2centsworth
09-15-2008, 07:58 AM
the collapse of Lehman and other investment banks.
http://news.yahoo.com/s/ap/20080915/ap_on_el_pr/obama
For those of you who want to know what's going on here's my explanation. It's a copy of an email I sent to someone.
Lehman Bros. filed for bankruptcy and Merrill Lynch was bought out by Bank of America. Both companies failed because of their investment banking activities.
Traditionally what investment banking has meant is dealing in mergers and acquisitions, taking companies public, and corporate financing. All three of those areas have slowed down dramatically since 2000, so the companies began looking for other ways to make money. Those other ways of making money included using leverage to make sub-prime real estate investments and credit swaps.
The leverage in the sub-prime market worked liked this. Borrow money at a low interest rate to purchase collateralized mortgage obligations (CMOs)(sub-prime real estate) that yielded higher returns. Then use the CMO as collateral to purchase other investments. The value of those CMOs have collapsed and are only worth 20 cents on the dollar. So not only have these companies lost money on their investment in CMOs, they used borrowed money to do so, and to top it off they used the CMOs as collateral for other debts. A recipe for financial disaster. Unfortunately the investments in CMOs are not isolated to these investment banks. However, the ultra-risky debt schemes were more than likely isolated to the investment banking industry, because traditional banks and insurance companies have traditionally made the lions share of their money by loaning money and collecting life, health and auto insurance premiums, not making investments.
The other problem for the investment banks such as, Lehman Bros. was the issuance of Credit Swaps. Credit Swaps are when the investment banker bears the risk of credit security (e.g. bond) in return for a fee. Now that the investment banks are going under because of their high-risk investments, what happens to the recipients (counterparties) of the credit swaps? In the case of Merrill Lynch, Bank of America has assumed the liabilities, but in Lehman's case the credit swaps will more then likely be deemed worthless. Hence, we could see further devaluation of those bonds that contained credit security. Credit Swaps was essentially the business of Fannie Mae, but on a much larger scale, so that's why the federal government stepped in and guaranteed the solvency of Fannie Mae.
http://news.yahoo.com/s/ap/20080915/ap_on_el_pr/obama
For those of you who want to know what's going on here's my explanation. It's a copy of an email I sent to someone.
Lehman Bros. filed for bankruptcy and Merrill Lynch was bought out by Bank of America. Both companies failed because of their investment banking activities.
Traditionally what investment banking has meant is dealing in mergers and acquisitions, taking companies public, and corporate financing. All three of those areas have slowed down dramatically since 2000, so the companies began looking for other ways to make money. Those other ways of making money included using leverage to make sub-prime real estate investments and credit swaps.
The leverage in the sub-prime market worked liked this. Borrow money at a low interest rate to purchase collateralized mortgage obligations (CMOs)(sub-prime real estate) that yielded higher returns. Then use the CMO as collateral to purchase other investments. The value of those CMOs have collapsed and are only worth 20 cents on the dollar. So not only have these companies lost money on their investment in CMOs, they used borrowed money to do so, and to top it off they used the CMOs as collateral for other debts. A recipe for financial disaster. Unfortunately the investments in CMOs are not isolated to these investment banks. However, the ultra-risky debt schemes were more than likely isolated to the investment banking industry, because traditional banks and insurance companies have traditionally made the lions share of their money by loaning money and collecting life, health and auto insurance premiums, not making investments.
The other problem for the investment banks such as, Lehman Bros. was the issuance of Credit Swaps. Credit Swaps are when the investment banker bears the risk of credit security (e.g. bond) in return for a fee. Now that the investment banks are going under because of their high-risk investments, what happens to the recipients (counterparties) of the credit swaps? In the case of Merrill Lynch, Bank of America has assumed the liabilities, but in Lehman's case the credit swaps will more then likely be deemed worthless. Hence, we could see further devaluation of those bonds that contained credit security. Credit Swaps was essentially the business of Fannie Mae, but on a much larger scale, so that's why the federal government stepped in and guaranteed the solvency of Fannie Mae.