Money, Banking, and International Financecollapsed, when homeowners stopped buying houses. Then the U.S. housing bubble deflated as
housing prices began plummeting.
Surge in mortgage defaults caused the investors to question ABS and CDOs, and they
stopped investing in securitized debt. Subsequently, both the commercial and investment banks
became stuck with billions in unsold CDOs. Furthermore, the banks and investors of CDOs and
ABS foreclosed on homes that are losing value. Unfortunately, if the banks accumulate too
many bad mortgages, then they become insolvent. Finally, the 2008 Financial Crisis caused fear,
panic, and paranoia to sweep across the financial world. Banks and financial institutions had
frozen all credit and loans overnight.
Key Terms
federal deposit insurance
balance sheet
capital
liabilities
non-transaction deposit
savings account
small-denomination time deposit
large-denomination time deposit
borrowings
discount loan
assets
vault cash
required reserves
marketable securities
loans
Federal funds market
Federal funds rate
net worth
bank failure
T-account
excess reserves
liquidity risk
credit risk
credit-risk analysis
collateral
credit rationing
restrictive covenants
interest rate risk
floating-rate debt
adjustable-rate mortgage
securitization
tranche
mortgage asset-back securities
collateralized debt obligationsChapter Questions
- Identify a bank’s assets, liabilities, and capital.
- Explain a bank’s net worth and its importance.
- Explain liquidity risk.
- How does a bank become insolvent?
- Identify methods banks can reduce adverse selection.
- How did the 2007 Housing Bubble cause banks to become insolvent?