Describe the financial crisis of 2007- 2009. What were the primary causes of this financial crisis?

Expert Solution

The financial crisis of 2007 was considered to be the biggest financial meltdown in the world history since the great depression in the 1930's. As it was a systemic collapse of the US financial system which had the ramifications across the globe, there was not one single factor responsible, but a combination of multiple factors that led to the crisis. Some of the major factors that led to financial crisis were

a) Inflated asset prices, mainly houses additionally some securities of specific characteristics.

b) Excessive lending and borrowing through the financial system and the economy.

c) Poor regulatory control, both in terms of the enforcement of legal system as well as how seriously the controllers played out the regulation.

d) In appropriate banking practices in sub-prime and other mortgage lending.

e) The mind boggling blanket of securities and subsidiaries often without transparency underlying these home loans.

f) The biased approach of statistical rating agencies where the issue of conflict of interest persist till date.

g) The compensation mechanisms in many financial institutions that defy the inherent logic of the times.

The above were some of the major factors that contributed to the global financial crisis. Now , coming to the model on which the crisis unfolded, the figure below provides some idea about the key players that were involved in the trigger of the financial crisis.

The originators is the bank that originates the loan, an Arranger typically another bank that evaluates the pool of assets the way it will be fed and the characteristics of securities to be issued , A Warehouse lender( typically a line of credit given to a loan originator to pay off the mortgage) , credit rating agency( an agency that rates the mortgage security on the basis of its inherent risk characteristics), Asset Manager( purchaser of securities who turn around and sell the securities), Investor( individuals and institutions that purchase securities).

The frictions and self interest of each of these players contributed to the financial crisis.

jeff jeffy answered 8 months ago

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