The subprime loan crisis (SLC) was a national banking emergency caused by a sharp increase in high-risk mortgages going into default after the bursting of the housing bubble. A financial crisis occurs when there is a disruption in the flow of funds between borrowers and lenders within the financial system causing financial friction. A financial crisis can arise due to a number of factors such as incorrect speculation of stock markets, an international crisis or like in the case of the 2008 crisis, an asset price boom or bust. A global financial crisis (GFC) is a situation where many nations at the same time decide that the contracts they hold are risky or that the financial assets they hold are likely to be worth less than thought…show more content… With Federal Reserve Interest rates lowered to 1%, investment banks were incentivised to borrow at a cheaper rate. With this they decided to buy thousands of mortgages that were distributed to homeowners through commercial banks. They took their collection of mortgage backed securities (MBSs) and they split it into tranches known as collateralised debt obligations (CDOs) which were dependent on default risk, maturity and interest rates.
These CDOs were supported by securisation, which is the process of taking an illiquid asset or a group of assets and through financial engineering and transforming them into a security. Securitisation distributes risk and permits investors to choose different levels of investment and risk. An MBS is a type of asset-backed security that is secured by a mortgage or collection of mortgages. The mortgages are sold to a group of individuals (a government agency or investment bank) that securitises, or packages, the loans together into a security that investors can buy. A CDO is so-called because the pooled assets – such as mortgages, bonds and loans – are essentially debt obligations that serve as collateral for the CDO. The tranches in a CDO vary substantially in their risk profile. With the success of the system,