The Financial Crisis Of Lehman Brothers

1948 WordsApr 12, 20168 Pages
Where It Began There are several distinctive moments for which a strong argument can be made as the start of the 2008 financial crisis. Some experts argue that the pivotal moment was the failure of Lehman Brothers, which resulted in a run on financial institutions, while others blame the crisis on the housing bubble that burst in 2007, following years of skyrocketing prices in that market. Digging deeper than the macro issue of the housing bubble, the true cause of the financial crisis can be traced to banks’ incredibly risky policies regarding how and to whom they made large real estate loans and the insatiable greed that drove them to adopt these practices. In this analysis of the perfect storm that facilitated the financial meltdown, I…show more content…
Because of the amortization, MBSs differ from traditional bonds that typically only makes interest payments, with the principal being repaid in its entirety at the bond’s maturity date. In addition to the expected monthly cash flows, investors that own MBSs also receive unscheduled payments of principal that is repaid early due to refinancing, foreclosures, or house sales. These premature payments make it difficult to predict the maturity of MBSs, a problem that traditional bonds do not have, making them more risky by default. In addition to the unique risk of prepayment, MBS are also subject to risks more typically associated with traditional bonds such as credit and default risk. Credit Default Swaps A credit default swap (CDSs) is essentially an insurance policy that allows speculators to bet against default on loans or bonds held by others. They are not always used in a speculatory fashion, as they can also be used to mitigate risk related to a loan held by the owner of the CDS. A fairly new concept, CDSs are primarily a mechanism to speculate and are mostly unregulated, a combination of factors by which they become a potentially dangerous financial instrument. Speculators simply pay insurance premiums against the underlying loans or bonds and wait for them to default, resulting in a large payout by the insurer. Market Conditions Leading Up to the Crisis Rapid Increase in Subprime Mortgages and the Perpetual Cycle After jumping more than 6% in 1999,
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