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Chapter 12: Q.14 (page 343)

What technological innovations led to the development of the subprime mortgage market?

Short Answer

Expert verified

Mortgage backed securities and collateralized debt obligations (CDOs) are some of the innovative products that are associated with subprime mortgages.

Step by step solution

01

Concept Introduction

Borrowers with poor credit ratings typically make up the subprime mortgage market. A prime conventional mortgage will not be offered due to the lender's belief that the borrower is at increased risk of default.

02

Explanation

Mortgage-backed securities :

Mortgage-backed securities, named MBS, are bonds secured by the home and other real estate loans. They are formed when a number of these loans, usually with identical characteristics, are pooled jointly. One bank might round up 10 million mortgages if it suggested home loans.

Collateralized debt obligation :

Collected debt obligations are complex financial instruments backed by loans and other assets, offered to institutional investors.

03

Final Answer

MBS, which are mortgage-backed securities, provide security for loans secured by real estate.

CDOs (collateralized debt obligations) are debt obligations backed by real estate.

In finance, collateralized debt obligations (CDOs) are elaborately structured financial instruments that make up a pool of loans or other assets that are sold to institutional investors.

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Most popular questions from this chapter

What is a credit spread? Why do credit spreads rise significantly during a financial crisis?

. Go to the St. Louis Federal Reserve FRED database, and find data on house prices (SPCS20RSA), stock prices (NASDAQCOM), a measure of the net wealth of households (TNWBSHNO), and personal consumption expenditures (PCEC). For all four measures, be sure to convert the frequency setting to “Quarterly.” Download the data into a spreadsheet, and make sure the data align correctly with the appropriate dates. For all four series, for each quarter, calculate the annualized growth rate from quarter to quarter. To do this, take the current-period data minus the previous-quarter data, and then divide by the previous quarter data. Multiply by 100 to change each result to a percentage, and multiply by 4 to annualize the data.

a. For the four series, calculate the average growth rates over the most recent four quarters of data available. Comment on the relationships among house prices, stock prices, net wealth of households, and consumption as they relate to your results.

b. Repeat part (a) for the four quarters of 2005, and again for the period from 2008:Q3 to 2009:Q2. Comment on the relationships among house prices, stock prices, net wealth of households, and consumption as they relate to your results, before and during the crisis.

c. How do the current household data compare to the data from the period prior to the financial crisis, and during the crisis? Do you think the current data are indicative of a bubble?

Define “financial frictions” in your own terms and explain why an increase in financial frictions is a key element in financial crises.

Describe the process of “securitization” in your own words. Was this process solely responsible for the Great Recession financial crisis of 2007–2009?

How does the concept of asymmetric information help to define a financial crisis?
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