Exploring the Contagion and Its Effect on Macroeconomic Conditions

1452 Words Feb 5th, 2018 6 Pages
The banking sector, heavily exposed to houses that were now underwater, by way of their investments in collateralized debt instruments featuring subprime mortgages, began to struggle. The result was a credit crisis, followed by substantial government intervention in the industry. This crisis then spread throughout much of the rest of the world. The contagion effect was driven by factors such as financial institution connectedness and exposure to the US economy. This paper will explore the contagion, and its effect on macroeconomic conditions both in the United States and around the world.
A contagion is defined as "a significant increase in market co-movement after a shock in one country" (Lee, 2012). The contagion's source was the US housing market. This market had experienced a bubble in the middle of the 2000s, and many mortgages were packaged into securities, which were then sold to financial institutions around the world, with particular concentration throughout the US banking system. While rated as AAA, these securities often paid higher returns than one would expect from a AAA security, making them attractive to international investors seeking superior returns on USD-denominated securities.
A number of the studies focused on the contagion effect of the subprime crisis focus on measuring the timeline of the crisis against stock market outcomes…