The United Stated financial crisis began in September of 2008 when the most respected financial institutions fell. Freddie Mac and Fannie Mae were virtually wiped out, Bear Sterns seemed o disappear overnight, Wachovia, AIG, Merrill Lynch suffered huge losses, and of course Lehman Brothers completely collapsed. The World Bank has even taken action toward assisting this global phenomenon. The crisis caused an eruption - who will get their money back and who should receive a bailout from the Feds?.
Lehman Brothers made a huge mistake when they borrowed significant amounts to fund their investing in the years leading to its bankruptcy in 2008. Doing this is a common economic process known as leveraging or gearing. A sizable portion of this investing was in housing-related assets, making it vulnerable to a downturn in that market. One measure of this risk-taking was its leverage ratio, a measure of the ratio of assets to owner's equity. This ratio increased rapidly from 2003 to 2008. Then, in 2008, Lehman faced an unprecedented loss due to the continuing mortgage failure. Lehman's loss was apparently a result of having held on to large positions in low-rated mortgages. Whether Lehman did this because it was simply unable to sell the lower-rated bonds, or made a conscious decision to hold them, is unclear. In any event, huge losses accumulated in lower-rated mortgage-backed securities throughout 2008. .
In their second fiscal quarter, Lehman reported losses of $2.8 billion and was forced to sell off $6 billion in assets. Above is a chart of Lehman Brothers common stock chart from 2005 to 2008. If you look closely at 2008, you can see the instability in the shareholders trust in the stock and eventually you can see the fail of the fund.
An analogy to more easily understand this economic failure was explained to my by a co-worker last summer. Think of a homeowner with a 96% mortgage and credit card bills.
