Start of the Crisis??
Everything was going on very smooth and everyone in the system was making huge amount of money. But suddenly in 2007, the housing market showed the sign of cooling down in price due to bubble burst and the continuous price increase halted. With the interest rate got increased because of high interest rate and refinancing the existing mortgage loans became tough. Buyers failed to refinance them at lower interest rate, started to foreclose the active mortgage loans. The foreclosures has put downward pressure on the housing prices. It came as a shock to the house owners and they had started selling houses with very narrow profit in fear of further cooling down in prices. Because of the selling pressure the price cooled down more and rang the alarm bell.
For some recent buyer the house price fell below the buying price and they have stopped repaying the installment amount and allowed the bank to seize their house. Banks have out those houses on sell and suddenly the supply got increased heavily in the housing market which dragged the housing price further. The default rate has started to increase and banks were taking back the house without selling them at available price with the hope of price rebound in the market, but that did not happen. The default rate reached a new high in 2008 and banks have started selling houses at much lower prices and booking loss for the same. The source of the whole money flow in the mortgage system, the number of customers paying installment had started to decrease significantly and disrupted the whole system. Banks were booking losses in the mortgage segment and were unable to pay the money to the investment banks. Investment banks started finding it very difficult to pay the interest on the money they have borrowed from all over the world as their source of income from the mortgage loan lenders banks dropped significantly. They went default for most of the mortgage backed securities. During the last third quarter of the year 2008, the banks and investment banks had made loss of billion dollars and became unable to repay money to their lenders.
Lehman Brothers’ bankruptcy
In September 2008, Lehman Brothers’ filed for bankruptcy as it did not have any money to pay the interest on the bonds issued by them and there was no buyer of the so called biggest investment bank in the world. The entire buy out talks were failed at that time because of Lehman Brothers’ management. At the time of collapse, Lehman Brothers’ had around USD 700 billion of debt across the world and the same amount of investors’ money was wiped out from the global financial system.
Banks bail out
At the same time, lots of big banks requested government to bail them out from the financial crisis. Government had bailed out big banks like Citibank, Bank of America, Well Fargo and mortgage lenders as Fiddie Mac and Fannie Mac to avoid the financial crisis getting into deeper. The situation could have been much worse if they were not bailed out by the US Government at that time.
AIG bail out
The default rate became so high that AIG had received huge claims against the defaults of the customers and banks for the credit default swap and the claim amount was couple of times more than they have estimated. The huge failure in the mortgage housing market has increased their loss in the CDS segment. The huge claim had forced them to request government to bail them out as well, without which bankruptcy filing was the only option left with them.