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incentives of the government. The innovation in lending practices, involvement of government, the rising home prices, decrease in federal reserve interest rate create demand for nontraditional mortgages such as non prime mortgages.

The mortgage originators found new innovative methods in lending to cope up with the borrowers demand this could have been done only with the help of government intervention. The aggressive lending methods and increase in non prime mortgages led to increase in credit risk for the borrowers and investors as well.

As the interest rate increased, the borrowers found it difficult to repay monthly installments as many borrowers are non prime borrowers with low credit history. So with the rise in interest rate these borrowers found it difficult to cope up with increased monthly installments. This in turn increased delinquency and foreclosure rate. The final blow came when housing prices started to decrease. The condition got much worse and additional stress contributed for much higher delinquency and foreclosure rate.

Banks in turn securitized these toxic loans and got extra liquidity to lend more loans. The extra liquidity in the hands of banks and demand for non prime mortgages made banks to lend more loans to non prime borrowers.

All these mortgages are pooled and sold to agencies who are SPV. These agencies then convert these pools of loans in to securities and sold to investors. Before selling to investors these securities need to get rated from rating agencies for its marketability. Rating agencies charged the agencies to rate the RMBS thereby there is change in role played by rating agencies. This change is role of rating agencies earned them millions of dollars of money. To rate these securities Moody's used statistical models.

Rating agencies like moody's relied on data provided by these agencies for their models. They have never verified the accuracy of the data provided by the agencies. And models used by rating agencies are not that accurate if the data is not accurate the results from these models are not accurate. And their methodologies lack transparency and had endogenous risk involved it. Finally these models predict probability of default for present and are not accurate for calculating future probability of risk. So rating agencies like moody's started to play catching up game by updating their models for changing economic conditions.

As risk involved is not clearly assessed by these banks they started to rate these tranches high enough. As the market started to meltdown because of financial crisis, moody's updated their methodology accordingly to changing economy and reviewed the securities and downgraded many top rated securities. These downgrades created uncertainty and doubt on quality of rating these rating agencies assigned. With more exposure to risk related to subprime debts, restricted liquidity of banks, the aftermarket for term loans has effected so there is sharp increase in risk premium. Thus banks lost confidence and have less liquidity. This resulted in present financial crisis.