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+---
+course: Finance
+date: 24-09-2024
+title: Financial Crysis of 2007-2009
+---
+### Tags: [[MBS]], [[Credit Default Swaps]], [[Housing Market]], [[Interest Rates]], [[Subprime Loans]], [[LTV]], [[Tranches]], [[Credit Risk]]
+# Financial Crysis of 2007-2009
+
+## Summary
+
+The Financial Crisis of 2007-2009 was primarily triggered by the collapse of the U.S. housing market, exacerbated by complex financial instruments such as Mortgage-Backed Securities (MBS) and Credit Default Swaps (CDS). The crisis began in the housing sector but quickly spread to the broader financial system, ultimately requiring government intervention to prevent a complete economic meltdown.
+```mermaid
+graph TD
+    A[Low Interest Rates] -->|Leads to| B[Housing Boom]
+    B --> C[Subprime Lending]
+    C --> D[High-Risk Mortgages]
+    D --> E[Mortgage-Backed Securities MBS]
+    E --> F[Investors]
+    G[Credit Default Swaps CDS] --> E
+    H[Housing Prices Fall] --> I[MBS Value Plummets]
+    I --> J[Bank Losses]
+    J --> K[Credit Freeze]
+    K --> L[Economic Downturn]
+    L --> M[Government Bailouts]
+```
+
+## Definitions and Important Concepts
+
+- MBS (Mortgage-Backed Securities): Investments consisting of a bundle of home loans and other real estate debt bought from the banks that issued them.
+- CDS (Credit Default Swaps): Financial derivatives that allow investors to swap or offset their credit risk with that of another investor.
+- LTV (Loan-to-Value) ratio: An assessment of lending risk that financial institutions examine before approving a mortgage.
+- Subprime Loans: Loans made to borrowers with poor credit histories, often with higher interest rates.
+- Tranches: Portions of a pooled collection of securities, usually debt instruments, that are split up by risk or other characteristics.
+- Credit Risk: The risk of loss resulting from a borrower's failure to repay a loan or meet contractual obligations.
+
+## Financial Theories/Models
+
+- Securitization: The process of pooling various types of debt instruments and selling them as securities to investors.
+- Risk Assessment Models: Tools used by financial institutions to evaluate the creditworthiness of borrowers and the risk of default.
+
+## Market Applications
+
+1. Housing Market:
+    - Low interest rates and relaxed lending standards led to a housing boom.
+    - Increased use of subprime mortgages with high LTV ratios.
+    - Rising home prices created a speculative bubble.
+2. Financial Market:
+    - Banks created and sold MBS, transferring the risk of subprime mortgages to investors.
+    - CDS were used to insure against potential defaults, creating a false sense of security.
+    - When housing prices began to fall, the value of MBS plummeted, causing significant losses for investors and financial institutions.
+
+## Case Studies or Examples
+
+1. Lehman Brothers Collapse: The failure of this major investment bank due to its exposure to subprime mortgages and MBS.
+2. AIG Bailout: The government rescue of AIG, which had sold massive amounts of CDS and faced bankruptcy when required to pay out.
+
+## Risk Considerations
+
+- Underestimation of systemic risk in the housing market.
+- Over-reliance on complex financial instruments without fully understanding their risks.
+- Inadequate regulation of the shadow banking system.
+- Misalignment of incentives in the mortgage origination and securitization process.
+
+## Key Takeaways
+
+1. The interconnectedness of the housing market and the financial sector through MBS and CDS amplified the crisis.
+2. High LTV ratios and subprime lending practices increased overall credit risk in the system.
+3. The crisis spread from the housing market to the broader financial sector, necessitating government intervention.
+4. The event highlighted the need for better risk management and financial regulation.
+
+## Questions for Analysis
+
+1. How did the misuse of financial instruments like MBS and CDS contribute to the severity of the crisis?
+2. What role did credit rating agencies play in the lead-up to the financial crisis?
+3. How have regulatory frameworks changed since the crisis to prevent similar events in the future?
+
+## References
+
+- Financial Crisis Inquiry Commission. (2011). The Financial Crisis Inquiry Report. U.S. Government Printing Office.
+- Tooze, A. (2018). Crashed: How a Decade of Financial Crises Changed the World. Viking.
+- Lecture notes, Date: [Financial Crisis of 2007-2009]
+- Course material: [Chapter on Modern Financial Crises]