Question

Explain how the financial crisis of 2007-2009 that originated in the real estate market and mortgage markets hurt financial intermediaries' attempts to use diversification to limit the riskiness of their loans.

Answer 1

The Causes of the Crisis 2007-2009 and Its Real Effects

• External factors and market influences that produced the house value balloon and the preconditions for the crisis.
• Political factors. - financial inequities had increased in the United States due to structural insufficiencies in the educational system that created an uneven entrance for various sections of society. Politicians from both parties observed the broadening of home buying as a way to deal with this increasing wealth disparity.
• Growth of securitization and OTD model. It has been proposed that the request of the U.S. government to expand ownership was also conducted by monetary policy that helped softer lending criteria by banks.
• Financial innovation. Earlier to the financial crisis, we observed an eruption of financial innovation for above two decades. One contributory factor was information technology, which caused it easier for banks to generate tradable contracts and made commercial banks more intertwined with the obscuration banking system and with financial markets.

Attempts to use diversification to limit the riskiness of their loans-

Prior to the crisis, many assumed that diversification was a remedy-all for all kinds of uncertainties. In particular, by pooling (even subprime) mortgages from different geographies and then issuing securities upon these supplies that were exchanged into the market, it was concluded that the benefits of two kinds of diversification were done: geographic diversification of the mortgage pool and later the holding of cases opposite these supplies by diversified investors in the capital market. Nevertheless, several of these securities were signifying continued by interconnected and systemically significant institutions that engaged in the financial market, so what the method actually did was to analyse risk on the scale coats of organisations in a way that generated greater systemic danger. Obviously, advancements in information technology and financial modernisation were facilitating agents in these improvements.