Mortgage and banking crises

The current financial crisis in the USA can be characterised by a fast expansion of mortgage loans to households in order to purchase real estate. A difference to the traditional Minskyan crisis and the previous type of financial crisis is that borrowers are not firms but households. The Japanese crisis was characterised by firms and banks borrowing to invest in real estate, and the East Asian crisis was characterised by firms and banks borrowing foreign-denominated debt. In the current worldwide crisis, financial fragility that has led borrowers from hedge to speculative and even Ponzi positions involves the dynamics of household income and interest payments.

There are three main reasons explaining the large increase in mortgage credit: competition between financial institutions; the interaction between real estate prices and credit constraints; financial innovations. These three elements have induced banks to relax screening and monitoring of borrowers and to increase the quantity of credit supplied to households. First, in the aftermath of the crash of the dotcom bubble in 2000 and in an environment characterised by low interest rates, banks, under the pressure of financial intermediaries such as hedge funds, found in mortgage debt a highly profitable business. Second, increasing real estate prices contributed to the relaxation of credit rationing. The increasing value of collateral has reduced default risk and has led banks to increase credit, in line with the financial accelerator model.