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 DISSENTING STATEMENT

this counterparty risk faced by many financial institutions meant that any
write-down of GSE debt would trigger a chain of failures throughout the finan-
cial system. In addition, GSE debt was used as collateral in short-term lending
markets, and by extension, their failure would have led to a sudden massive
contraction of credit beyond what did occur. Finally, mortgage markets de-
pended so heavily on the GSEs for securitization that policymakers concluded
that their sudden failure would effectively halt the creation of new mortgages.
All three reasons led policymakers to conclude that Fannie Mae and Freddie
Mac were too big to fail.
• In September, the Federal Reserve, with support from Treasury, “bailed out”
AIG, preventing it from sudden disorderly failure. They took this action because
AIG was a huge seller of credit default swaps to a number of large financial
firms, and they were concerned that an AIG default would trigger mandatory
write-downs on those firms’ balance sheets, forcing counterparties to scramble
to replace hedges in a distressed market and potentially triggering a cascade of
failures. AIG also had important lines of business in insuring consumer and
business activities that would have been threatened by a failure of AIG’s financial
products division and potentially led to severe shocks to business and consumer
confidence. The decision to aid AIG was also influenced by the extremely
stressed market conditions resulting from other institutional failures in prior
days and weeks.
• In November, the Federal Reserve, FDIC, and Treasury provided assistance to
Citigroup. Regulators feared that the failure of Citigroup, one of the nation’s
largest banks, would both undermine confidence the financial system gained
after TARP and potentially lead to the failures of Citi’s major counterparties.

Conclusion:
The risk of contagion was an essential cause of the crisis. In some cases the financial
system was vulnerable because policymakers were afraid of a large firm’s sudden and
disorderly failure triggering balance-sheet losses in its counterparties. These institu-
tions were too big and interconnected to other firms, through counterparty credit
risk, for policymakers to be willing to allow them to fail suddenly.

Systemic failure type two: a common shock
If contagion is like the flu, then a common shock is like food poisoning. A common
factor affects a number of firms in the same way, and they all get sick at the same
time. In a common shock, the failure of one firm may inform us about the breadth
or depth of the problem, but the failure of one firm does not cause the failure of
another.
The common factor in this case was concentrated losses on housing-related assets
in large and midsize financial firms in the United States and some in Europe.