Lehman Brothers

Introduction

The roots of the current financial crisis can be traced back to 1993 during the Clinton Administration when Roberta Atchenberg was appointed as assistant secretary of the Department of Housing and Urban Development. It was her goal to increase home ownership amongst minorities and the poor. Throughout her tenure, she encouraged and even bullied banks into giving mortgages to under qualified candidates with no down payment (McDonald). During this time, the housing market was strong and the securitization of subprime mortgages barely existed. In fact, from March 1997 to June 2006, the Case and Shiller National Index of Real Estate increased every month, except for two. On average, real estate prices increased 12.4 percent annually, due to historically low interest rates (Zingales).

This housing bubble swelled for years, heightened by the existence of credit derivatives. The securitization of sub-prime mortgages was bundled by banks into structured bonds, often dividing them into different risk tranches. These credit default swaps (CDS), which are thought to be at the heart of the financial crisis, gave an incentive for distributing more credit to more risky borrowers. Since the credit originators were able to pass their risk on to other agents, they were less careful about the quality of their loans which they wrote CDS on. The market in which these credit default swaps were bought and sold was completely unregulated. Since they were unregulated, companies were not required to meet a certain amount of reserve (Coudert). Before the housing bubble burst, delinquency rates in sub-prime mortgages accounted for less than one percent of the total world debt. (Persaud).

Prior to the Collapse

Lehman Brothers, like many other financial houses, used the securitization of mortgages as a means of keeping risk within their institution because of the overleveraging it allowed. This had resulted in them failing to spread risk among different investors. When...