THE ECONOMIC TIMES

The current financial turmoil is rooted to the sub prime crisis. During boom years, mortgage brokers enticed by the lure of big commissions, talked buyers with poor credit into accepting housing mortgages with little or no down payment and without credit checks. 

Banks and financial institutions often repackaged these debts with other high-risk debts and sold them to world-wide investors creating financial instruments called CDOs or collateralised debt obligations. The serious sub prime mortgage crisis began in June of 2007 when two Bear Stearns hedge funds collapsed. 

Federal Reserve Bank and European Central Bank dumped $100-billion in liquidity into the system that calmed the market down for a short period. However the sub prime crisis continued to be solid as long as the housing market continued to escalate and interest rates didn’t go up. 

BOUNCED CHEQUES 

Lehman Brothers Lehman’s slow collapse began as the mortgage market crisis unfolded during the summer of 2007. Its stock began a steady fall from a peak of $82 a share. The fears were based on the fact that the firm was a major player in the market for sub prime and prime mortgages. 

Lehman managed to avoid the fate of Bear Stearns, the other of Wall Street’s small fries, which was bought by JP Morgan Chase at a bargain basement price under the threat of bankruptcy. 

Lehman and Bear Stearns had a number of similarities. Both had relatively small balance sheets, they were heavily dependent on the mortgage market, and they relied heavily on the “repo” or repurchase market, most often used as a short-term financing tool. 

On June 9, 2008, Lehman announced a second-quarter loss of $2.8 billion, far higher than analysts had expected. The situation became worse after the government on announced on September 8 a take-over of Fannie Mae and Freddie Mac. Lehman’s stock plunged as the markets wondered whether the move to save those mortgage giants made it less likely that Lehman might be bailed out. 

Treasury Secretary Henry M. Paulson Jr. and Federal Reserve officials did encourage other financial institutions to buy Lehman, but by the end of the weekend the two main suitors, Barclay’s and Bank of American, had both said no. Lehman had reached the end of the line. 

AIG Investment banking is an intrinsically cyclical business, but Wall Street’s greedy-and-aggressive top management forgot about that as they chased profits and bonuses during a stretch in which money was always easy to obtain. 

AIG shouldn’t have had problems as it’s primarily an insurance company. However, when you look at AIG’s balance sheet, it has also made a speciality of speculative trading in derivatives. That was an attractive business for many years but like other businesses has recently run into trouble, it also followed suit. 

Merrill Lynch Shortly after Lehman Brothers filed for bankruptcy, Merrill Lynch complained of suffering from a similar disease, and before the effects could become devastating, it cut a deal with the Bank of America for $50b, far below its value. 

IMPACT IN INDIA 

IT Cos: With nearly half of their revenues coming from banking and financial services segments, India’s top software exporters are closely monitoring the financial crisis spreading across markets. 

The IT giants which had all these investment banks as their clients are TCS, Wipro, Satyam and Infosys Technologies. HCL seems to have escaped the loss as neither Lehman nor ML were their clients. 

Banks: The government is worried the ongoing crisis would have an adverse impact on Indian banks. Lehman Brothers and Merrill Lynch had invested substantially in the stocks of Indian banks. The banks, in turn, have invested in derivatives, which might have exposure to these investment bankers. 

PSU banks like Bank of India, Bank of Baroda have exposure towards derivatives. ICICI bank is the worst hit as of now. With Lehman Brothers filing for bankruptcy in the US, the country’s largest private bank ICICI Bank is expected to lose approximately $80 million (Rs 375 cr), invested in Lehman’s bonds through the bank’s UK subsidiary. The meltdown is also expected to hit Axis bank but the impact is not clear yet. 

Real estate: Lehman Brothers Real Estate Partners had given Rs 740 crore to Unitech Ltd, for its mixed-use development project in Santa Cruz. Lehman had also signed a MoU with Peninsula Land Ltd-a Ashok Piramal real estate company-to fund the latter’s projects to the tune of Rs 576 crore. Another major real estate organisation whose valuations are affected by this meltdown is DLF Assets in which it had invested $200 million. 

Bailout Package 

The White House gave a package of over $500 bn which came as a lifeline to sinking equity markets around the world. US President George W Bush said the administration’s new rescue plan to revive the credit markets and restore market liquidity will ease pressure on the balance sheets of banks and other financial institutions. He said that America’s economy was facing unprecedented challenges, and they were responding with unprecedented action. 

Meanwhile in India, finance minister P Chidambaram assured that PSU banks had virtually no exposure to Lehman Brothers. Although the credit crunch globally will impact credit availability in the Indian market, there is no cause for any alarm that any Indian bank is vulnerable, the FM said.

What Caused The Financial Crisis Of 2008?

I think we can sum up the cause of our current economic crisis in one word — GREED. Over the years, mortgage lenders were happy to lend money to people who couldn’t afford their mortgages. But they did it anyway because there was nothing to lose. These lenders were able to charge higher interest rates and make more money on sub-prime loans. If the borrowers default, they simply seized the house and put it back on the market. On top of that, they were able to pass the risk off to mortgage insurer or package these mortgages as mortgage-backed securities. Easy money!
My Greedy Real Estate Agent

My own experience with these greedy lenders and real estate agents happened about two years ago. My wife and I were thinking about upgrading our home to something slightly bigger, and in a better neighborhood. As we go through the process, we resolved not to do it because it would double our monthly mortgage payment and add another 20 years to our mortgage term.

When I told the real estate agent I couldn’t afford the monthly payment, he said I could go for a 40 years mortgage with 5% down payment, and apply for more than what I needed so that I’ll have an emergency fund. Basically, he advised me to decimate my cash flow and savings so that I can pay mortgage into my 70s. And while I am at it, I should pay private mortgage insurance (PMI) for a couple of years. Now, that’s irresponsible and greedy.

The sad thing about the scenario above is that I am certain there are borrowers who didn’t know any better and went along with a similar plan.
What Went Wrong With Our Financial System?

The whole thing was one big scheme. Everything was great when houses were selling like hot cakes and their values go up every month. Lenders made it easier to borrow money, and the higher demand drove up house values. Higher house values means that lenders could lend out even bigger mortgages, and it also gave lenders some protection against foreclosures. All of this translates into more money for the lenders, insurers, and investors.

Unfortunately, many borrowers got slammed when their adjustable mortgage finally adjusted. When too many of them couldn’t afford to make their payments, it causes these lenders to suffer from liquidity issue and to sit on more foreclosures than they could sell. Mortgage-backed securities became more risky and worth less causing investment firms like Lehman Brothers to suffer. Moreover, insurers like AIG who insured these bad mortgages also got in trouble.

The scheme worked well, but it reverses course and is now coming back to hurt everyone with a vengeance.
The Bailout And Who Should Pay

I don’t like the idea of government bailout, because the government is using my money to help out greedy bankers. Unfortunately, it may be the only option we have right now, but I hope these greedy lenders won’t get away scot-free. Somebody made a lot of money leading up to this crisis and they should pay for it — at least the government should make them. 

In my opinion, the government should force conversion of bad mortgages into 30 years fixed rate mortgages. The interest rate on these converted mortgages could be higher than normal. This way it’s more affordable to more borrowers resulting in a lower default rate. Yes the lenders will make less money, but in my opinion, they already made too much. By the way, the borrowers aren’t completely innocent either, that’s why they should pay a little more as well.

Since it was fine from them to play with our economy and our lives, I think this is the least that they could do to take part in the recovery effort. Why should my tax dollars go toward helping these greedy bankers who already made billions out of the scheme? I am sure no one will come to my rescue if I my greed got me in trouble

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