Explanation:
The rapid global spread of the 2007-2008 financial crisis was primarily driven by the interconnectedness of global financial markets and the widespread distribution of US mortgage-related toxic assets.
Financial institutions in Europe, Asia, and globally had heavily invested in collateralized debt obligations (CDOs) and mortgage-backed securities (MBS) originated in the US due to their attractive yields and high credit ratings. When the US housing market collapsed and subprime mortgage defaults skyrocketed, the value of these collateralized debt instruments plummeted. This caused massive losses on the balance sheets of foreign banks, leading to a severe contraction in interbank lending, a freeze in global liquidity, and effectively transmitting the US housing crisis to the rest of the world.
Therefore, Choice D is the correct answer. Options A, B, and C do not capture the primary contagion mechanism, which was the direct exposure of international banks to US toxic securitized assets.
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Q.418 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.
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