Which of the following contributed to the systemic failure during the credit crisis that began in 2007?

Which of the following contributed to the systemic failure during the credit crisis that began in 2007?
A . Stress tests that did not stress enough
B . Moral hazard from the strategy of ‘originate and distribute’
C . Inadequate attentionpaid to liquidity risk
D . All of the above

View Answer

Answer: D

Explanation:

All the factors listed above contributed to systemic failure. Liquidity risk was not on the radar of regulators, and was a second priority for risk managers, and most of the focus was oncapital adequacy as liquidity was thought to be an unlikely problem. Liquidity, regardless of capital adequacy, was the primary cause of failure of a number of institutions during the crisis.

Similarly, stress tests proved to be much milder than the shocks that were actually experienced, and the strategy of ‘originate and distribute’ implied that the mortgage and other debt originators had no interest in any due diligence as they intended to package and sell the debt to other investors.

Therefore Choice ‘d’ is the correct answer.