Knowledge and Liquidity: Institutional and Cognitive Foundations of the Subprime Crisis

Abstract (Via Northwestern)

This paper examines the central role played by credit rating agencies in the production of “knowledge” about financial instruments. That “knowledge,” in the form of credit ratings, underpinned disintermediation in mortgage markets by giving investors confidence that they knew the risk-and-return properties of otherwise opaque collateralized debt obligations and mortgage-backed securities. Credit ratings helped to “standardize” structured financial products and create liquid markets. However, this cognitive machinery failed and liquidity collapsed during the current crisis. We use this failure to examine the role of institutionalized cognition in the production of market liquidity

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