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Credit chains, credit bubbles, and financial fragility: Explaining the U.S. financial crisis of 2007-09

Thomas L Bernardin, University of Massachusetts Amherst


This dissertation addresses the cause of the U.S. financial crisis of 2007-09. Most existing literature has examined causality from the perspective of market failures in isolated segments of the financial system. In contrast, this dissertation examines the ways in which interactions between various market segments contributed to an increase in financial fragility prior to the crisis. This dissertation begins by distinguishing between two dimensions of fragility which are commonly entangled within the literature. It disentangles these dimensions of fragility by differentiating between fragility relative to an exogenous shock and fragility understood as an unsustainable feedback process. This dissertation then reappraises the securitized banking system as it existed prior to the crisis in light of this distinction by developing a map of the mortgage market credit chain. This map emphasizes the credit flows across multiple links along the chain rather than the risk dispersion properties of any given link. Using this map, this dissertation then develops several empirical models which examine the relationship between each of the links along the mortgage market credit chain. These models examine interactions both between adjacent as well as non-adjacent links along the credit chain. The central empirical finding is that a credit supply shift originated the CDO market in early 2004 which drove an unsustainable credit expansion through its interaction with home price appreciation. In this context this dissertation argues that characterizing home price dynamics over the pre-crisis period as a housing bubble is misleading in the sense that it implies home buyers and their expectations were the central location of an unsustainable feedback process. Rather, home prices are best characterized as having operated as part of a credit bubble centered around feedbacks and expectations in the CDO market. As a result, the crisis can be broadly characterized as the bursting of a credit bubble rather than a housing bubble as is more common.

Subject Area

Finance|Economic history

Recommended Citation

Bernardin, Thomas L, "Credit chains, credit bubbles, and financial fragility: Explaining the U.S. financial crisis of 2007-09" (2013). Doctoral Dissertations Available from Proquest. AAI3603054.