Question

How did subprime mortgage loans contribute to the global financial crisis of 2007 & 2008?

1. Investment companies borrowed money from banks to buy subprime loans
2. Banks were indirect investors in subprime loans
3. Banks had to reduce their reserves as they wrote off bad loans
4. High interest rates on subprime loans caused defaults on the loans

Answer 1

Subprime mortgage loans contributed to the global financial crisis through investment exposure, direct investment by banks, and reduced reserves due to write-offs of bad loans.

Step-by-step explanation:

Subprime mortgage loans contributed to the global financial crisis of 2007 & 2008 in several ways:

1. Investment companies borrowed money from banks to buy subprime loans: Investment companies, such as hedge funds, borrowed money from banks to invest in subprime mortgage-backed securities. These securities consisted of bundles of subprime loans that were given to borrowers with poor credit history. When housing prices began to decline, many borrowers defaulted on their loans, causing the value of the mortgage-backed securities to plummet.
2. Banks were indirect investors in subprime loans: Banks themselves were also investors in subprime loans, either by holding the loans on their balance sheets or by investing in mortgage-backed securities. As the value of these loans and securities decreased, banks suffered significant losses, leading to financial instability.
3. Banks had to reduce their reserves as they wrote off bad loans: As borrowers defaulted on their subprime loans, banks had to write off these loans as losses. This led to a decrease in their reserves, making them less able to withstand financial shocks and causing a tightening of credit availability in the economy.

Overall, the combination of high-risk subprime loans, investment exposure to these loans, and the subsequent write-offs by banks contributed to the global financial crisis of 2007 & 2008.