NOOL, Winelle E.

March 3, 2018
FM 3-6

1.) 2008 US Financial Crisis

The financial crisis of 2007–2008, also known as the global financial crisis and the 2008
financial crisis, is considered by many economists to have been the worst financial crisis since
the Great Depression of the 1930s

It began in 2007 with a crisis in the subprime mortgage market in the United States, and
developed into a full-blown international banking crisis with the collapse of the investment bank
Lehman Brothers on September 15, 2008. Excessive risk-taking by banks such as Lehman
Brothers helped to magnify the financial impact globally. Massive bail-outs of financial
institutions and other palliative monetary and fiscal policies were employed to prevent a possible
collapse of the world financial system. The crisis was nonetheless followed by a global economic
downturn, the Great Recession. The European debt crisis, a crisis in the banking system of the
European countries using the euro, followed later.

The Dodd–Frank Act was enacted in the US in the aftermath of the crisis to "promote the
financial stability of the United States". The Basel III capital and liquidity standards were
adopted by countries around the world.

2.) Home Mortgage Securities

In 2008, the United States teetered on the brink of financial disaster. Unemployment looked to
reach its highest levels in two decades. Homeowners defaulted on their loans in record numbers.
Enormous investment banks that had been in business for more than a century and had endured
the Great Depression faced collapse. The economy, in other words, was circling the drain. And
all of it, every last part of this looming economic disaster, was due to a unique financial
instrument called the mortgage-backed security.

Mortgage-backed securities (MBSs) are simply shares of a home loan sold to investors. They
work like this: A bank lends a borrower the money to buy a house and collects monthly
payments on the loan. This loan and a number of others -- perhaps hundreds -- are sold to a
larger bank that packages the loans together into a mortgage-backed security. The larger bank
then issues shares of this security, called tranches (French for "slices"), to investors who buy
them and ultimately collect the dividends in the form of the monthly mortgage payments. These
tranches can be further repackaged and sold again as other securities, called collateralized debt
obligations (CDOs). Home loans in 2008 were so divided and spread across the financial
spectrum, it was entirely possible a given homeowner could unwittingly own shares in his or her
own mortgage.
It sounds innocuous enough, and it is. It's also an excellent and safe way to make money when
the housing market is booming. And in the early 21st century, the U.S. housing market was
booming. A person who bought a new home in January 1996 for $155,000 could reasonably
expect to make a profit of $100,000 when selling it in August 2006. But 2008 wasn't 2006; the
housing market in the United States was no longer booming. And it was the mortgage-backed
security that killed it.

3.) Asset Backed Securities

Asset backed securities are important because they provide lending capacity to the banking
industry that is needed to finance economic recovery. Homes, automobiles, credit cards and
most consumer and business activities are financed in the asset backed securities (ABS) market.

ABS have a dark history; they bankrolled the housing bubble, sub-prime mortgages and liar
loans. When housing crashed, it was the lack of new asset backed securities that pushed the
economy into recession by freezing up the banking system and destroying consumer and small
business credit markets.

After being left for dead in 2008, there are signs of rebirth in asset backed securities. Last week,
industry leaders came together at the ABS East Conference in Miami and took a walk down
memory lane. Money managers who were stars in 2006, and then shunned as economic leaches
in 2008, were once again recognized as South Beach finance gurus.

The capital markets are trying to return to the practice of providing liquidity to borrowers that no
one else will lend to, and industry leaders from 20 years ago have been resurrected as if the last
two decades hadn’t happened.

According to Securitization Intelligence, through the first nine months of 2012, approximately
$145.5 billion of asset backed securities were issued in the U.S. That’s the largest amount since
2008, although less than 25% of the peak year of 2006 according to the American Securitization
Forum. 2013 is projected to be another year on the road to recovery.

While the future could be bright for the asset backed securities industry, lurking in the shadows
are signs of new problems. Asset backed securities professionals have a pathological desire to
relive the past while hoping that this time around things will turn out differently. Market
participants act like Texas oil men of the 1980s who plastered the state with bumper stickers
saying “Please God Give Me One More Oil Boom. I Promise Not to Piss It Away.” But pissing
it away is exactly what the securities industry is doing.

4.) Securities Fraud

Securities fraud, also known as stock fraud and investment fraud, is a deceptive practice in the
stock or commodities markets that induces investors to make purchase or sale decisions on the
basis of false information, frequently resulting in losses, in violation of securities laws. Offers of
risky investment opportunities to unsophisticated investors who are unable to evaluate risk
adequately and cannot afford loss of capital is a central problem.

5.) Stock Market Bubble

A stock market bubble is a type of economic bubble taking place in stock markets when market
participants drive stock prices above their value in relation to some system of stock valuation.

Behavioral finance theory attributes stock market bubbles to cognitive biases that lead to
groupthink and herd behavior. Bubbles occur not only in real-world markets, with their inherent
uncertainty and noise, but also in highly predictable experimental markets.

6.) Insider Trading

Insider trading is the trading of a public company's stock or other securities (such as bonds or
stock options) by individuals with access to nonpublic information about the company. In
various countries, some kinds of trading based on insider information is illegal. This is because it
is seen as unfair to other investors who do not have access to the information, as the investor
with insider information could potentially make larger profits than a typical investor could make.

The authors of one study claim that illegal insider trading raises the cost of capital for securities
issuers, thus decreasing overall economic growth However, some economists have argued that
insider trading should be allowed and could, in fact, benefit markets.

Trading by specific insiders, such as employees, is commonly permitted as long as it does not
rely on material information not in the public domain. Many jurisdictions require that such
trading be reported so that the transactions can be monitored. In the United States and several
other jurisdictions, trading conducted by corporate officers, key employees, directors, or
significant shareholders must be reported to the regulator or publicly disclosed, usually within a
few business days of the trade. In these cases, insiders in the United States are required to file a
Form 4 with the U.S. Securities and Exchange Commission (SEC) when buying or selling shares
of their own companies.

The rules governing insider trading are complex and vary significantly from country to country.
The extent of enforcement also varies from one country to another. The definition of insider in
one jurisdiction can be broad, and may cover not only insiders themselves but also any persons
related to them, such as brokers, associates and even family members. A person who becomes
aware of non-public information and trades on that basis may be guilty of a crime.

7.) Case of Lehman Brothers

On September 15, 2008, Lehman Brothers filed for bankruptcy. With $639 billion in assets and
$619 billion in debt, Lehman's bankruptcy filing was the largest in history, as its assets far
surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the
fourth-largest U.S. investment bank at the time of its collapse, with 25,000 employees
worldwide.

Lehman's demise also made it the largest victim of the U.S. subprime mortgage-induced
financial crisis that swept through global financial markets in 2008. Lehman's collapse was a
seminal event that greatly intensified the 2008 crisis and contributed to the erosion of close to
$10 trillion in market capitalization from global equity markets in October 2008 – the biggest
monthly decline on record at the time.

The History of Lehman Brothers

Lehman Brothers had humble origins, tracing its roots back to a small general store that was
founded by German immigrant Henry Lehman in Montgomery, Alabama in 1844. In 1850,
Henry Lehman and his brothers, Emanuel and Mayer, founded Lehman Brothers.

While the firm prospered over the following decades as the U.S. economy grew into an
international powerhouse, Lehman had to contend with plenty of challenges over the years.
Lehman survived them all – the railroad bankruptcies of the 1800s, the Great Depression of the
1930s, two world wars, a capital shortage when it was spun off by American Express Co. (AXP)
in 1994, and the Long Term Capital Management collapse and Russian debt default of 1998.
However, despite its ability to survive past disasters, the collapse of the U.S. housing market
ultimately brought Lehman to its knees, as its headlong rush into the subprime mortgage market
proved to be a disastrous step.

The Prime Culprit

In 2003 and 2004, with the U.S. housing boom (read, bubble) well under way, Lehman acquired
five mortgage lenders, including subprime lender BNC Mortgage and Aurora Loan Services,
which specialized in Alt-A loans (made to borrowers without full documentation). Lehman's
acquisitions at first seemed prescient; record revenues from Lehman's real estate businesses
enabled revenues in the capital markets unit to surge 56% from 2004 to 2006, a faster rate of
growth than other businesses in investment banking or asset management. The firm securitized
$146 billion of mortgages in 2006, a 10% increase from 2005. Lehman reported record profits
every year from 2005 to 2007. In 2007, the firm reported net income of a record $4.2 billion on
revenues of $19.3 billion.

Lehman's Colossal Miscalculation

In February 2007, the stock reached a record $86.18, giving Lehman a market capitalization of
close to $60 billion. However, by the first quarter of 2007, cracks in the U.S. housing market
were already becoming apparent as defaults on subprime mortgages rose to a seven-year high.
On March 14, 2007, a day after the stock had its biggest one-day drop in five years on concerns
that rising defaults would affect Lehman's profitability, the firm reported record revenues and
profit for its fiscal first quarter.

In the company's post-earnings conference call, Lehman's chief financial officer said that the
risks posed by rising home delinquencies were well contained and would have little impact on
the firm's earnings. He also said that he did not foresee problems in the subprime market
spreading to the rest of the housing market or hurting the U.S. economy.

The Beginning of the End for Lehman

As the credit crisis erupted in August 2007 with the failure of two Bear Stearns hedge funds,
Lehman's stock fell sharply. During that month, the company eliminated 2,500 mortgage-related
jobs and shut down its BNC unit. In addition, it also closed offices of Alt-A lender Aurora in
three states. Even as the correction in the U.S. housing market gained momentum, Lehman
continued to be a major player in the mortgage market.

In 2007, Lehman underwrote more mortgage-backed securities than any other firm,
accumulating an $85 billion portfolio, or four times its shareholders' equity. In the fourth quarter
of 2007, Lehman's stock rebounded, as global equity markets reached new highs and prices for
fixed-income assets staged a temporary rebound. However, the firm did not take the opportunity
to trim its massive mortgage portfolio, which in retrospect, would turn out to be its last chance.

Lehman's Hurtling Toward Failure

Lehman's high degree of leverage – the ratio of total assets to shareholders equity – was 31 in
2007, and its huge portfolio of mortgage securities made it increasingly vulnerable to
deteriorating market conditions. On March 17, 2008, following the near-collapse of Bear Stearns
– the second-largest underwriter of mortgage-backed securities – Lehman shares fell as much as
48% on concern it would be the next Wall Street firm to fail.

Confidence in the company returned to some extent in April, after it raised $4 billion through an
issue of preferred stock that was convertible into Lehman shares at a 32% premium to its price at
the time. However, the stock resumed its decline as hedge fund managers began questioning the
valuation of Lehman's mortgage portfolio.

On June 9, Lehman announced a second-quarter loss of $2.8 billion, its first loss since being
spun off by American Express, and reported that it had raised another $6 billion from investors.
The firm also said that it had boosted its liquidity pool to an estimated $45 billion, decreased
gross assets by $147 billion, reduced its exposure to residential and commercial mortgages by
20%, and cut down leverage from a factor of 32 to about 25.

Too Little, Too Late for Lehman

However, these measures were perceived as being too little, too late. Over the summer, Lehman's
management made unsuccessful overtures to a number of potential partners. The stock plunged
77% in the first week of September 2008, amid plummeting equity markets worldwide, as
investors questioned CEO Richard Fuld's plan to keep the firm independent by selling part of its
asset management unit and spinning off commercial real estate assets. Hopes that the Korea
Development Bank would take a stake in Lehman were dashed on Sept. 9, as the state-owned
South Korean bank put talks on hold.

The news was a deathblow to Lehman, leading to a 45% plunge in the stock and a 66% spike in
credit-default swaps on the company's debt. The company's hedge fund clients began pulling out,
while its short-term creditors cut credit lines. On Sept. 10, Lehman pre-announced dismal fiscal
third-quarter results that underscored the fragility of its financial position.

The firm reported a loss of $3.9 billion, including a write-down of $5.6 billion, and also
announced a sweeping strategic restructuring of its businesses. The same day, Moody's Investor
Service announced that it was reviewing Lehman's credit ratings, and also said that Lehman
would have to sell a majority stake to a strategic partner in order to avoid a ratings downgrade.
These developments led to a 42% plunge in the stock on Sept. 11.

With only $1 billion left in cash by the end of that week, Lehman was quickly running out of
time. Last-ditch efforts over the weekend of Sept. 13 between Lehman, Barclays PLC and Bank
of America Corp. (BAC), aimed at facilitating a takeover of Lehman, were unsuccessful. On
Monday Sept. 15, Lehman declared bankruptcy, resulting in the stock plunging 93% from its
previous close on Sept. 12.

The Bottom Line

Lehman's collapse roiled global financial markets for weeks, given the size of the company and
its status as a major player in the U.S. and internationally. Many questioned the U.S.
government's decision to let Lehman fail, compared with its tacit support for Bear Stearns, which
was acquired by JPMorgan Chase & Co. (JPM) in March 2008. Lehman's bankruptcy led to
more than $46 billion of its market value being wiped out. Its collapse also served as the catalyst
for the purchase of Merrill Lynch by Bank of America in an emergency deal that was also
announced on Sept. 15.