The generation and transmission of the current international financial crisis

[Summary of content] A storm caused by the crisis in the US subprime mortgage market has swept through the world's major financial institutions such as the United States, the European Union and Japan. Market, this article further analyzes on the basis of existing research why the crisis has such a large impact on subprime debt with a small asset scale. On the one hand, the rapid development of derivatives CDOs generated by financial innovation has led to the decentralization of risk holders and the globalization of the financial market, which has increased the contagion and impact of risks, causing the crisis to gradually spread to all parts of the world; on the other hand, credit Rating agencies distort the ratings of structured finance products, further amplifying financial risks. At present, my country's property market is booming, house prices are rising, the mortgage market is growing, inflation is high, and interest rates are rising. These are all very similar to the financial background before the subprime mortgage crisis in the United States. We must take warning and take precautions before they happen.

[Keywords] Financial crisis, subprime mortgages, securitization, liquidity

The crisis caused by U.S. subprime housing mortgages that began in March 2007 The international financial crisis has been going on for nearly a year. The causes, manifestations, governance and impact of this crisis on China have attracted the attention of academics and industry insiders. Many people have written articles and expressed their opinions, but some issues require further discussion and analysis: For example, why are subprime housing mortgage loans issued? What caused the crisis for such loans? Why did the crisis spread to subprime debt with a small asset scale? The scope is so vast, this article attempts to explore these aspects.

1. Background of the crisis

(1) Why are subprime housing mortgage loans issued?

1. There are three types of housing mortgage loans in the United States, subprime Home mortgages are just one of them. In the United States, mortgage loans are divided into prime, subprime, and subprime mortgages based on the borrower's credit conditions and the ratio of the loan to the asset value. Subprime home loans are mainly for those with poor credit records, missing income certificates, and large debts. Provide high-risk, high-yield loans to serious customers. The average credit score of this type of borrower is more than 100 points lower than that of borrowers with ordinary loans, and the loan interest rate is usually 2%-3% or more higher than that of prime mortgage loans.

Subprime housing loans mainly have floating interest rates. Among ARMs, the "2/28" type hybrid ARM (fixed interest rate for the first two years and an additional interest rate on the basis of 6-month LIBOR after two years) (regularly adjusted interest rate at a certain premium) accounted for 83%. Borrowers can also choose other types of ARMs. For example, they can choose a repayment method with interest-free or low interest in the early stage, high interest in the middle and later stages, or a repayment method that only repays interest in the early stage and does not repay the principal. Diversified innovative products allow borrowers to bear only a low repayment amount in the early stage. However, once the interest rate is reset or the principal is recalculated a few years later, the monthly interest payment may increase by 50% or more, and the repayment pressure will increase sharply. . As loan repayments are deferred, financial risks are more likely to accumulate.

2. Reasons for the issuance of subprime loans. In the United States, subprime mortgage loans only account for a small part of the total residential mortgage loans, about US$130 million, accounting for 10% of the entire residential mortgage loans, but they cover a wide range of areas. Here, it is worth pondering: Why are financial institutions keen on such loans? In summary, there are four main reasons: (1) Since 2001, the Federal Reserve has implemented a low interest rate policy. After the "911" terrorist attacks, the Federal Reserve adopted a rapid interest rate reduction policy. Short-term interest rates were reduced from 6.5% to 1.75% in just one year, falling to the lowest level in 40 years. The low interest rate policy has made the cost of higher-priced subprime mortgage loans quite low, and a large number of home buyers with low credit ratings have used subprime mortgage loans to purchase houses. (2) House prices in the United States have risen strongly. The Bush administration used low interest rates coupled with tax cuts to encourage people to buy houses. From 2000 to 2006, house prices across the United States rose by 80%, the highest increase in history. Because the yield on subprime mortgages is higher than that on prime loans, even if the default rate is high, as long as house prices rise, the collateral can be confiscated in the event of default and the principal and interest of the loan can be recovered through auction. Therefore, rising housing prices have strongly supported the issuance of subprime mortgage loans. Borrowers can relieve repayment pressure through refinancing and achieve risk-free arbitrage. Excessive lending has led to the escalation of the real estate market bubble. (3) These loans issued can be securitized. Securitization can transfer the potential high risks of financial institutions. Driven by huge profits and intensified competition, lending institutions only focus on promoting subprime mortgage products, while intentionally ignoring the steps of explaining risks to borrowers and confirming the borrower's repayment ability. Federal Reserve data show that subprime loans accounted for 20% of all residential mortgage loans from 5% in 2006. Some lending institutions have even launched "zero down payment" and "zero documents" loan methods. The relaxed loan qualification review abandons the first source of repayment emphasized in the credit process - the borrower's solvency, and relies only on the mortgage value of the real estate. , resulting in the continuous accumulation of loan default risks. (4) Securitization continues to introduce new financial instruments to meet market demand. Repeated derivatives and leveraged transactions of asset-backed securities satisfied market demand, but at the same time passed risks to investors around the world, contributing to the crisis.

(2) Subprime housing mortgage loans promote the creation of financial derivatives

1. The design of collateralized debt obligation derivatives (CDO).

A securitization product directly related to real estate subprime mortgages is real estate loan-backed securities, which package a series of real estate mortgage loans and issue securities to the secondary market. Similar to traditional MBS, but with credit enhancement designed through its own structure. Most subprime mortgage loan companies lack sales outlets, use brokers as their sales channels, do not accept deposits, rely on the secondary market for loans and securitization of credit assets to obtain liquidity, and obtain funding sources through the sale of asset-backed securities. After the investment banks of the underwriters purchase the ABS, they issue collateralized debt obligations (CDO) based on the cash flow in the asset pool. CDO is both an asset-backed security and a structured financing product. It can obtain cash flow from a fixed income asset pool and transfer the cash flow obtained to investors through different "series" according to its own unique structure. , CDO is a tool that redistributes credit risks in asset pools. CDOs obtain a pool of assets and issue a series of securities with different credit qualities. According to the repayment level, it is divided into high-level series, intermediate series and secondary series. Each "series" of credit ratings will receive a different credit rating in turn. Some CDOs also have equity series, which are usually not publicly issued and do not receive credit ratings. They are mostly bought back by the issuer themselves as credit support for other series. Once a loss occurs, it will be absorbed first by the equity series, and then by the secondary series, intermediate series (level B and above), and senior series (level A and above), so the senior "series" will be protected by the intermediate and secondary series. The income generated from the assets held by the CDO will first repay the senior series. If there is any remaining, it will be repaid in the order of intermediate and subordinate series. The asset portfolio of a CDO is different from the general ABS asset portfolio. The various assets in the general ABS asset portfolio are homogeneous, while the CDO asset portfolio is very dispersed and includes structured products such as ABS, MBS, junk bonds, A diversified portfolio of high-risk fixed income assets such as emerging market bonds and bank loans. This design can ensure that when the CDO assets do not encounter credit problems, the secondary series and equity series will be able to obtain excess returns.

2. The diversification of trading varieties brings continuous innovation of CDO products. Innovate synthetic (CDO) based on credit default swaps (CDS): Synthetic CDO does not directly own a portfolio of fixed-income assets, but provides cash flow to the CDO by acting as the seller of a credit risk swap contract. By signing a CDS contract, the sponsor regularly pays premiums in exchange for credit insurance, and in the event of a default, receives full or partial compensation. As the seller of CDS, the CDO can receive regular insurance premiums, but must also bear the losses caused to CDS assets when specific credit events occur. Losses are borne from the lowest level upwards. When the CDO obtains the initial investment from investors, it will directly invest the initial investment in a high-quality fixed asset pool to ensure sufficient cash flow once the CDS needs to pay out compensation.

(3) Why are CDOs, derivative products generated by financial innovation, favored by investors?

This issue can be summarized as the following points: (1) Packaged bond issuance, comprehensive value foundation, downplaying the degree of risk; (2) through bankruptcy isolation, claims can be protected; (3) operating costs are low and returns are relatively high; (4) intermediary structures participate in operations and enhance credit ratings. Structured credit enhancement and diversification of asset pools eliminate the need for investors to have detailed knowledge of the credit risk information of underlying loans and can navigate based on standardized credit ratings.

Because senior CDOs have the highest rating of AAA, in the context of excess global liquidity, due to historically low default records and relatively high long-term fixed yields, buyers are mostly large-scale investments. Funds and foreign investment institutions, including many retirement funds, insurance funds, education funds and various government-managed funds. For "intermediate CDOs" and "subordinated CDOs", investment banks set up independent hedge funds and then "split" the CDOs from their balance sheets to independent hedge funds. Due to the low interest rates and rapid rise in housing prices in the United States in recent years, the credit market has been loose. Subprime lenders can easily obtain funds and even maintain monthly payments by borrowing new debt to repay old debt. The delinquency rate of subprime loans is far lower than Original estimate.

The turnover in the CDO market is very low and there is no high risk. Because of the lack of reliable price information reference, the US regulatory authorities allow hedge funds to use internal mathematical model calculation results as asset evaluation standards, making CDO hedging The fund has achieved a huge high rate of return, attracting more and more investors to request purchases, and a large amount of money has poured in. Hedge funds have become the fastest money-making machine for investment banks. On the other hand, the basic characteristics of hedge funds are high-risk and high-leverage operations. Hedge fund managers require commercial banks to use CDOs as collateral for mortgage loans. As long as there is an AAA rating, coupled with the high rate of return of CDO, clearing banks accept the collateral of hedging transactions, include them as pledgeable securities, and issue loans to continue to create bank money, the leverage ratio of hedge funds' mortgage loans to banks can reach 5-15 times. Even higher. At this time, the banking system has already used part of the underlying mortgage debt of the same mortgage to distribute funds for the Nth time. The default risk of the subordinated debt is derived N times and returns to the banking system in an amount amplified dozens of times.

In the period of low interest rates and rising housing prices, everyone in the chain can benefit, and CDOs are greatly favored and sought after: investors on the far left enjoy the pleasure and satisfaction of owning a home, and can enjoy Refinancing opportunities brought about by rising house prices; investors holding CDO high credit rating series have received higher returns than bonds with similar credit ratings; hedge funds holding CDO subordinated bonds have received excess interest because there is no A large number of borrowers defaulted on their loans, disrupting cash flow; the financial institutions that managed CDOs held the equity series themselves, taking advantage of the interest rate difference between CDO asset income and CDO liability interest.

Because CDO issuance is flexible and fast, and products can be used to design bond series with different credit risks to meet the needs of investors with different risk preferences, it has grown very rapidly and has now become a means of financing, hedging and various types of debt. The leading tool for trading. According to data provided by the financial market: from 2004 to 2006, the global CDO market issuance scale was US$157 billion, US$249 billion, and US$489 billion. By the end of 2006, hedge funds accounted for 10% of the bond holders of subprime mortgages, pension funds accounted for 18%, insurance companies accounted for 19%, asset management companies accounted for 22%, and the rest were foreign investors. Hedge funds, banks and other institutions use high leverage ratios for financing in CDO and other derivatives transactions, which amplifies the risks in the financial market and puts trading positions at a critical point sensitive to interest rates and housing prices. Once the macroeconomic conditions are reversed, there will be crisis, causing a series of chain reactions.

2. Reasons for the crisis and transmission mechanism

(1) Reasons for the crisis

1. Continuous interest rate hikes have aggravated the anxiety of home buyers. Loan repayment burden. From June 2004 to June 2006, the Federal Reserve raised interest rates 17 times in a row, and the benchmark interest rate was raised from 1% to 5.25%, which led to continuous increases in subprime mortgage interest rates, which are mainly floating interest rates, especially in 2004 and 2005. The subprime mortgage loan contracts issued entered the interest rate reset period in 2006 and 2007. Interest rates increased sharply (increased by 50% or more), late payments and defaults began to occur, and the proportion of delinquent debt and the foreclosure rate rise.

2. The real estate market continues to cool down after the expansion, resulting in a decline in the credit quality of mortgage loans. Since 2006, the U.S. real estate market has gradually cooled down. Once there is an expectation of price reductions in the entire housing market, it will be difficult for borrowers to sell their homes or obtain new financing through mortgages, and the value of the homes may also fall to a level that is not enough to repay the remaining loans. situation.

3. The savings rate of U.S. residents is seriously insufficient and they have no risk resistance. The personal savings rate in the United States has declined sharply and continuously in the past 30 years. Especially in recent years, Americans advocate consumption and have almost no savings, resulting in them having no risk tolerance at all.

4. Derivatives such as CDOs based on subprime housing loans have insufficient liquidity. Derivatives such as CDOs derive many products based on the same underlying asset. When the underlying asset faces credit risk, a chain reaction will occur. CDOs and other products are highly personalized products that are traded in various institutions through the OTC market. Their liquidity is very poor, and it is difficult to obtain reasonable consideration in the case of forced sales. Investors rely on complex derivatives such as credit default swaps (CDS) to manage and hedge risks. These innovative instruments are also very illiquid and lack a transparent market for continuous transactions to price them. They can only rely on theoretical models and artificial parameters to determine prices. When the assumptions do not hold true, significant losses may occur due to model errors. Instead of weakening the risk, it actually aggravates the crisis.

5. Credit rating agencies distort the ratings of structured finance products, which expands financial risks. Rating agencies not only assess credit risks, but also participate in the construction of structured financing products, which can easily lead to conflicts of interest. Structured financing products have complex structures and have been combined and layered many times. They have low transparency and lack of historical data, which affects the independence of ratings. 90% of the revenue of rating agencies comes from rating fees paid by issuers. In order to contract more business, they are motivated to give higher ratings to structured finance products. About 75% of all subprime loan bonds are rated AAA, 10% are rated AA, another 8% are rated A, and only 7% are rated BBB or lower. The actual situation is that the subprime loan default rate reached 14.44% in the fourth quarter of 2006, and increased to 15.75% in the first quarter of 2007. Investors mainly rely on the ratings issued by rating agencies to make decisions. Once a rating agency makes a rating error or downgrades a CDO, it will trigger credit risks, cause a new round of market selling, and expand the crisis.

(2) Transmission of the crisis risk mechanism

The first wave of impact was some subprime real estate financial institutions that did not accept public deposits and had low capital adequacy ratios. Since real estate financial institutions cannot securitize all mortgage loans, they must bear the cost of default on unsecuritized claims that remain on their balance sheets. Nationwide Financial Corporation (CFC), the largest mortgage bank in the United States, saw its revenue drop sharply by 33% in three months, while New Century Financial Corporation, the second largest subprime debt provider in the United States, was unable to repay US$8.4 billion in liquidity debt. In April 2007, it applied for Bankruptcy protection has created a domino effect, with a large number of subprime debt providers going bankrupt or filing for bankruptcy protection.

The second wave of impact was hedge funds and investment banks that purchased ABS and CDOs with lower credit ratings. Rising mortgage defaults have resulted in holders of intermediate- or equity-grade MBS and CDOs being unable to receive principal and interest payments on time, causing the market value of these products to shrink, thereby deteriorating the balance sheets of hedge funds and investment banks. Once a hedge fund's investment portfolio suffers serious losses, the hedge fund will face redemption pressure from investors, early loan recovery pressure from commercial banks, and margin calls from intermediary structures. As a result, the hedge fund will be forced to sell high-quality assets or even go bankrupt and dissolve. After the crisis broke out, the subordinated bonds pledged in hedging transactions suddenly lost their liquidity and were downgraded from AAA to "junk bonds". Securities clearing banks had to forcibly liquidate their positions. At this time, the fund would suffer huge losses or even go bankrupt. At present, A large number of hedge funds have announced that they will stop redemptions or are on the verge of disbanding. This is represented by the hedge funds of Bear Stearns and BNP Paribas. On August 5, 2007, Bear Stearns, the fifth largest investment bank in the United States, announced that its Senior Structural Credit Fund and Senior Structural Credit Enhanced Leverage Fund had filed for bankruptcy protection. Investment The losses exceeded US$1.5 billion. As of August 11, Goldman Sachs Group's largest Global Alpha hedge fund has fallen by 26%, and investors have withdrawn 40% of their capital.

The third wave of impact is insurance companies, mutual funds and pension funds, commercial banks, etc. that purchase ABS and CDOs with higher credit ratings. In the face of a series of negative news about hedge funds being unable to repay, the market has begun to worry about the risks of senior securities due to the opacity of hedge funds' information, which prevents the market from clearly judging the scope and scale of losses suffered by hedge funds in this impact. On July 10, 2007, Moody's announced that it had downgraded the credit ratings of 399 subprime mortgage bonds, involving an amount of US$5.2 billion. Standard & Poor's downgraded 612 subprime loan-related securities of approximately US$12 billion, and Fitch lowered the ratings of 200 subprime-backed bonds of approximately US$2.3 billion, marking a further shift in the risk of subprime mortgage loans to those with high credit ratings. Graded pension fund and insurance fund pass-through. Since such institutions have strict investment standards and cannot invest in bond varieties below a certain level, as the credit rating of the corresponding varieties in the portfolio decreases, they have to sell them for cash. The CDO market is an over-the-counter market. As a large number of investors Portfolio adjustments and reductions in holdings have led to a sharp decline in the prices of such securities, which in turn has led to floating losses in the net value of the funds of investors holding such securities, and they have demanded redemption of the funds. In response to investor redemptions, the corresponding funds were forced to further meet their liquidity needs by liquidating assets in other markets, which triggered significant fluctuations in a series of markets that were not directly related to the bond market, such as the stock market and commodity market. In order to avoid greater losses caused by liquidating related assets in the current market environment, individual funds have even stopped valuing the fund's net worth and rejected investors' redemption applications. In July 2007, two funds of the French financial insurance company AXA shrank by 13%, and the monthly assets of another bond fund shrank by 40%. On August 10 of the same year, three funds under BNP Paribas that invested in ABS could not be reasonably valued and stopped subscriptions and redemptions. Deutsche United Investment Management Company and Frankfurt Trust also stopped redemptions of similar funds. Originally limited to internal problems in the United States, they began spread to Europe and even the world. The crisis further affected the commercial paper market, corporate bond market, stock market, commodity futures and foreign exchange market. The market's tendency to avoid risks is at an all-time high, and the new bond issuance market has shrunk severely. Many banks have a large backlog of bonds that they cannot sell, with an estimated total value of more than 200 billion US dollars. The corporate bond market and commercial paper market are sluggish, and corporate financing costs have increased. The subprime mortgage problem in the United States triggered a credit crisis. Investors began to worry about whether the credit problem would turn into an overall economic market crisis. They sold stocks and held cash. This led to violent fluctuations in the U.S. stock market. The Dow Jones Industrial Index fell nearly 400 points. At the same time, Asia-Pacific stock markets also suffered heavy losses as a result. Global stock markets plummeted, quickly affecting the commodity futures and foreign exchange markets. Metal crude oil futures and spot gold prices plunged sharply. International foreign exchange market carry trades flattened on a large scale. The risk of the subprime mortgage crisis itself gradually evolved into Systemic risk.

3. The effectiveness and limitations of central bank bailouts

Because financial institutions do not understand each other’s losses on subprime mortgages and are worried that the other party will default due to liquidity difficulties, The willingness to lend funds in the market is low and the supply of funds in the inter-bank market is insufficient, causing sharp fluctuations in short-term lending rates. On August 9, 2007, interest rates in the inter-bank market suddenly rose sharply, with USD LIBOR rising from 5.35% to 5.86% and Euro LIBOR rising from 4.11% to 6%. The global fixed income product market and stock market fell sharply, credit tightened, and the liquidity crisis spread to Australia, Europe and even the world, forcing central banks of various countries to urgently inject funds to rescue the market. The Federal Reserve even lowered the discount window interest rate by 50 basis points.

(1) The effectiveness of central banks’ injection of base currency to rescue the market

Many central banks have injected capital into the market, indicating a high degree of vigilance against financial market turbulence. This is the case for major developed economies in the past six years. For the first time, the monetary authorities simultaneously took measures to provide an "emergency blood transfusion" to the financial market. With the help of massive capital injections, the stock market stopped falling, U.S. and European banks basically weathered short-term difficulties, and overnight lending rates in the interbank market returned to pre-crisis levels.

However, the central bank's actions to rescue the market have occurred frequently, the number of interventions has increased significantly than in the past, and the effect of intervention has significantly declined.

(2) Limitations of central banks in various countries’ injection of base currency to rescue the market

First of all, injection of currency can solve the temporary shortage of liquidity, but it cannot solve the problem of falling real estate prices. As the housing market continues to cool, a large number of home buyers with low credit and low income will be unable to repay their loans, which will lead to more lending institutions and investment institutions facing crises, and capital injections may trigger a new round of asset price bubbles. Secondly, injecting currency can solve the position problem of financial institutions, but cannot solve the loss problem caused by the crisis. Huge losses leave the government and taxpayers to foot the bill, which will distort the mismatch between returns and risks. Finally, bailouts foster moral hazard behavior. Light penalties for reckless behavior will encourage a repeat of past mistakes, and central banks will respond to current markets by stimulating growth. Global economic excesses will worsen, leading to a continuation of high inflation.

IV. Lessons for China to Learn

Currently, my country’s capital account has not yet been liberalized, and cross-border capital flows are restricted. Therefore, the U.S. subprime loan crisis has an actual impact on our country’s economy and capital market. Not much, but Chinese commercial banks also suffered losses on their portfolios of U.S. subprime bonds. my country Construction Bank holds $1.062 billion in U.S. subprime mortgage-backed bonds; Bank of China has invested $8.9 billion in U.S. subprime mortgage-backed bonds; ICBC has invested $1.229 billion in U.S. subprime mortgage-backed bonds. The three companies combined Holds US$11.256 billion. The U.S. subprime debt crisis has become the focus of global investors' attention recently. Due to the small proportion of funds involved, the direct losses caused by the subprime debt crisis to my country's commercial banks are relatively small. At present, the conditions for a subprime mortgage crisis in my country are not met, but The real estate market is booming, housing prices are rising, the mortgage market is growing, the inflation rate is high, and interest rates are rising. These are all very similar to the financial background before the subprime mortgage crisis in the United States. Our country also has hidden dangers of the crisis.

(1) Effectively prevent the rapid rise in asset prices and the accumulation of asset bubbles, and avoid the risk of economic and financial fluctuations caused by the bursting of asset bubbles

The subprime debt crisis shows that although asset prices It is a virtual economic element, but it hides considerable destructive power. The direct consequence of its rapid rise is to cause huge harm to the smooth operation of the real economy. As global monetary policy tightens in general, and domestic macro-control in particular will further intensify, the possibility of a correction in domestic asset prices in the future will increase. It is necessary to combine curbing housing price bubbles with controlling risks.

(2) Pay close attention to the risks of personal housing credit and personal housing mortgage loans, and establish a real estate financial early warning system

In recent years, my country’s asset prices, represented by housing prices and stock prices, have increased Rapidly, commercial banks, driven by both the profit impulse caused by strong loan demand and the profit pressure caused by excess liquidity, generally regard personal housing credit as a high-quality business and the main growth point of income. The rapid growth of personal credit has strengthened the banks' The trend of long-term credit has increased the risk of rising non-performing assets of banks. It is necessary to establish a real estate financial early warning system to prevent credit funds from entering high-risk areas such as the stock market.

(3) Strengthen the credit risk management of financial derivatives

Financial innovation provides hedging and diversification means for risk management, but it only changes the risk allocation structure and does not ultimately eliminate risks. It is necessary to improve risk management capabilities, pay more attention to the origin of derivatives - the risks of basic products, and control the upper limit of leverage transactions. The main source of funds for my country's commercial banks is deposits, so they must be more cautious when investing in high-risk bonds and other financial derivatives, and they must strengthen their experience accumulation in QDII investments. Especially in the context of the current surge in foreign exchange reserves and the state's encouragement of qualified enterprises to invest abroad, it is even more important to improve the investment risk management capabilities of domestic financial institutions.

(4) Improve the credit awareness of rating agencies

Strengthen the supervision of rating agencies in the inter-bank bond market and credit market, improve the transparency and technical level of rating agencies, standardize data accumulation, and build a complete tracking system Ratings and conflict of interest avoidance mechanisms.

(5) Establish a complete information disclosure mechanism and loan standards, and pay attention to the prudence of financial institutions' operations

The low-income class can be separated into the housing rental and low-rent markets, and housing loans can be reformulated Approval and loan recovery systems, establish a hierarchical control system, suppress the housing market bubble factors caused by the banking credit system, and minimize the large-scale non-performing credit assets caused by the bursting of the housing market bubble in the future.

For reference only, please learn from it yourself.

Hope this helps.