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Unformatted text preview: lems with asymmetric informa9on → declines in economic ac9vity) could stop here. 16 Stage 3: Debt Defla9on •  The spiral can go further… •  If contrac9ons in economic ac9vity are large enough, the price level starts to fall. •  Debt defla9on: A situa9on in which a substan9al decline in the price level sets in, leading to a further deteriora9on in firms’ net worth because of the increased burden of indebtedness. 17 The Subprime Financial Crisis of 2007 – 2008 •  Financial innova9ons emerge in the mortgage markets: –  Subprime and Alt- A mortgages –  Mortgage- backed securi9es –  Collateralized debt obliga9ons (CDOs) –  Securi9za9on: The process of transforming otherwise illiquid financial assets into marketable capital market securi9es –  Risk diversifica9on ⇒ a security is made up of many loans with different characteris9cs. 18 The Subprime Financial Crisis of 2007 - 2008 •  Process of securi9za9on (originate to distribute model) Commercial Banks Commercia...
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