From the mid-1990s onwards in the United States, it was ridiculously easy to get a home loan. Home prices soared about 85 per cent from 1996 through 2006 because of easy credit, fuelled by low interest rates. Buyers were seduced by cheap 'teaser' loans with low interest rates that were later 'adjusted' much higher. A bubble was created.
2 THEN INVESTMENTS GOT TIED TO MORTGAGES
The bubble in housing spread to banks though mortgage-linked investments.
During the boom, trillions of dollars worth of mortgages were packaged together into investment products that promised to pay investors with the proceeds of those loan payments. These products were created by banks and bought and sold to each other. They paid better rates than other types of assets during the boom years, so other banks from around the globe poured as much money as they could into those investments.
3 MORTGAGES WENT SUB-PRIME
Faced with this demand, banks starting making 'sub-prime' loans to riskier borrowers, many with no proof of income. When prices of homes were rising, this was not a problem. The risk of loan foreclosure or default was low because home owners were able to sell their houses for a profit.
Then the bubble burst.
4 HOUSING BUST LED TO BANK WRITE-DOWNS AND LOSSES
Once prices began falling, mortgage defaults and foreclosures shot higher. The value of investments tied to mortgages started to fall.
Banks were forced to repeatedly write down the value of their mortgage-linked investments, causing huge losses. With no end in sight to the housing bust, it became impossible to value those assets as the market for them disappeared.
5 AND TURNED INTO A CREDIT CRISIS
Banks became desperate to raise fresh capital but it got harder to attract new investments.
At the same time, banks tightened on credit as they grew scared of lending to each other for fear they wouldn't be repaid. Other cheap loans - to businesses and individuals - began to disappear.
6 LACK OF GOVERNMENT OVERSIGHT
After banks and brokerages were deregulated in the US in the late 1990s, it was legal for them to keep many loss-making investments 'off balance sheet', keeping investors in the dark. Regulators needed to make new rules but did not.
7 POOR RISK MANAGEMENT
The Nick Leesons and Jerome Kerviels were just the tip of an iceberg that became visible above water. In many banks, few understood, let alone could police, the increasingly complex investment products they were buying and selling.
8 FAILURE OF RATING AGENCIES
They were criticised for moving too slowly in cutting the ratings of banks which were also their customers. But the pendulum has swung, and now some critics accuse them of moving too quickly to downgrade, fuelling panic.
9 UNCONTROLLED SHORT-SELLING
Short-sellers were able to drive down the share prices of already weakened banks faster and harder than they would otherwise have fallen, blocking off one means of survival - selling shares to raise capital.
10 GREED
Blame it too on a culture that gave outsized rewards for success and risk-taking but did not penalise failure. US taxpayers will have to fork out hundreds of billions of dollars but Lehman Brothers' boss Richard Fuld gets to keep the US$490 million (S$700 million) he earned.
This article was first published in The Straits Times on September 21, 2008.
