*This is a modified version of a lecture delivered at the International Conference on “Issues in Finance-Theory and Empirics”, held at Jadavpur University, Kolkata on 2–3 January, 2008. The paper is based on data available up to the first week of February, 2008.
In light of the nature of developments in the US mortgage and housing markets during the period 1995–2007, the paper provides a critical appraisal of three popular explanations of the crisis: (a) imprudent lending; (b) lax monetary policy; and (c) the home price bubble originating in sociopsychological factors. This paves the way for examination of the roots of the crisis and its contagion in terms of interaction between the real and the financial factors operating in the US economy. The intertwining of the factors helps to resolve the three major puzzles characterising the crisis, viz., the disproportionately large losses and write-downs of financial entities in relation to the quantum of subprime default; the relative ineffectiveness of monetary policy; and the failure of widely used risk management and credit rating models.
