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Financial crisis

occurs when an increase in asymmetric information from a disruption in the financial system causes severe adverse selection and moral hazard problems that render financial markets incapable of channeling funds efficiently from savers to household and firms with productive investment opportunites

Bank panic

occurs when multiple banks fail simultaneously

financial liberalization

the elimination of restrictions on financial markets and institutions, or when major financial innovations are introduced to the marketplace ,as occurred recently with subprime residential mortgages.

credit boom

With restrictions lifted or new financial products introduced, financial institutions frequently go on a lending spree. Expand their lending at a rapid pace


With less capital these financial institutions cut back on their lending

Asset-price bubble

increases in asset prices in the stock and real estate markets that are driven well above their fundamental economic values by investor psychology

debt deflation

substantial unanticipated decline in athe price level sets in, leading to a further deterioration in firms net worth because of the increased burden of indebtedness

subprime mortgages

mortgages for borrowers with less than stellar credit records

Alt-A mortgages

mortgages for borrowers with higher expected default rates than prime, but with better credut records than subprime borrowers


By lowering the transactions costs, computer technology enabled the bundling together of smaller loans like mortgages into standard debt securites

Mortgage backed securities

The ability to cheaply bundle and quantify the default risk of the underlying high risk mortgages in a standardized debt security

Financial engineering

the development of new sophisticated instruments

structured credit products

derived from cash flows of underlying assets and can be tailored to have particular risk characteristics that appeal to investors with differing preferences

collateralized debt obligations (CDOs)

paid out the cash flows from subprime mortgage backed securites in different tranches, with the highest rated tranch paying out first, while lower ones paid out less itf there were losses on the mortgage backed securites

originate to distribute


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