Question

Why did the 2007 U.S. subprime crisis spread rapidly?

A. Banks in other countries failed to measure the risk of real estate derivatives.

B. The United States adopted the fixed exchange rate system.

C. The Fed failed to act at the right time.

D. The United States had a large current account surplus.

E. There was speculation against the U.S. dollar.

Answer 1

The housing bubble preceding the crisis was financed with mortgage-backed securities (MBSes) and collateralized debt obligations (CDOs), which initially offered higher interest rates (i.e. better returns) than government securities, along with attractive risk ratings from rating agencies.

There were early signs of distress: by 2004, U.S. homeownership had peaked at 70%; no one was interested in buying or eating more candy. Then, during the last quarter of 2005, home prices started to fall, which led to a 40% decline in the U.S. Home Construction Index during 2006. Not only were new homes being affected, but many subprime borrowers now could not withstand the higher interest rates and they started defaulting on their loans.

This caused 2007 to start with bad news from multiple sources. Every month, one subprime lender or another was filing for bankruptcy. Hence because Bank failed to measure the risk of real estate derivative , there were subprime crisis.

Hence ( A ) part is a correct answer