Question

Discuss what caused the financial crisis and why that caused such a large amount of banks to fail.

Answer 1

Financial crisis was caused by excessive exposure of commercial bank into highly risky assets which have derivatives and that were interlinked with each other so the contagian was too widespread to control.

The primary cause of financial crisis was real estate boom led irrational pricing of housing sector and belief among the investor that real estate will have complete realisation value in any adverse economic scenario and they floated a large number of derivative security and writting off a large number of the securities in order to make quick gains. They bundled low quality investment bonds and issued to the public to buy them with good ratings and treating them as investment grade bonds under collateralized debt obligation.

When the credit system tightened, and there was a freeze on the liquidity in the overall market, it lead to Assets of the banks turning bad, and that lead to a contagian in the financial market which triggered the widespread collapse, and many of the large banks started to fear that they would be bankrupt as they were short on their cash and they were not able to fulfill with their required debt obligation.

It even led to insurance related AIG push itself on the brink of bankruptcy by writing of a lot of credit default swaps, which were triggered once the borrowers were unable to repay the debt, so it lead to a widespread contagian leading to crisis in the financial market leading to major commercial banks and Insurance company to collapse.