The Financial Abstraction Ladder: The Story of the Global Financial Crisis
“It is difficult to get a man to understand something, when his salary depends upon his not understanding it!” — Upton Sinclair
In this paper, I present the analogy of a financial abstraction ladder to capture the causes of the financial crisis. The ladder starts at the ground level, where you have a housing market consisting of buyers and sellers. Most buyers need a loan to cover the majority of the initial cost of a home, turning to their local bank who after assessing their creditworthiness puts together a mortgage contract.
This local bank is sitting on the first rung of the financial abstraction ladder, as we have gone from a buyer with some assets and a credit history, to a contract that involves complex legal language and multiple parties. From there, the bank sells off the mortgage to another institution sitting on rung 2 that packages that mortgage along with a lot of other mortgages into a single security through a process called securitization. Climbing to rung 3, that institution turns around and sells the securitized mortgages to an investment bank who further repackages and complicates the mortgage contracts and the process of financial abstraction continues.
