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Lehman Brothers, The Subprime Mortgage Business, And Also Fannie/Freddie

Thursday, October 6th, 2011

Because the monetary industry will be taking this weekend to decide the future of Wall Street firm Lehman Brothers, this would appear an appropriate time to think about investment company’s role within the subprime mortgage crisis. Right after all, from the implosion of hundreds of lenders, to the failure of Bear Stearns, the selling of Countrywide, as well as the most recent Fannie Mae and Freddie Mac bailout, the collapse of Lehman is just the newest in a string of prior giants within the subprime industry going under.

Lehman Brothers had been one of the most prestigious names on Wall Street, playing within the world monetary flows amongst such other firms as Bear Stearns, Citigroup, Merrill Lynch, Credit Suisse, and other people. Lehman, along with Bear Stearns, although, led the way in subprime mortgage lending and securitizations of these loans into bonds salable to other finish investors.

Soon after the terrorist attacks of September 11, 2001, the largest Wall Street firms began reacting towards the Federal Reserve policy of low interest rates and cheap fiat money by purchasing billions of dollars of subprime loans. These were most likely bought from nonbank mortgage companies, which borrowed money from companies like Lehman to be able to make loans and swiftly resell them to Wall Street.

Actually, Lehman extremely practically owned this market, as other players like Merrill Lynch were late arriving to the subprime lending and securitizing game. Lehman Brothers and Bear Stearns were the major players in subprime, extending dollars inside the type of warehouse lines of credit to nonbank lenders, obtaining the mortgage merchandise, turning them into asset backed securities (ABS), after which selling these bonds to finish investors like insurance corporations, pension funds, local governments, and .

While the media portrays the credit crisis as if the largest Wall Street firms are basically unwitting victims of the subprime lenders and greedy homeowners who have decided to do absolutely nothing to on speculation houses, the banking giants are counting on the ignorance of the public on a minimum of two significant points. Lehman participated in each of these games, drastically increasing their own exposure to the risks.

First, the Wall Street firms provided vast amounts of help to mortgage businesses (subprime and otherwise) in going public. From managing their initial public offerings (IPOs) to giving the corporations loans so that you can make subprime mortgages, Lehman might be involved with a lender from beginning to end, all of the although hiding its role from actual residence buyers. Immediately after helping organizations go public and extending them lines of credit to make mortgages, Lehman would usually buy the mortgages so as to securitize them and generate much more fees from the sale of the new bonds.

Second, as the hysteria for subprime loans grew during the early part of the 2000s, Wall Street firms would often develop into the owners of residential mortgage lending or . Bear Stearns owned the notorious EMC Mortgage, whilst Lehman owned Aurora Loan Services. Conveniently, everyone who had a loan via these corporations would not have the ability to connect the name of the lender towards the Wall Street firm it was backed by, insulating the investment businesses from negative publicity on the portion of the subprime lenders they owned.

Hedge funds that invested heavily in subprime mortgage bonds were also usually managed by the largest Wall Street firms. Immediately after all, unless the banking giants could control no less than several of the funds going into these securities, it would be tough to raise demand artificially and convince municipalities and public pension funds to develop into investors. The credit crisis itself is popularly believed to have begun in August 2007 when two Bear Stearns hedge funds collapses on account of a lack of confidence in its subprime mortgage holdings.

Using the government takeover of mortgage giants Fannie Mae and Freddie Mac due to insolvency, it really should come as no surprise that the investment firms most involved with the Government Sponsored Enterprises (GSEs) would also face collapse. When the GSEs experienced a wave of investigations and regulatory constrictions within the aftermath of the discovery of accounting regularities in 2003, Wall Street stepped into the void to give securitization and obtain of mortgages.

With Fannie and Freddie’s hands temporarily tied and unable to buy as quite a few loans within the secondary market as were getting originated, Lehman and other people searched for or produced new buyers. From selling mortgage backed securities (MBSs) to the GSEs to opening trading desks dedicated to purchasing unsecuritized whole loans from Savings & Loans and nonbank lenders, Wall Street could create mortgage bonds and sell them without the help of Fannie and Freddie. These loans would be packaged into MBSs and sold to investors with Structured Investment Vehicles (SIVs) taking the place of the government enterprises, with Lehman generating fees at every level of the process.

So, this is the company that all of Wall Street and Washington will likely be spending this weekend deciding the ultimate fate of. Whether it ends up in bankruptcy, is absorbed by another investment giant, bailed out by the Federal Reserve or the Treasury, or allowed to move forward with its “restructuring” plan, the firm has left an indelible mark on the US housing market. The smart money has left Lehman by now, just as it had left the subprime business before its collapse; now the sharks must make a decision how best to dispose of the carcass and leave shareholders along with the public with the responsibility of cleaning up the mess left behind.

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