Question

What could have done the central bank to avoid financial crisis in 2007 ?

Answer 1

Ignoring the early warning signs caused the financial crisis

The 2007 GDP growth came in at 1.9%. But economy-watchers didn't realize the sheer size of the subprime mortgage market. It created a "perfect storm" of bad events.

1. Central Bank should have been worried about the credit-worthiness of borrowers and not allowed to resell the mortgages on the secondary market.
2. Check on unregulated mortgage brokers who made loans to people who weren't qualified.
3. Measures to avoid Homeowners taking out interest-only loans to get lower monthly payments. As mortgage rates reset at a higher level, these homeowners could not pay the mortgage. Then housing prices fell and they couldn't sell their homes for a profit. As a result, they defaulted.
4. Banks should not have been allowed to repackage mortgages into mortgage-backed securities. They hired sophisticated "quant jocks" to create the new securities. The "quants" wrote computer programs that further repackaged these MBS into high-risk and low-risk bundles. The high-risk bundles paid higher interest rates, but were more likely to default. The low-risk bundles paid less. The programs were so complicated that no one understood what was in each package. They had no idea how much of each bundle were subprime mortgages. When times were good, it didn't matter. Everyone bought the high-risk bundles because they gave a higher return. As the housing market declined, everyone knew that the products were losing value. Since no one understood them, the resale value of these derivatives was unclear.
5. Put check on individual investors, pension funds, and hedge funds. That spread the risk throughout the economy. Hedge funds used these derivatives as collateral to borrow money. That created higher returns in a bull market but magnified the impact of any downturn. ​The Securities and Exchange Commission did not regulate hedge funds, so no one knew how much of it was going on.