According to the US Federal Reserve (2004) subprime credits represent a natural evolution of the credit system. Only in 2007, the US Federal Reserve started considering the risks connected to these financial tools. Subprime credits rose thanks to the real estate market boom, to very low short-term interest rates, and because of their high returns due to predatory practices. By means of securitisation, subprime credits were incorporated into investment funds and sold outside the US. The favourable rating of these funds allowed the spread of risks outside the US market, and this dramatically reduced the confidence in rating agencies and in their ability to assess the creditworthiness of borrowers, funds and banks. According to many analyses, the roots of the subprime crisis are both congiuntural (real estate boom, wrong evaluation of risks, expansionary monetary policies), and structural (deregulation, speculation and risk loving) (Gorton, 2009 and Oldani, 2008).
After the dot-com bubble burst (2001) and the corporate scandals (2002-03, Enron among others), financial wealth moved to the real estate market, a cheap money tank, and Over The Counter fuelled by deregulation and the free market philosophy.
The credit risk assessment had become fundamental to let resources flow in the global financial system; rating agencies determined, sometimes in a position of conflict of interests, methodologies for the evaluation of creditworthiness and transparency had been always guaranteed. On this issue see Mazzoni and Masera.
Over the period 2001-06, monetary policy was expansionary, with respect to the needs of the financial system, it provided abundant liquidity and sustained the credit growth. Interest rates in most currencies were particularly low, sometimes zero, like the Federal Fund rate in the period 2008-09 in the US.
The result of expansionary monetary policy was the loss of control over wide money aggregates (like M3), but this was perceived to be the cost of growth. In 2006, the Fed decided to cease the measurement of M3 because “it lost the relationship with the underlying economic activity”, which was the hypothesis at the base of its use. Financial deregulation allowed financial proliferation and the creation of a shadow banking system, which operated parallel to the traditional raising funds, in absence of vigilance and control (i.e. hedge fund, private equity, sovereign wealth fund).
The faith on free and efficient markets and their ability to autocorrect is at the root of deregulation; it allowed the continuous creation of innovative securities, tailored on customers’ needs, which attracted huge amounts of resources. These deregulated financial tools entered the financial system by means of securitisation, which represents a large share of financial and banking intermediaries’ assets. During 2008-09, the US central bank together with the European, Japanese and British ones injected enormous amounts of liquidity to avoid the credit crunch. They also bought bonds, which had no marketability. This monetary policy pushed interest rates toward zero, and probably succeeded in the soft landing. Because of massive public spending, and excessive debt two European countries have almost bankrupted in 2010 (Greece and Ireland), and the EU and the International Monetary Fund ( intervened to save them. In 2011, central banks will have to figure out what is the exit strategy, to avoid soaring inflation, which will finally hit the productive system that has already paid the cost of banks and countries' rescue.

Bernanke B. (2007), The subprime mortgage market, speech at the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, Chicago, Illinois, May 17.
González-Páramo José Manuel (2008), Sub-prime crisis, liquidity tensions and central banks: One year on, Member of the Executive Board of the ECB,2nd Spanish Capital Markets Forum Madrid, 30 September.
Gorton Gary (2009), The subprime panic, European Financial Management, Vol. 15, No. 1, pp. 10-46, January 2009.
Gramlich Edward M. (2004), Subprime Mortgage Lending: Benefits, Costs, and Challenges, The Financial Services Roundtable Annual Housing Policy Meeting, Chicago, Illinois, May 21.
Oldani C. (2008), Governing Global Derivatives, Ashgate, London.
US Federal Reserve (2006),
Discontinuance of M3, Federal Reserve Statistics Release.
Editor: Chiara OLDANI

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