The obligations (CDOs) in mortgage markets during

The financial crisis of 2007-2008 had considered as the worst financial crisis, the main reason because of Lehman Brothers and different issues occurred during the period. One of the factor is financial innovation and subprime mortgage markets. Financial innovation known as creating new financial instruments, technologies, institutions and markets. The outcome of financial innovations are mortgage-backed securities products and collateralised debt obligations (CDOs) in mortgage markets during the financial crisis. Subprime mortgage in US market was estimated at $ 1.3 trillion and over 7.5 million subprime mortgage is outstanding. Collateralized Debt Obligations (CDOs) did a big effect during the crisis, its special purpose vehicle (SPV) had created to buy assets, create securities from those assets, and then sell those securities to investors. Many subprime mortgage bundle together sold and dependent on US federal government backstops and guarantees. Wherefore, a moral hazard may happen when one party intentions to behave inappropriately after a financial transaction has taken place while another party bears the costs if things go badly. Banking crisis is another main factor that affects banking activity. For instance, bank runs occur when large number of bank customers withdraw their deposits because they believe the bank might fail. Besides that, banking crisis include banking panics and systemic banking crisis, which affect many banks and a country experiences a large number of defaults. Numerous of financial institution assist during the crisis and government had adopted fiscal policies to prevent possible collapse of the world financial system. On September 2008, Lehman Brother filed for bankruptcy, Merrill Lynch had sold to Bank of America at “fire” sale prices and AIG had experienced liquidity crisis. In addition, the factor led to the financial crisis is agency problems and asymmetric information. Agency problems happened when mortgage originators did not hold the actual mortgage but they sold the note in the secondary market and they earned the fees from the volume of the loans produced. During the subprime mortgage crisis, originators had sold bundles of loans to banks and they knew many of borrowers were to default. Asymmetric information mean parties to transaction do not have same quantity and same quality of the information. In order to assess the accurate potential risk, banks need considerable and symmetric information to make a rational decision. Asymmetric information able to exist between investors and companies or investors and investment firms. There is a risk for any investor or analyst because when evaluating companies, companies have good or bad information while investors and analyst is lack for that. The risk between investment firms and investors is investment firm may suggest to buy a company’s stock while they knew the stock’s price is going down.

 

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