Financial crises (2008) - what it is, how it was triggered and reasons for it.

1. 2008 - FINANCIAL CRISES.
To understandthe crises we have to go back to the starting of
the 20 century. In early 2000, U.S economy started
experiencing a sudden boom in real estate prices known as
Housing Bubble. After 9/11, its brunt was felt all over the U.S
economy. To revive the economy back to its track, interest
rates on mortgage were reduced from 6.5% to 1.75% in 2001.
Again in 2003 interest rates were slashed to 1%, lowest in 45
years. Due to easy lending terms and low interest rates,
peopleborrowed mortgages to buyhouse property which was
way above their paying capacities. Banks gave weightage to
theirpersonalprofits andstarted lendingmortgages to people
having low credit scores (high default risk). This lead to
increase in Sub-primemortgages (mortgages with highdefault
risk) in the economy. These sub-prime mortgages were issued
at variable interest rate: low interest rate in the beginning
which would later increase to a double digit interest rates.
Increase in housing prices motivated banks to lend sub-prime
mortgages because if the borrower defaults, banks would still
have the housing property as mortgage, which could be used
to recover the debt or more.
In 2003 and 2004, many financial firms like Lehman Brothers
stepped into Mortgage Backed Securities (MBS) and
Collateralized Debt Obligations(CDO). MBS is a facility which
allows a bank to sell its loans to some other financial
institutions and then the financial institution securitizes the
loans together into a security that investors can buy, thus
cutting itself free from the risk of default. Now the investors
who have invested in MBS have to bear the risk and are

2. entitledto receive interest onthe loan.In case of defaultthese
MBS were backed by the house property (mortgage).
Commercial banks took the benefit of MBS and gave sub-
prime mortgages without proper judgment of credit score of
the borrower. It is estimated that 56% of home purchases
during the period were made by people who would not have
been able to afford them under normal lendingrequirements
and shockingly all these people were sub-prime borrowers.
Easy availability of mortgage triggered inflation in the
economy. Tocurb it Federal Reserve hiked the interest rate for
17 consecutive quarters (2004-2006). By 2006 interest rate
reached a whopping5.25%. This gave a big clout to borrowers
as sub-prime mortgage holders saw their mortgage payment
skyrocketed as much as 60%.
In 2006, Increase in interest rate put the homeownership out
of reach for many buyers and various borrower could not pay
high interest rate on their mortgage. Inability to pay interest
on mortgage lead to default and foreclosures. Demand for
house property was quite low as compared to high supply. So
now simpleeconomicfundament:increaseinsupply, decrease
in demand leading to slash in price. So prices of house
property started to fall by 4.9% from September and by 6.1%
from October 2006. In some areas the fall in price was 30%-
50% from bubble's peak range. Federal Reserve reduced the
interest rate to stabilize the price of house property but
despite all the efforts prices continued to fall.

3. Ignoring the prescient warning, Aurora Loan Services and BNC
mortgage LLC (both acquired by Lehman Brother) were still
lending almost $50 billion per month and IndyMac originated
over $90 billionofmortgage in2006. LehmanBrother was one
of the leading buyers of MBS along with Fannie Mae, Freddie
Mac and IndyMac was one of the major lender of Alt-A loans.
Sub-prime mortgage became 20% of the market and some
banks made sub-prime mortgage their entire business.
In 2007, the game changed with the housing bubble burst,
leading to financial collapse. The wealth of banks who lended
majority of mortgage as sub-prime mortgage and of investors
dealing in MBS and CDO was draininglike water. Fall in prices
of house property and defaults reduced the value of MBS.
Lot of banks lost their money on the account of default. The
value of house properties was not just enough to land the
banks out of the losses. Various financial investment
companieswere making heavylosses dueto plummeted value
of MBS. During February and March itself, more than 25
subprime lenders filed for bankruptcy, which was enough to
start the tide.
In 2008, banks and financial institutions just waited for the
repercussions. IndyMac was the first institution to run into
trouble and filed for bankruptcy in July. Lehman Brothers
went bankrupt in September after the Federal Reserve
declinedto guaranteeits loans,causing the Dow Jonesto drop
504 points, it was the worst decline in seven years. Various
other institutions like Merrill Lynch, AIG, Royal Bank of
Scotland were expected to follow, but got bailed out by

4. package announced by Federal Reserve or were acquired by
some other financial institutions .
All the bankruptcies, financial collapse and contraction
triggered The Financial Crises In 2008. The main culprits
behindthis crises were MBS, unfairlendingpractices and sub-
prime mortgage