So today,I've just assisted to a talk of Xavier Ragot (a man from the french Central bank) about the cause of the credit crisis. He didn't say anything really new. For him the cause are mainly three (with the ratio of importance in brackets):-the policy of the fed under the Greenspan era, the decrease of the rate of interest which made people more or less overconsume and get into debt (10%)-the current change policy of China which wants a stable Yuan and so bought a lot of US treasury bond and overflood the market (30%)-the mispricing and misrating of derivative securitized contracts (60%)I asked him what is the main default of the current models used by practitionners in trade rooms according to him and he said that for him the most important feature that should be seriously taken into account is the liquidity problem (the market is not infinitevely liquid and that the volume is obviously finite). I think that there are already some models which incoporate that but if you have some reference paper don't hesitate. It was a very brief sum up of a 2 hours talk. Any comment is welcome

The cause of the crisis was smart people. People who knew they would pay no price for defaulting, people who saw an opportunity to get something for nothing.

Yeah he also talked about the "too big to fail" behaviour. But just say that to Lehman Brothers (simply dead), Merrill Lynch (bought by bank of America) or Bear Stearns (bought by JP Morgan Chase). But I agree that some banks, didn't play the game of the Paulson plan. The money was not reinvested for recapitalize them but was distributed in dividends to shareholders. Then there are indeed smart people who anticipated the crisis and bet on it (as the Paulson& co hedge fund).

Quote-the policy of the fed under the Greenspan era, the decrease of the rate of interest which made people more or less overconsume and get into debt (10%)-the current change policy of China which wants a stable Yuan and so bought a lot of US treasury bond and overflood the market (30%)-the mispricing and misrating of derivative securitized contracts (60%)I agree US federal reserve gave too easy money. But barely too easy. There has to be some room in the structure of other institutions for the Fed to not be perfect!No doubt China contributed to the liquidity, and resulting boom-bust. But it took more than just liquidity. It took for people to just do crazy stuff, with no thought of default.It is not practical to hope for the Fed to not make errors, or for there to never be a boom in liquidity from a trading partner or something. It is also not practical to expect derivative pricers to be perfect.But is it possible, in the labyrinth of human civilization, to restrict lending to people with no evidence of any income to pay off the loan? That would solve your problem right there.QuoteStated Income / Stated Asset Mortgage - SISAWhat Does It Mean?What Does Stated Income / Stated Asset Mortgage - SISA Mean?A type of reduced documentation mortgage program which allows the borrower to state on the loan application what their income and assets are without verification by the lender; however, the source of the income is still verified.Investopedia SaysInvestopedia explains Stated Income / Stated Asset Mortgage - SISASISA loans usually fall into the Alt-A classification, and may carry a higher interest rate than a prime mortgage. Self-employed borrowers often use SISA loans because their tax returns might not reflect that actual cash flow they have available to pay their mortgage. Other borrowers might use a SISA loan because their income comes from sources which are hard to document (such as tips in the food service industry). Some lenders may require the borrower to sign a form authorizing the lender to obtain a copy of the borrower?s tax returns from the IRS should the borrower default on the mortgage.

I remember it had to be either early 1998 or early 2000. A mortgage officer called into a radio show. He said listen to what I have here. I have a guy who makes like $250,000 a year who wants to buy a house. But he has a tax lien, and so based on my guidelines I cannot approve the loan. And also on my desk, I have an application to buy the same (?) house from three people on welfare (or SSI or whatever), who have pooled their three government incomes. And based on new directives, I have to approve this loan!

QuoteOriginally posted by: frenchX Then there are indeed smart people who anticipated the crisis and bet on it (as the Paulson& co hedge fund).Since when distinguishing pathologic situations and expecting their correction is called smartness? Its more of a luck, its market timing. Recall markets can stay irrational for longer than you can stay solvent. If Paulson had placed his bets a couple of years earlier, he would have lost both his shirt and his boxers...