­ment, a gen­er­ally healthy de­vel­op­ment”. But I also warned the panel that the tur­moil had “the po­ten­tial to cause sub­stan­tial dam­age…through a gen­eral ero­sion of con­fi­dence among businesses and house­holds.”

From “Stress Test: Re­flec­tions on Fi­nan­cial Crises”

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