Final answer:
Portfolios with a heavy concentration in mortgage-backed securities are particularly vulnerable to credit risk. The securitization process that off-loaded mortgage risks from lenders to investors along with overly lenient credit ratings significantly contributed to the risks faced by these securities.
Step-by-step explanation:
Portfolios weighted with mortgage-backed securities are most subject to credit risk. Financial institutions created these securities by pooling together subprime loans and selling them to investors. This financial innovation was intended to distribute the risk of borrower default. If losses occurred, different investors would absorb varying amounts of loss, with some investors only experiencing losses after significant depreciation of the securities' value.
Mortgage-backed securities were attractive to investors as they seemed to provide a steady income stream, conditional on borrowers repaying their loans. However, credit risk materialized significantly during the 2000s financial crisis. Ratings agencies were criticized for being too lenient in assessing the associated credit risks, creating false security among investors. Bank and financial regulators failed to curtail the growth of these securities, which contributed to the financial crisis. The process of securitization off-loaded mortgage risks from lenders to investors, which, in combination with rising housing prices and lax regulation, led to a massive expansion of subprime mortgages.