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Answer: Foreign banks in Asia, Europe and other parts of the world had bought collateralized US debt and therefore when defaults rose, these banks lost a lot of money and consequently global lending, even among banks themselves, took a downward spiral.
## Explanation The global financial crisis of 2007-2008 spread rapidly worldwide primarily because: **Key Mechanism:** - Foreign banks in Asia, Europe and other regions had purchased substantial amounts of collateralized US debt (primarily mortgage-backed securities and CDOs) - When US mortgage defaults rose dramatically, the value of these collateralized debt instruments plummeted - This caused massive losses for international banks that held these assets - Consequently, global lending froze as banks became risk-averse and faced solvency issues **Why Other Options Are Incorrect:** **Choice A:** While US banks did finance foreign banks, this was not the primary transmission mechanism. The crisis was fundamentally a solvency issue related to toxic assets, not just a liquidity problem. **Choice B:** The crisis spread was not primarily due to emerging market instability concerns. The core issue was direct exposure to US housing market through complex financial instruments. **Choice C:** While declining US demand for exports did contribute to the global recession, this was a secondary effect that occurred after the financial contagion had already spread through the banking system. **The correct transmission mechanism was the global interconnectedness of financial institutions through complex US mortgage-backed securities, which created a domino effect when the underlying mortgages defaulted.**
Author: Tanishq Prabhu
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While the financial meltdown of 2007-2008 started in the US, it spread fast to other countries leading to worldwide economic turmoil. Which of the following statements best describes why the crisis spread so fast?
A
Banks in the US had been the main financiers of a multitude of smaller foreign banks, and therefore when the financiers suffered liquidity problems, the smaller banks just couldn't obtain funding.
B
Global investors had overestimated the stability of emerging markets, which led to widespread panic and sell-offs when the U.S. financial crisis began.
C
The US entered into a recession, and their demand for exports fell, and therefore many countries experienced a major decline in exports, triggering a worldwide recession.
D
Foreign banks in Asia, Europe and other parts of the world had bought collateralized US debt and therefore when defaults rose, these banks lost a lot of money and consequently global lending, even among banks themselves, took a downward spiral.