Question

from this case study "the 2007-2009 Financial Crisis" , whats the role of derivative securities, government, politicians played in increasing indebtedness of households?

Answer 1

Financial crisis

A situation in which the supply of money is outpaced by the demand for money. This means that liquidity is quickly evaporated because available money is withdrawn from banks, forcing banks either to sell other investments to make up for the shortfall or to collapse

Derivative security

A Derivatives as the name implies are derived from the value of the underlying asset and hence are used to hedge against a rise or fall in the value of the underlying asset.

The recent financial crisis, commonly referred to as the sub-prime mortgage crisis of 2007 -2009 began with the failure of a series of derivative-based consolidation of mortgage-backed securities that encapsulated extremely high risk loans to home-owners into a falsely ‘safe’ investment.

Banks offered loans to debtors that couldn’t afford them, and then bundles these debt instruments and sold them.

The banking crisis spread into a broader financial crisis as companies were negatively affected by the crisis in financial institutions to which they were connected.

The government did not regulate the housing market at all, as a result of the elimination of two critical clauses: verification of income and a 20% down payment.

The U.S. stock market, realizing the scale of errors of the banks, lost all investment confidence. This cut the NYSE in half, drastically reducing the value of the U.S. economy.