Identify the correct sequence of events as it unfolded in the credit crisis beginning 2007:

Identify the correct sequence of events as it unfolded in the credit crisis beginning 2007:

I. Mortgage defaults increased

II. Collapse in prices of unrelated assets as banks tried to create liquidity

III. Banks refused to lend or transact with each other

IV. Asset prices for CDOs collapsed
A . III, IV, I and II
B . I, III, IV and II
C . I, IV, III and II
D . IV, I, II and III

View Answer

Answer: C

Explanation:

According to a paper by the BCBS, here is an excellent summary of what happened. Based on this, Choice ‘c’ is the correct answer.

"At the outset of the crisis, mortgage default shocks played a part in the deterioration of marketprices of collateralised debt obligations (CDOs). Simultaneously, these shocks revealed deficiencies in the models used to manage and price these products. The complexity and resulting lack of transparency led to uncertainty about the value of the underlying investment. Market participants then drastically scaled down their activity in the origination and distribution markets and liquidity disappeared. The standstill in the securitisation markets forced banks to warehouse loans that were intended to be soldin the secondary markets. Given a lack of transparency of the ultimate ownership of troubled investments, funding liquidity concerns were triggered within the banking sector as banks refused to provide sufficient funds to each other. This in turn led to the hoarding of liquidity, exacerbating further the funding pressures within the banking sector. The initial difficulties in subprime mortgages also fed through to a broader range of market instruments since the drying up of market and funding liquidity forced market participants to liquidate those positions which they could trade in order to scale back risk. An increase in risk aversion also led to a general flight to quality, an example of which was the high withdrawals by households from money market funds."