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

Which feature of the pre-crisis housing market most directly made subprime mortgages with low initial 'teaser' rates vulnerable to widespread default?

Teaser-rate subprime loans reset to higher payments, and borrowers relied on rising house prices to refinance. When prices stopped rising, refinancing was unavailable and payment shocks produced widespread defaults.

  1. ARate resets to higher levels combined with reliance on rising house prices to allow refinancingCorrect
  2. BFixed 30-year rates that never changed over the life of the loan
  3. CMandatory 40% down payments that reduced borrower equity
  4. DFull income documentation that excluded weaker borrowers

Explanation

Many subprime loans were adjustable with low initial rates that reset higher. Borrowers expected to refinance using house price appreciation. When prices stalled and fell, refinancing became impossible and payments rose, driving defaults. The other options describe features that would reduce default risk.

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