Unformatted text preview: but this did not prevent a net increase in the overall liabilities of financial
intermediaries, and hence in credit supply.
The financial crisis that began in summer 2007 also originated in a change in
the supply of intermediation. It began when increased perceptions of risk resulted
in increases in the margin requirements demanded by creditors in short-term
lending collateralized by mortgage-backed securities, creating a liquidity crisis for
issuers of asset-backed commercial paper. The effect of deleveraging in this sector
on the market value of mortgage-backed securities further impaired the capital of
financial intermediaries more broadly, requiring further deleveraging, in a vicious
spiral: again, Brunnermeier (2009) describes this process in detail in this journal.
In terms of the model, the net result of both reductions in the acceptable degree
of leverage and impairment of the capital of the financial sector was a sharp leftward
shift of the supply of intermediation XS. As illustrated by Figure 4, the result was a
simultaneous contraction of the volume of...
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