The Globalization Reader, 5th Edition

25 The Global Financial Crisis and Its Effects

Malcolm Edey

A Brief Chronology

As is now well known, the immediate background to the crisis was the emergence of problems in the US market for sub-prime housing loans in the first half of 2007. Sub-prime loans, in US terminology, are loans that do not meet standard criteria for good credit quality, such as a sound credit history on the part of the borrower, good income documentation and/or a conservative loan-to-valuation ratio. Sub-prime lending became very significant in the United States from around the middle part of this decade; by 2006, these loans were around one-fifth of new housing lending and an estimated 15 per cent of the stock of housing loans outstanding in the United States.

An important feature of this period was the securitization of sub-prime and other loans by their original lenders and their subsequent sale to other investors. This occurred partly through conventional mortgage-backed securities but also, increasingly, through more complex products such as collateralised debt obligations (or CDOs), which came to play an important part in the spreading of the crisis. CDOs work by layering the claims in a pool of mortgages into tranches, with the most senior tranches provided the most protection against potential losses. That structure enabled some of these securities to gain high credit ratings even when the average quality of the underlying loans was poor. In combination with their relatively high yields, ...