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

Which of the following was a key reason that the failure of the US subprime mortgage market spread into broader funding stress for financial institutions in 2007-2008?

Financial institutions and conduits funded long-term, illiquid securitized assets with short-term wholesale funding such as repo and asset-backed commercial paper. When asset values and trust fell, this funding could not be rolled over, turning mortgage losses into a system-wide liquidity crisis.

  1. ADependence on short-term wholesale funding such as asset-backed commercial paper and repo, which became hard to roll over as asset values and counterparty trust fellCorrect
  2. BHeavy reliance by banks on long-term equity capital that investors withdrew immediately
  3. CGovernment-mandated suspension of all interbank lending in 2006
  4. DExcessive holdings of insured retail deposits that depositors withdrew at once

Explanation

Many institutions and off-balance-sheet vehicles financed long-term, illiquid securitized assets with short-term wholesale funding. As losses mounted and collateral values fell, lenders refused to roll over funding, creating liquidity stress and forced asset sales. Equity and insured deposits were not the main channel, and no such mandated suspension occurred.

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