Iycee Charles de Gaulle Summary Mortgage Backed Securities and Crisis Essay

Mortgage Backed Securities and Crisis Essay

Mortgage Backed Securities and Crisis

            On September 15, 2008, the biggest bankruptcy which nearly destroyed American Economy took place under Chapter 11 bankruptcy protection. Lehman Brothers was a 158 years old firm situated on Wall Street ended by shocking the global financial system. According to Lehman, they will still continue their business while it investigates about its broker’s sale and other strategic options. When the news of Lehman Brothers bankruptcy was sent to the financial stocks the shares belonged to firm’s tumbled for more than ninety percent. Documents illustrates that Lehman closed it doors from a debt of $600 billion. The bank itself had total debts of $613 billion in opposition to the total asset of $639 billion. According to Bankruptcy Court of Southern District New York, Lehman Brothers has somewhat more than hundred thousands of creditors. As Lehman Brothers collapsed, it put hundreds and thousands of jobs on risk all around the world which also includes maximum 4,000 jobs in the city itself. It has also shocked the banking world around the globe with commentators who predicted that damage due to Lehman Brothers bankruptcy can also be felt throughout the industry and UK can be pushed for downturn. (Market Watch, 2008)

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 Major causes for Lehman Brothers bankruptcy are the following:

–          First of all, Lehman Brothers provided a huge amount of loans to mortgage companies to help them go in public. It gave loans to the corporations in order to create sub-prime mortgages in which Lehman could get involved from the beginning till the end though covering its position from the actual lenders. After assisting the companies to go in public and giving them lines of credit to generate mortgages, Lehman Brothers frequently also bought mortgages to secure themselves and to generate more fees from the new bonds sale.

–          Secondly, as madness for sub-prime loans rose in early 2000, most of the Wall Street companies became owners of the housing mortgage loan servicing corporations. Lehman Brothers owned Aurora Loan Services therefore any firm that got loan from these companies were not permitted to integrate their names with the housing mortgage loan corporation. As a result, the company used to cut off from the negative publicity on the measurement of sub-prime lenders they possessed. Firms also managed the hedge funds that were heavily invested in sub-prime mortgage bonds. In this way, at least some of the money went into securities as it also became difficult to amplify the demand falsely plus to convince public pension funds to convert into invertors for them.

The credit crisis began in August 2007 due to the collapse of Bear Stearns hedge funds as they lacked of confidence in the holdings of sub-prime mortgage. The takeover of Fannie Mae and Freddie Mac by the government due to insolvency surprised other firms that involvement with Government Sponsored Enterprises (GSE) can also face collapse. As the GSE investigated and regulated restriction after discovering the accounts in 2003, firms in Wall Street stepped into the null and void situation and offered securitized purchase of mortgages. During this process Lehman Brothers including other firms tried to search for new buyers while Fannie and Freddie’s were not able to buy loans in the secondary markets. Firms of Wall Street could have generated bonds and sell them without the assistance of Fannie and Freddie by selling mortgage backed securities to the government, opened the trading to purchase unsecured loans from non bank lenders of Saving & Loans. These loans could have been sold under mortgage backed securities to the investors with Structured Investment Vehicles (SIV) which would have helped to take government place. (Nick Adama)

            However, as the Lehman Brothers got bankrupted, Treasury bond prices went down where the investors reacted on the most dramatic economic news that took place in the history of United States. Stock market also fell precipitously as Dow Jones was closed on 500 points which is the worst point drop since the attack of terrorist in September 2001. Mean while, President George Bush ordered the government not to bail out the Lehman Brothers by saying, “we are working to reduce disruptions and minimize the impact of these financial market developments on the broader economy”. While against to the orders of the president, American International Group Inc. was asking emergency funding from Federal Reserve. Though, a number of banks working in New York with the government officials, announced to fund for $70 billion for the troubled company. Several other banks such as Bank of America and Citibank announced to lend $7 billion to help boost up the liquidity and other confronts affecting the debt markets as well as world wide equity. Federal Reserve also donated money with other banks investments. Still in London, FTC 100 share index was down by 4.07%, in Paris CAC-40 was down by 4.5% and in Germany DAX-30 was off by 3.23%. India’s Sensex dropped by 3.4%, while in Taiwan the benchmark index tumbled by 4.1% and Singapore by 3.2%. The chief of European and UK economist at Global Insight, Howard Archer, has already warned that the surviving banks might be even more hesitant to lend loans.

            According to Lehman, bankruptcy will only affect Lehman Brothers Holdings therefore its subsidiaries such as Neuberger Holdings LLC will still take control its customers and trades. Asset of Neuberger is not included into Lehman creditors as said by the company. However, Lehman Brothers is to trade its sector of investment management which consists of Neuberger Berman, Clayton Dubilier & Rice and Bain Capital. One of the prime failures of the oldest corporation came to come to blows the United States world wide credit crunch which exaggerated the problems again after ten years.

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            Lehman Brothers fell under the loss of $60 billion in estate holding as a result, credit markets ultimately pressurized to look for protection given by the court. Since last year, the credit crisis had already caused worldwide banks to write down more then three billion dollars in asset plus it also caused the shotgun deals of Merrill Lynch & Co. Lehman Brothers and Merrill Lynch Co. together enlarged their business regarding property which included sub-prime mortgages; lend loans to people who are low on income and individuals with poor credit records. In past, Lehman had already went into loss with $14 billion for approximately eighteen months after they were obliged to take massive amount of write downs depending on the value of their investments. The collapse amid Lehman and Barclays came after the government officials came to the US central bank for three days. US treasury and Fed both hoped to secure Lehman Brothers as the Asian markets were going to open soon after. As Lehman Brothers collapsed all of the traders rushed towards government treasury bonds on the other hand, price of dollar went down against yen and euro. Managing director of Knight Equity Markets stated that financial system of US is finding tectonic plates below its base as it has been shifted like never before. Same like Bill Gross, officer at Pacific Investment Management warned of the up coming tsunami due to complicated derivative position forced by the dealers took place. Former chairman of Fed, Alan Greenspan, describe the credit disaster as a once in a century kind of an occurrence. (Msnbc News Services, 2008)

            Analysts of financial crisis said that home prices has been cut down to approximately twenty five percent and can drop even more for another fifteen percent. As loans provided by a number banks plus consumers have engraved their spending the crisis has been slow down. Now various economists are forecasting that by the end of the year the US economy can slip into downturn. This way additional loss can take place such as loss of commercial banks on credit cards, student loans and auto loans. Fed has expected to keep interest rates below inflation and steady at two percent. It is also possible that central bank will cut its rates to calm the current market situation. Banks have given only $350 billion for the losses but as predicted by International Monetary Fund this year, total losses due to the credit crisis can reach up till $1 trillion. Commercial banks have also gone into crisis therefore eleven of them have been already closed such as IndyMac Bank that had $19 billion in its deposits and $32 billion in assets. Managing Director of Institutional Risk Analytics, Christopher Whalen, has predicted that almost one hundred and ten bank with $850 billion in assets can close till July 2009. This total was made out of 8,400 government insured organizations which all together gripped $13 trillion in assets. (Guardian News and Media Limited, 2008). According to Fed, investigations, collapse due to Lehman Brothers is not that much disastrous for the markets as compared to Bear Stearns or Freddie Mac. Although this year, the stock of the company lost more then 75% in value. However, Fed decided not bail out Lehman Brothers for the fact that Fed never wanted to come into sight like the way it does not “walk the talk”. When Bear Stearns was bailed out by Fed in March 2008, the company defended its position by saying that bailing is not an unusual event. To save some other financial would be like Federal Reserve like and would not keep its word.
Lehman Brothers, the company on which Washington and Wall Street has spent so much resources and time to decide its ultimate fate. Whether the company has been absorbed by another giant investment companies, ended up in bankruptcy, bailed out by Treasury or Federal Reserve or permitted to go ahead with its restructuring plan, the company has left US housing market with an unforgettable mark. As Lehman Brothers had left industry of sub-prime before it got into crisis, the smart money has left Lehman. Now government, shareholders and public has the responsibility to clean up the mess which is left behind.

Bibliography

Nick Adama, How Lehman Brothers Participated in the Sub-prime Mortgage Industry and Why it Failed, Ezine Articles, Accessed on November 22, 2008 from http://ezinearticles.com/?How-Lehman-Brothers-Participated-in-the-Subprime-Mortgage-Industry-and-Why-it-Failed&id=1586806

Market Watch (2008), Wall Street Titan goes under After Frenzied Search for Buyer Falls Short, Lehman Files for Bankruptcy Protection, Accessed on November 22, 2008 from,http://www.marketwatch.com/News/Story/Story.aspx?guid=50d06af40ad54b388206d4c8d6e62ec7&siteid=nwhwk&sguid=EbkHc_MynE-vFgBrehdOnA

 Msnbc News Services (2008), Industry Emerging Transformed After Frantic Weekend of Crisis Management, Wall Street Scrambles as Lehman, Merrill Falter, Accessed on November 22, 2008 from http://www.msnbc.msn.com/id/26709927/

Guardian News and Media Limited (2008), Banking Crisis: Lehman Brothers Files for Bankruptcy Protection, Accessed on November 22, 2008 from http://www.guardian.co.uk/business/2008/sep/15/lehmanbrothers.creditcrunch