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