Why is the shadow banking system an important part of the 2007-2009 financial cr

Question

Why is the shadow banking system an important part of the 2007-2009 financial crisis? A. The shadow banking system was able to take on significantly less risk than other financial firms, preventing the economy from losses. B. An increase of funding from the shadow banking system resulted in a decrease in the issuance of CDOs, increasing the severity of adverse selection and moral hazard problems. C. A decrease of funding from the shadow banking system caused a restriction of lending and a decline in economic activity. D. A large amount of funds flowed through the shadow banking system, which increased interest rates and fueled some of the housing bubble.

Explanation / Answer

C. A decrease of funding from the shadow banking system caused a restriction of lending and a decline in economic activity.

Shadow banking comprises a diverse set of institutions and markets that, collectively, carry out traditional banking functions — but do so outside, or in ways only loosely linked to, the traditional system of regulated depository institutions. Examples of important components of the shadow banking system include securitization vehicles, asset-backed commercial paper [ABCP] conduits, money market funds, markets for repurchase agreements, investment banks, and mortgage companies"

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