Question

The main purpose of insuring bank deposits through programs such as the FDIC is to prevent ______.

		Securitization
		Bank runs
		Liquidity risk
		Gambling with other people's money

Which of the following contributed to the financial crisis of 2008?

		Failure of the ratings process
		Vanishing liquidity of securitized mortgage assets
		Fragmented and ineffective bank regulation
		All of the above

Answer 1

The answer is all of the above.

The financial crisis was primarily caused by deregulation in the financial industry. That permitted banks to engage in hedge fund trading with derivatives. Banks then demanded more mortgages to support the profitable sale of these derivatives. They created interest-only loans that became affordable to subprime borrowers.

In 2004, the Federal Reserve raised the fed funds rate just as the interest rates on these new mortgages reset. Housing prices started falling as supply outpaced demand. That trapped homeowners who couldn't afford the payments, but couldn't sell their house. When the values of the derivatives crumbled, banks stopped lending to each other. That created the financial crisis that led to the Great Recession.