The Financial Crisis Of Lehman Brothers

In the movie the big short, Lewis Ranieri, who is a banker of the Wall Street, created an idea that companies packed thousands of mortgage all bundled together to sell, which is the AAA credit-rating bond, and can obtain high yields with low risk because everyone should pay for their mortgage. The concept of Lewis Ranieri is called mortgage-backed securities (MBS). However, the demand of buying MBS is more than MBS supply. Therefore, when the risk of MBS is high, Collateralized Debt Obligation (CDO) is a way to change subprime loans to high- rating bonds and it can be sold again. Although CDO is full of subprime loans, it still can get AAA rating because

In 2008 America’s financial system was brought to a stand still as decades of negligence and financial decisions caused our economy to sink into the worst recession since the great depression. Cultivating a problem worse than America has seen in roughly a century points one finger not at a particular cause, but a string of events that finally gave way. Now, eight years later our economy is still recovering, and time has allowed us to look back at decades of mistakes to try and connect the dots of the perfect storm that collapsed our financial market in 2008. In 2009 Brookings Institution, one of Washington’s oldest think tanks, concluded there were three causes that resulted in the crisis. Economists Martin Baily and Douglas Elliot stated that the results of government intervention in the housing market, the influences Wall Street had on Washington, and global economic forces were the three main causes of the economic collapse. They believed that a housing bubble inflated when Fannie Mae and Freddie Mac, two government-sponsored enterprises, intervened in the housing market. The banking industry was called out to be blamed for years of manipulation of our political and financial systems. Lastly, Baily and Elliot cite the global economy and the existence of a credit boom throughout European and Asian nations. Low inflation and consistent growth throughout the world economy spiked investors’ interest in acquiring riskier investments, which encouraged

June 13, 2007 is the day that Richard C. Cook claims in his article, “It’s Official: The Crash of the U.S. Economy Has Begun.” In the past couple of years, months, and weeks, the United States economy and stock market showed significant failures and inefficiencies to the world. Perhaps the greatest evidence signaling the recent economic meltdown is the subprime mortgage problems that started a little over a year ago. The burst of the U.S. housing market bubble was caused by a combination of risky lending and borrowing practices and higher interest rates coupled with dropping housing prices, making refinancing more difficult. To deepen the drama, Wall Street’s excessive debt and unsustainable

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

Freddie Mac was supposed to remain highly capitalized and use all its resources to fulfill its national goal as a fund provider to the private mortgage market while increasing its revenues and paying out dividends to its shareholders. All these factors made Freddie invest more in all the profitable but risky mortgages. As a result, its mortgage portfolio started to deviate from “conforming mortgage” to the so-called “private label ” MBS which included “balloon mortgages ” , “interest only ”, and “negative amortization mortgages ”. Freddie built a huge portfolio out of these risky mortgages to the extent that they accumulated in 2007, $230 billion on their $800 billion portfolio. (Citation Needed)

Securitized mortgages, also known as mortgage-backed securities, is not a twenty-first century concept. Since the 1980s, securitized mortgages have transformed the financial sector “By transforming illiquid [mortgages] into tradable securities, [which] has helped channel cash flow to borrowers and

On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and $619 billion in debt, Lehman 's bankruptcy filing was the largest in history, as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees worldwide. The consequences for the world economy were extreme. Lehman’s ' fall contributed to a loss of confidence in other banks, a worldwide financial crisis and a deep recession in many countries. Lehman 's collapse roiled global financial markets for weeks, given the size of the company and its status as a major player in the U.S. and internationally. Many questioned the U.S. government 's decision to let Lehman fail, as compared to its tacit support for Bear Stearns, which was acquired by JPMorgan Chase & Co. (JPM) in March 2008. Lehman 's bankruptcy led to more than $46 billion of its market value being wiped out. Its collapse also served as the catalyst for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also announced on September 15.

And the other causes are securitization practices, inaccurate credit ratings, government policies, policies of central bank and financial institutions debt levels. Securitization is structured finance process in which assets, receivables or financial instruments are acquired, pooled together as collateral for the third party investments( Investment banks). There are many parties involved. Due to the securitization, investor appetite for mortgage-backed securities (MBS), and the tendency of rating agencies to assign investment-grade ratings to MBS, loans with a high risk of default could be originated, packaged and the risk readily transferred to others that began in 1970. Now things start to get complicated. Pieces of mortgage-backed securities can be inserted into new investment vehicles, with a remarkable result: investments originally rated as risky can re-emerge rated as safe. This can be done when An investment bank creates a new security from risky slices of multiple securities. In

The year 2008 was a chaotic time in the United States. The investments from companies in collateralized mortgage obligations (CMOs), which were supported by subprime mortgages caught up with those same companies (Poole, 2010, p. 424). Three companies who invested in these CMOs made headlines: Bear Stearns, Lehman Brothers, and American International Group (AIG). This paper will explore what the causes of the financial crisis were, a specific law case involving Lehman Brothers, the Federal Reserve (the Fed) and Congress’s responses, and solutions to prevent an event like this from happening again.

Both Robert Wade’s and Charles Kindleberger’s respective pieces, “Wheels Within Wheels: Rethinking the Asian Crisis and the Asian Model” and “Manias, Panics and Crashes: A History of Financial Crises”, show how credit booms can lead to market failure. On Wall Street, Kindleberger recounts how the housing bubble collapsed and how this breakdown affected United States banking institutions. Firms with a lack of capital income and low capital reserves could not pay off their debts when scared investors pulled their money out of banks during bank runs. Many firms had risky investments and low reserves because they believed that the government would bail them out, but Lehman Brothers, the fourth-largest investment bank at the time, was allowed

Although Lehman Brothers were considered “too big to fail,” it was not bailed out because the Fed claimed that Lehman’s collateral was insupportable under section 13(3), which allows “the Fed to lend to a wide range of borrowers using good collateral if at least five Fed governors approve” (Smith, 2011, p. 17). Consequently, investors withdrew their money from “all banks and money-market funds” (Smith, 2011, p. 19). AIG, the largest insurance company in the US, had a major liquidity issue because of its investments in credit default swaps (CDS) (Safa, Hassan, Maroney, 2013, p. 1337). Since AIG was considered too big to fail, the Federal Reserve decided to inject $85 billon to save the company, and an additional $37.8 billion in October (Safa, Hassan, Maroney, 2013, p. 1338, 1346). However,

In 2007, the United States experienced a crippling recession in the mortgage/real estate field. This crushed the American economy as countless individuals lost their homes due to foreclosure as banks and other various lending institutions were forced to freeze their practices to ensure their survival. While this seemed to happen virtually overnight, there were several factors that served as signs and eventual learning points, providing insight into the cause of the crash.

Credit default swap (CDS )is a financial instrument that is designed to trade credit risk that a reference entity has credit events, and it is a credit derivate that is traded over-the-count. There are two sides in a CDS contract –the buyer and the seller. Generally, the buyer needs to pay a periodical premium to the seller , and in return, if the credit events occur, the seller pay the compensation to the buyer. The credit events refer to defaults of corporations or debts. The credit default swap was introduced in 1994 and started to be prevalent from 2001. According to the ISDA Market Survey ( 2010 ), at the end of 2007, the CDS market size had increased to 62 trillion from 919 billion in 2001.

Before the firm became bankrupt, they had more than $275 billion in assets under management. Furthermore, since the time the bank went public in 1994, the firm had increased net revenues over 600% from $2.73 billion to $19.2 billion and increased its employee headcount over 230% from 8,500 to almost 28,600 (Demyanyk, Y. S. and Hemert, O. V. 2008).

The financial services industry is highly competitive and constantly evolving. Not long ago, terms such as collateralized debt obligations, credit default swaps, and synthetic collateralized debt obligations would seem like a strange foreign language. But today, they have risen to become an increasingly larger share of our industry. It’s no secret that these types of financial instruments played a significant role in the financial crisis of 2008-2009. However, they are a necessary evil and must be part of any viable growth strategies in the financial services world. We must take similar risks in order to maximize our profits. That’s