Final answer:
Banks agree to short sales to manage risks by selling loans quickly in the secondary market, which reduces the need for keeping extra funds. Securitization can lead to less careful lending practices, increasing default risks. Yet, banks still face potential net worth declines during recessions.
Step-by-step explanation:
Banks sometimes agree to a short sale because it allows them to manage and reduce risk associated with loan defaults. By selling loans in the secondary market and securitizing them, banks can obtain immediate cash rather than wait for the full term of the loan for repayment. This strategy also means that banks do not need to maintain significant extra funds when making a loan, relying on the ability to sell the loan to recoup their capital.
However, this approach leads to securitization concerns, as banks may be less diligent in their borrower scrutiny, potentially leading to a higher volume of subprime loans. Once loans are securitized and sold, the originating bank's incentive to ensure a borrower's ability to repay is diminished, increasing the risk of defaults and financial instability.
Despite this, during economic downturns, such as lengthy recessions, most banks may still see net worth decline as the default rates on loans rise, indicating that securitization is not a foolproof method against economic hardships.