Question

What is the asymmetric information problem.

How did the asymmetric information problem(s) lead to the financial crisis in 2008?

Answer 1

Answer 1

In any economic transaction, when one party lacks the required information whereas other party has all the information regarding the transaction then the problem is said to be the asymmetric information. The asymmetric information affects the decision of parties that further affect their interests therefore, it is considered a significant problem. This problem mostly arises in insurance sector, banking and financial sector, and health care sector.

Answer 2

One of the major reasons why the financial crisis occured is because the major banks lend enormous amount to the risky borrowers in the greed of heavy interests. The real estate was performing very well and the financial markets predicted that the house prices are not going to fall in the future. In fact, they were overpessismistic about the house prices which led them to adverse selection (type of asymmetric information) of borrowers. Financial intermediaries had asymmetric information about the buyers of the financial product (CDOs). Huge amounts of loan were given in the form of subprime mortgage to purchase houses. In the end, the borrowers failed to repay the loans of the financial institutions and ready to leave the houses. This led to the fall in the prices of houses in the market. Investors were not showing interests in the real estate. This led to the collapse of the real estate market and led to housing bubble. This is how, the asymmetric information about borrowers played the role in financial crisis of 2008.