Fault Lines: How Hidden Fractures Still Threaten The World Economy

by Raghuram G. Rajan

The gravy train eventually came to a halt after the Federal Reserve raised interest rates and halted the house price rise that had underpinned the frenzied lending. Subprime mortgage-backed securities turned out to be backed by much riskier mortgages than previously advertised, and their value plummeted. The seemingly smart bankers turned out to have substantial portions of these highly rated but low-quality securities on their balance sheets, even though they must have known what they contained. And they had financed these holdings with enormous amounts of short-term debt. The result was that short-term creditors panicked and refused to refinance the banks when their debts came due. Some of the banks failed; others were bailed out even as the whole system tottered on the brink of collapse. Economies across the world went into a deep slump from which they are recovering slowly.