2. Credit default swaps (CDSs): CDSs are financial instruments that allow investors to insure themselves against the risk of default on a debt obligation. CDSs were widely used by banks and other financial institutions to hedge their exposure to subprime mortgages. However, when the value of subprime mortgages declined, the value of CDSs also declined, leading to losses for the financial institutions that had purchased them.
3. Collateralized debt obligations (CDOs): CDOs are financial instruments that are backed by a pool of debt obligations, such as subprime mortgages. CDOs were often rated AAA by credit rating agencies, which led investors to believe that they were safe investments. However, when the value of the underlying subprime mortgages declined, the value of the CDOs also declined, leading to losses for investors.
4. Excessive leverage: Financial institutions used excessive leverage, or borrowed money, to increase their returns on investment. This allowed financial companies to purchase large numbers of subprime mortgages and CDOs, which magnified their exposure to the financial crisis. With the downfall in asset values, the excessive financial leverage only increased losses.
5. Lack of regulation: The financial industry was not adequately regulated during the time leading up to the financial crisis. This allowed banks and other financial institutions to take on excessive risks without being properly monitored.
6. Greed and fraud: Some financial institutions engaged in illegal and unethical practices in order to maximize their profits. This included misrepresenting the risk of subprime mortgages and CDOs to investors, and engaging in insider trading.