Question

In the late 1990s and early 2000s, there was an explosion in the issuance of bonds backed by mortgages, also known as mortgage-backed securities (MBSs). The underlying cause of the financial crisis was a combination of debt and mortgage-backed assets.

True or False

Credit Default Swaps are a kind of insurance on bonds.

True or False

In 1999 the Depression-era Glass-Steagall Act (1933) was partially repealed, allowing banks, securities firms, and insurance companies to enter each other’s markets and to merge, resulting in the formation of banks that were “too big to fail” .

True or False

By 2007 the steep decline in the value of MBSs had caused major losses at many banks.

True or False

By the summer of 2008 Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation), the federally chartered corporations that dominated the secondary mortgage market (the market for buying and selling mortgage loans) were in serious trouble.

True or False

Answer 1

In the late 1990s and early 2000s, there was an explosion in the issuance of bonds backed by mortgages, also known as mortgage-backed securities (MBSs). The underlying cause of the financial crisis was a combination of debt and mortgage-backed assets.

This statement is TRUE. Even though, MBS existed in prior times as well, the late 1990s and early 2000s were the times when lenders majorly pooled subprime mortgages into MBS and CDOs and these products were also given high credit ratings by the Credit rating agencies.

Credit Default Swaps are a kind of insurance on bonds.

This statement is TRUE. Credit Default Swap is an instrument in which the buyer of the Credit Default Swap (CDS) pays a premium to the seller of the CDS till the underlying bond expires or a "default event" (as defined by the CDS contract) occurs. When the default event occurs, the seller pays the buyer the face value of the bonds and takes possession of the underlying bonds on which the seller might collect recovery amounts later (in case of physically delivered CDS)

In 1999 the Depression-era Glass-Steagall Act (1933) was partially repealed, allowing banks, securities firms, and insurance companies to enter each other’s markets and to merge, resulting in the formation of banks that were “too big to fail” .

This statement is TRUE.  Glass-Steagall Act (1933) created a regulatory firewall between commercial and investment bank activities in banks, both of which were curbed and controlled. The act was repealed in 1999 due to which banks could take on more risky businesses and hence entering into the subprime mortgages securitization. Banks were no longer prevented from operating as both commercial and investment banks, and the repeal allowed banks to become substantially larger, or "too big to fail."

By 2007 the steep decline in the value of MBSs had caused major losses at many banks.

This statement is TRUE. Increasing defaults caused the value of MBS securities to go down. the steep decline in the value of MBSs had caused major losses at many banks, hedge funds, and mortgage lenders and forced even some large and prominent firms to liquidate hedge funds that were invested in MBSs, to appeal to the government for loans, to seek mergers with healthier companies, or to declare bankruptcy.

By the summer of 2008 Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation), the federally chartered corporations that dominated the secondary mortgage market (the market for buying and selling mortgage loans) were in serious trouble.

This statement is TRUE. In 2007 itseld, Fannie Mae and Freddie Mac started experiencing large losses on their MBS portfolios. By 2008, both the firms landed into financial troubles.