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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Which development in the US housing market during the early-to-mid 2000s most directly contributed to the buildup of subprime mortgage risk before the 2007-2009 crisis?

Loose underwriting to weak borrowers, supported by rising house prices and the originate-to-distribute model, most directly built up subprime risk. Lenders sold loans into securitizations, so they had little incentive to check borrower quality, and rising prices masked the deteriorating credit standards.

  1. AWidespread adoption of fixed-rate mortgages with full income documentation and large down payments
  2. BA sharp rise in lending to weak borrowers under loose underwriting standards, supported by rising house prices and the originate-to-distribute modelCorrect
  3. CA decline in mortgage securitization volumes as banks retained loans on their balance sheets
  4. DTightening of rating agency criteria for mortgage-backed securities

Explanation

Subprime growth was driven by lax underwriting (low documentation, high loan-to-value, teaser-rate ARMs), fuelled by rising house prices and the originate-to-distribute model that passed risk to investors. The other options describe conservative or opposite conditions.

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