The Rise and Fall of

LEHMAN BROTHERS

Points should present in the project. Content .

Background of Lehman brothers. Little (History) Their Business. Genesis of Crises. US Mortgage Industry. Reason For Failure of Lehman Brothers. Sub Prime Crises Regulators Role

Content
Rating Agency. --- FICO credit rating agency. Auditors Role in 5 to 10 years back.(Accounting fraud) Post Crises Scenario . Lessons Learnt.

Fair Isaac Company (FICO) score

Credit rating.
35% Payment history Late payments on bills, such as a mortgage, credit card or automobile loan, can cause a FICO score to drop. Paying bills on time will improve your FICO score. 30% Credit utilization The ratio of current revolving debt (such as credit card balances) to the total available revolving credit or credit limit. You can improve your FICO scores by paying off debt and lowering the credit utilization ratio. Alternatively, applying for and receiving the credit limit increase will also drive down the utilization ratio. Closing of existing revolving accounts will typically adversely affect this ratio and therefore have a negative impact on their FICO score. 15% Length of credit history As your credit history ages it can have a positive impact on their FICO score.[6]

 10% Types of credit used (installment, revolving, consumer finance, mortgage) You can benefit by having a history of managing different types of credit.[7] 10% Recent search for credit Credit inquiries, which occur when you are seeking new credit, can hurt your score. Individuals shopping for a mortgage or auto loan over a short period will likely not experience a decrease in their scores as a result of these types of inquiries, however.[8] While all credit inquiries are recorded and displayed on your credit report for a period of time, credit inquiries that were made yourself (to check your credit), by your employer (for employee verification) or by companies initiating prescreened offers of credit or insurance do not have any impact on your credit score

SCORES.
The FICO score ranges form low of 350 to 850, lower the score the more likely that borrower will not manage the new credit well. The rating is divided into 3 parts
Prime :- These are someone to whom lenders are eager to do business.. Alt A :- These have good credit history but with something not quite right. Eg) An investor or borrower whose income has not been documented and verified may classify as Alt - A Sub Prime :- These have a blemished credit history.

Default credit rating system

The person whose score has less than 620 is considered as Sub-Prime and average score is near about 700. But during that period a score of 650 is considered as good score for lending because it fetch higher interest rates.

 EVERY ENDING HAS A BEGINNINGG .SO LETS SEE THE BEGINNING OF

LEHMAN BROTHERS

About Lehman Brothers.

Lehman Brothers founded in 1850, is a global financial-services firm. The firm does business in
Investment banking, Equity and fixed-income sales, Research and trading, Investment management, Private equity, and private banking. It is a primary dealer in the U.S. Treasury securities market.

History
In 1844, 23-year-old Henry Lehman, the son of a cattle merchant, emigrated to the United States from Rimpar, Bavaria. He settled in Montgomery, Alabama, where he opened a dry-goods store. Later on his borther joined in his business, at that point of time he change the name from H Lehman to H Lehman & brothers Later on one more brother joined his business at that point of time Lehman Brothers came into picture. In 1850 Lehman brothers set up the merchant bank in New York after making money in railway bonds. In this way this finance giant came into existence in USA.

Every Body Should Own House. (1)

Financial Success can be defined by size and quality of the house that we own. After Great Depression of 1929, Govt policies are drafted in such a way that it motivates and facilitates every American to Own a home. So the they created FHA :-Federal Housing Administration , Fannie Mae , and Freddie Mac Earlier financial Institution would pay loan and hold them until maturity, but advent of mortgage backed securities remove the incentives for financial institution.

CR Act (2)
In February 1970, the U.S. Department of Housing and Urban Development created the transaction using a mortgage-backed security. CRA(Community Reinvestment Act) was introduced into the system and it was mandatory for the bank to help the needs of subprime creditors. This was also an objective of CRA that is to provide equal opportunity for poor. Banks were not allowed to expand or mearge unless they have good CRA number.

(3)
In 1994 President Clinton unveiled National Homeownership strategy which make difficult for the banks to achieve CRA ..so as a result banks started lending more to poor. In 1996, Department of Housing Under Development gave Fannie Mae , and Freddie Mac target of 42 % of their mortgages has to go low and moderate income borrowers and 12 % to affordable housing borrowers with income less than 60 % of the median of that Area. By the end of 2000 and 2002 these targets have increased more.

Genesis of Crises.
Birth of Subprime Financial shock was set much early after tech stock blast, 9/11, and invasion of Afghanistan and Iraq. Seeing this , FED has started reducing their interest rate and in 2003 it was record low, but they were concern about the rising inflation. Fearing their own economies would go slump under the weight other economies in the world lower their interest rates.

Federal Funds Rate.

 Fed Cut the rates beyond the point of necessary. It took too long for the Fed to bring the interest rate on normalcy. This unnatural lower interest rate , sky rocketed the Asset and this time it was real estate not stock market.

 Meanwhile in year 2003 , China Joined the World Trade Organization ,this has open the flood gates for china and he entered the global market. Low cost Chinese made goods flooded markets and price fell nearly everywhere and inflation seem a remote concern. China s explosive growth, driven by mgft and exports boosted global demand for oil and other commodities.

 Us was facing trade deficit because 100 s billion dollar was flown to china as china has become the exporter , so this money was coming back to US in the form of investment by china and other Asian market. Initially this money was invested in US treasury bonds which produce a low int rates. Later on in the quest for higher returns they expanded to riskier financial instrument.

Frenzied Innovation
2 factor that contributed the Innovative and riskier financial product .
Lower int rates and surging global investor demand.

 Wall street came up with various products..few among those are futures option and derivatives on government and corporate debt and even bonds backed by residential mortgage payments.

Wall street Creation

Earlier the procedure was simple, which involve single borrower and single lender that is bank loan you money to buy single home , car and you pay bank over time.. This whole scenario has changed when wall street bank realized that individual loan and mortgages could be tied and securitized A simple debt agreement can now be traded as just with other bonds and stocks among investor world.

 Now monthly mortgage payment make a trip that is cash pooled from hundreds of others individual mortgage payments and flow to the investor who owned the new mortgage backed securities. Another innovation was they have sliced and bundled them according to the risk appetite of investor.

 Those who want to seek safe investment is paid first and lower int rates. By mid of the decade any asset which has cash flow seemed to qualify for such slice and dice treatment. Residential mortgages loans Merger and financing and even tolls generated by public bridge and highways were securitized.

 DESIGNING PACKAGING AND RESELLING BECAME THE MAJOR SOURCE OF FINANCE for wall street bankers and salesman marketed them to investor very well.

Chain effect (Balance sheet effect)

Originally lenders were facing limitation because it was reflected on balance sheet but after secutrization .this loans were re sold and that money is used proceeds further loan. Government regulators like because it seems that risk was spread broadly. But the main problem was they were not assessing the lending side risk they just got carried away in volumes

GOLDE

N ERA ENDS

Again Fed played a important role in the span of 24 months it has increased 425Bps points. As Interest went up market yield went up this has resulted in 2 things.

Real Estate Price start to fall

Market Lending and Borrowing Rate start to increase

Lehman Debacle

CDS (Credit Default Swaps)

Mortgage Backed Securities.(MBS)

A type of asset-backed security that is secured by a mortgage or collection of mortgages. These securities must also be grouped in one of the top two ratings as determined by a accredited credit rating agency, and usually pay periodic payments that are similar to coupon payments. Furthermore, the mortgage must have originated from a regulated and authorized financial institution.

ARM (Adjustable Rate Mortgage)

It ARM role proves to be significant for the debacle of US Mortgage Industry. ARM was develop in early 1980 s when interest rates and inflation was high. (+):-In the Initial years the borrower has to pay Low Rate of Interest than Current interest rate. (-):- Lack of Transparency in the system.

(4)