Question

Why is the originate-to-distribute business model subject to the principal–agent problem? True, false, or uncertain: Deposit insurance always and everywhere prevents financial crises. How did a decline in housing prices help trigger the subprime financial crisis that began in 2007? What role did the shadow banking system play in the 2007–2009 financial crisis? Why is it a good idea for macroprudential policies to require countercyclical capital requirements?

Answer 1

The originate-to distribute problem is subjet to the principal agent problem because the mortgage originator , the agent for the investor has less stimulus  to prove that the mortgage is a good credit risk.

The decline in housing prices triggered the financial crisis that started in 2007.Sub prime borrowers found that they owed more on  mortgages than the real worth of their houses.As a result homeowners were motivated  to return the keys to the lender and move away from the houses.Due to this defaults on mortgages rose which inflicted loss to the financial institutions . The financial institutions then lessened their lending.

Shadow banks are financial institutions that borrow short term and lend long term, but they are outside traditional banking regulation.Thus there was fall in funding from the shadow banking system and shadow banking restricted lending ,This caused   fall in economic activity . So with increase in the loan losses ,the balance sheet of the banks worsen and lendinf activity falls.

Lending activity increases during boom and reduces during recession.So in order to reduce lending, there is need for more capital held during booms.This policy will reduce lending and during boom period ,credit bubbles will be reduced.