![]() The investors relied on their insurance policy - the CDS - and also neglected to monitor the borrowers. The loans were no longer on the lenders’ books, so they had less incentive to monitor the borrowers. Poor quality loans were originated by lenders, and then were repackaged, securitized and sold to investors. The researchers found a direct effect between credit default swaps and higher loan default rates. When investors buy mortgage-backed securities, a CDS provides protection to the investor in case the borrower defaults on the loan. “One of the issues that people have paid particular attention to is the role played by derivative securities, and in this case, credit default swaps.”Ī credit default swap (CDS), in essence, acts as an insurance policy, Zhang said. “There are many media reports that to some extent link the financial crisis to the housing market crash, and subsequently, research has confirmed that,” Zhang said. Lenders increasingly offered subprime mortgages, which inevitably drove much higher mortgage default rates. The researchers found that the presence of credit default swaps further stimulated the strong demand for mortgage-backed securities, which led to lax lending standards in the mortgage origination market and encouraged predatory lending and borrowing practices. Feng Zhao, was published in the April issue of The Journal of Finance. The study, authored by finance and managerial economics professor Dr. Researchers at The University of Texas at Dallas recently published the first empirical investigation connecting credit default swaps to mortgage defaults that helped lead to the 2007-2008 financial crisis. ![]()
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