Sep 20, 2008

FINANCIAL TERRORISM - " Lehman Brothers crisis"

Any one who leads to such panic in the market should be termed as “ Financial terrorist”. Reason for using the term “ Financial terrorism “ is that even the good assets are being badly hit because of negative sentiments and many small investor like me lose .

Ask the best brain about the problem with Lehman and they will confuse you by using terms like “ Institution being over leveraged “.

That's truly CONSULTING - “Simple things being made Complex “

I am not saying its wrong but the common man will never understand the real problem.
Always Credit Crisis occurs when loan and investment books are much bigger than its capital.

I will attempt to simplify it further …

An Investment bank uses its own money to lend other and invest. Banks like Lehman, buy mortgage loans (like housing loan etc ) from other banks and then package them to sell bonds against the loan pool. If mortgage earns 5%, than investment banks sells bonds at 3.5 % . The difference between 5% and 3.5% (i.e. 1.5%) called as spread is the earning of investment bank. They also add cash to make loan pool look attractive so that the bonds are sold at higher prices. These banks sell these structured bonds to raise money and frees the capital . BUT WHEN THE HOME BUYERS START DEFAULTING THESE BONDS LOSE ITS VALUE.

Banks like Lehman face redemption when these bond start losing its value. Also Lehman has to repay another bank it has borrowed from. Under such situation it sells mortgage –backed bonds whose prices have fallen . Since this selling will not raise funds as expected ,so investment banks sell some of the good assets or bonds which has nothing to do with mortgages. As a result situation in the markets dips prices of these good assets /bonds . This crisis spreads which termed as DOMINO EFFECT .

This impacts balance sheet as all the banks are required to mark –to- market their investments. So , if the price of an instrument falls , the difference between the price at which the instrument was brought and the current prices is to be provided by deduction from the earning . But the bigger problem which has deepened crises is “ How to provide when there is NO MARKET “ ie when bank actually goes to sell the derivative , it discovers that there are no takers . This is due to derivatives being marked –to –model than being marked –to- market.

Huge Loses are suffered with difference between the prices thrown by these artificially constructed financial models by best brains and prices that buyers are willing to pay in the market . Problem compounds further due to strange accounting practice and also disclosure issues.

Such Crisis shows banks /financial services industry should employ not just the best brains from IIT/IIM but also those who are best on ethics & can relate to comman man.

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