Question

A significant number of European banks held large amounts of assets as mortgage-backed securities derived from the U.S. housing market, which crashed after 2006. How does this demonstrate both a benefit and a cost to the internationalization of financial markets?

Short answer

The cost of holding such securities is an adverse shift in the market scenario, as a significant drop in the US stock market results in a high default risk and cases, which leads to an increase in mortgage prices.

Step-by-step solution

Step 1. Introduction

As the name suggests, the securities backed by mortgages are known as mortgage-backed securities or MBS. It is an investment that is created by a bundle of mortgages. These mortgages are sold by banks which issued them.

Step 2. Explanation

When European banks have huge amounts of assets in the form of mortgage-backed securities, they are able to provide financial and capital support to people in the US financial market through the exchange of these securities. It permits both parties, such as European banks and US borrowers, to benefit from it.

The cost of internationalization is that the decline in the value of mortgage-backed securities caused a financial crisis in the European market. So, even though housing market collapse happened in the US, its affect was felt in Europe.