Monday, August 6, 2012

Subprime crisis, How Did it Happen?


After the great depression of 1936, US  and most of developed countries have experienced a 40 years growth bringing confidence in the markets.

Investment Banks started to get very rich from a non-stop growth such as JP Morgan, Lehman Brothers, and Morgan Stanley, and salary for Investment Bankers started to raise compare to other salaries.

After that in the end of the 90’s, Investment Banks started to promote heavily internet companies that they know would fail, but they were making substantial profits from it.
In 2002 the banks were fined for this, bribing officials and laundering money, this period was followed by heavy regulations on equities and especially on derivatives which were until that time totally unregulated.

The beginning of the 2000’s was the start of a growth period which brought confidence back to the market and people start investing in house which leaded to a bull market on housing prices where almost everyone was able to get a mortgage on a house, moreover of those mortgages were pooled and securitized into different categories relative to their maturities and credit ratings, those instruments are called CDO’s (collateralized debt obligations). Through this “Food chain securitization” wall street bonuses started to become extremely high.

Credit Rating agencies who are supposed to give opinions on those instruments, started to rate those CDO with excellent grades such as AAA in exchange of substantial amount of money from investment banks, but the bubble bursts when people were not able to repay their debts, the system collapsed, many people had to live their homes, the real estate sector plunged and some of the financial giants such as Lehman Brothers had to declare bankruptcy.

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