Econ

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

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These losses necessitated governmental action in the financial markets. Companies such as Lehman Brothers and Bear Stearns lost all of their stock’s value and were forced into bankruptcy. This risk spread throughout the American banks, forcing the American government to step in and buy all of the securitized, troubled assets from the balance sheets of

During the times leading up to the power struggle, the power dynamic within Lehman was steadily shifting as trading profits became increasingly more important to Lehman versus traditional investment banking profits. Thus, Glucksman was able to step into the spot light and Peterson became more expendable. Peter Peterson’s core

Rep. Barney Frank (D-MA) explains the old system of lending and the new securitization process. Matt Demon narrates how the home buyers repaid their loans to lenders, and consequently, the lenders sold the loans to the investment banks which combined the mortgage loans with other credit loans creating a collateral debt obligation a complex derivative. The collateral debt obligation sold to investors who paid the rating agency to evaluate the CDO's. The home buyers were now paying investors through this

In 2008 the United States economy faced it most serious economic downturn since the great depression. This crisis began in 2006 when the subprime mortgage market showed an increase in mortgage defaults. This would lead to the decline of the U.S. housing market after a decade of high growth. The problems in the mortgage market where able to spread to other sectors of the economy especially in financial markets because of Collateralized Mortgage Obligations or CMOs. CMOs where mortgage backed securities that where given out by investment banks and where not regulated by the government. These securities fell as did mortgages due to increasing default rates. Because of CMOs companies bought Credit Default swaps or CDSs. These CDSs where nominally

CDSs are used as an insurance against the possibility that the borrower could not repay his or her loan. In such case the issuer has to pay a specified sum to the buyer. Of course they are sold for a premium and if no credit events occur, the issuer makes profit. After the subprime mortgage crisis began, and many borrowers started defaulting on their loans, the pressure on the companies that had issued CDSs was rising. There were companies that simply did not have enough money to repay everything they owed. A famous example is AIG. The subprime mortgage crisis and the bankruptcy of big financial companies, like Lehman Brothers, meant that AIG had to pay much more money that it expected and made the company insolvent. The company itself had AAA rating shortly before this. This made the investors confident that even their high-rating investments failed, the insurer would certainly be able to repay them. A bailout from the US government followed. Generally, the issuers of these instruments can be held accountable for issuing them, without the ability to pay what they had to, when the credit events occurred. Of course many of them were mislead by the credit rating agencies and the overall conviction in the market that it was not as risky as it actually was. Many people argue that such instruments need to be regulated much better. They can create clear conflict of interests. For example, a

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Rating agencies would rate CDO’s (Collateralized Debt Obligations) on the basis of what tranches they were put into. The highest credit rating and safest is an AAA senior tranche, which has the lowest return because it’s considered “safe”. The middle tranches are rated AA and BB, these are considered riskier but have a higher rate of return. Eventually, when qualified people who would be considered to have an AAA mortgage ran dry. Lenders were quick to lend money out to lower-rated mortgages because they knew they would sell the to investors and pass on the risk to someone else. Even rating agencies were rating BB tranches and then labeling them AAA. While all of this was happening, big time investors thought they were buying safe investments

Briefly explain the rise and fall of LTCM. What was the moral hazard issue the fed was worried about? How did they try and get around the moral hazard issue? What specifically was the Fed's role in the bailout? What roles specifically did Bear play and not play in the LTCM's life and death?

A CDO is created when mortgage loans are grouped together, divided by risk, and sold to investors from the banks that hold them. The banks, when doing so, pass the risk of a loan defaulting onto the investor. However, they do not make as much money on the loan, as the investor has to make their profit as well (Kiviat 30). These CDO’s initially appeared as a sound investment, but when the demand for CDO’s exceeded supply for investment, artificial CDOs were created by dividing up other CDOs. This allowed people to be deceitful of the quality of their investments. Investments are rated on a scale from AAA to A and BBB to B, with AAA being the least risky, and B being the most. What these artificial CDOs did was carefully chop up grade BBB or even grade BB legitimate CDOs and repackaged as AAA investments even though they contained things like subprime mortgages and no documentation loans in the mix (Kiviat 30). Because some holding groups invested heavily in CDOs, losses in the subprime market caused hedge funds to become nearly worthless. One of the hardest hit companies was BearStearns, who had two hedge funds go from over $1.5 billion to practically nothing (Kiviat 30).The artificial CDOs created by greed on Wall St. has also caused international banks, like BNP Paribas SA, France’s biggest bank to freeze funds because the bank couldn’t “ ‘fairly’ value their holdings after

The financial crisis of 2008 was the worst economic disaster since the Great Depression. It caused the collapse, take over, merging, or buying out of financial services firms and banks such as, Lehman Brothers, Merill Lynch, Wells Fargo, Goldman Sachs, AIG, Royal Bank of Scotland, Fannie Mae and Freddie Mac. The “Big Three” credit rating agencies, Standard & Poor’s, Moody’s, and Fitch Ratings, were at the helm of the financial crisis of 2008 because they were all found of wrongly assigning triple- A securities ratings to mortgages and debt assets that were way below “investment grade” level, which greatly contributed to the growing financial crisis. The ensuing result of the financial crisis of 2008 was the Great Recession, a period of great economic decline in America and the rest of the world. The financial crisis and Great Recession were triggered by subprime mortgages and mortgage backed securities, known as Collaterized Debt Obligations (CDOs). Mortgage-backed securities are a form of an asset-backed security that deals with different type of mortgages, while subprime mortgages are mortgages that are loaned out to people with low credit scores. CDO’s are very complex because they are built into different levels, known as tranches, that consist of various types of assets. The tranches of CDO’s are structured on the basis of risk, with the lowest credit rated tranches holding the highest amount of risk. A demand for mortgage-backed securities and subprime mortgages

The CDS does not require buyers to actually hold underlying assets. That means a third party can “insure” against default risk that it would not bear the consequence at the first place. A financial institution can act like an insurance company by selling CDSs. American International Group (AIG) was the largest CDS underwriter during the crisis. AIG issued tons of CDSs because historical default rate on bonds were so low that issuing CDS became a cash generator. They simply collected the premium and never though of paying out anything until the crisis hit.