Question

) What were the main vulnerabilities of the U.S. financial system prior to the 2007-2009 financial crisis?

Answer 1

The main vulnerabilities of the US financial system prior to the 2007 to 2009 were mainly associated with the formation of bubbles in housing sector, interconnected risk and underestimation of risk associated with the derivative products. The housing prices were rising and it continue to rose to a point where it seems that the price of the houses were way beyond what even they were worth it and the people those who were buying houses by taking loans were buying it for speculative purposes by taking loans over the houses. The speculation in the market can lead to formation of bubbles. The second risk was risk related to the use of derivatives in the securitization of the loans. Most bank by using complex derivative products transfer the risk of default of loan to third party but they underestimated the counterparty risk and they did not realize that if the other party defaulted, they would also have to incur loses. This was underestimation of risk. The interconnectedness of risk is related to the fact that the default of one entity could lead to the series of default of many banks and that what actually happened.