Why the Crisis Was Unavoidable and Why TARP Didn’t Help

This paper creates a simple model to describe the relationships between, banks, mortgage agencies, mortgage arrangers, and aspiring home owners. Using this model, the author illustrates how slight changes in real estate appreciation assumptions would reverberate through the collateralized debt market creating a reverse feedback loop which fed cheap credit. Building further on the model, the author then describes how the incentive structures of the collateralized debt market rationally incentivized over investment in high credit risk individuals. The author then explains how these two phenomena, in consort, created bank insolvency. By tracking the repercussions of these two phenomena through this simple model the author suggests that while the crisis may have been exacerbated by bad behavior, it may still not have been avoidable absent serious regulatory intervention. In addition, the author explains why TARP I failed and why TARP II, while correct in theory, was too late to stop the bleeding