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

Which of the following best explains why the securitization chain's information problems, such as moral hazard in loan origination, were exacerbated before the crisis?

Each link in the securitization chain relied on others, with investors depending heavily on credit ratings instead of analyzing the underlying loans. Since originators and arrangers were paid on volume, nobody had strong incentives to monitor loan quality, which worsened the information and moral hazard problems.

  1. AInvestors in senior tranches typically performed their own loan-level due diligence, replacing ratings
  2. BEach party in the chain could rely on others' work, so reliance on credit ratings substituted for independent analysis of the underlying loansCorrect
  3. CSecuritizers were prohibited from sharing loan data with rating agencies
  4. DOriginators were paid only after the loans fully matured

Explanation

Investors leaned heavily on ratings, and rating agencies relied on data and models rather than loan-level checks, while originators and arrangers were paid on volume. This weakened monitoring at every link. Option A is the opposite of what occurred.

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