Bank Risk-Taking, Securitization, Supervision, And Low Interest Rates: Fill & Download for Free

In India, it is the real economy that got impacted first — on account of exports and the drying up of overseas finance for many firms.Banks were affected indirectly by the slowing down of the economy. The direct impact of the crisis on the Indian banking system had been small because Indian banks do not have big exposures to the subprime market. Indian banks are well placed to weather this impact. This is not a contrarian view. The RBI itself exudes optimism about the outlook for Indian banking in its latest Report on Trend and Progress in Banking.At a time when the financial system across the globe is engulfed in a deep crisis, the Indian banking system continued to show resilience. The underlying fundamentals of the Indian economy would continue to underpin the robust performance of the banking sector which remains profitable and well capitalized.World map showing real GDP growth rates for 2009. (Countries in brown were in recession.)The banking sector in India is largely (70%) dominated by the public sector. Partly as a result, India has not been witness to the kind of crisis of confidence seen in advanced countries. Additionally, strict regulation and conservative policies adopted by the Reserve Bank of India have ensured that banks in India are relatively insulated from the travails of their Western counterparts. However, this cannot be advanced as a reason either for continuance of public sector dominance or for resistance to further financial sector reform. The example of Canada where the private sector plays a major role in the banking sector and is, by and large, less affected by the present financial crisis is a case in point. Indian banks are well-capitalised with a low level of non-performing assets (NPAs), though the level of NPAs is expected to go up as the slowdown begins to bite.The Reserve Bank of India has initiated a series of steps to ease the liquidity problems being faced by banks. It had cut the cash reserve ratio to 5.5% and the repo rate at which the central bank pumps liquidity into the system to 7.5%. It has also reduced the SLR or statutory liquidity ratio to 24%, down from 25% earlier.The reasons for tight liquidity conditions in the Indian market in those times were quite different from the factors driving the global liquidity crisis. Some reasons included large selling by Foreign Institutional Investors (FIIs) and subsequent Reserve Bank of India (RBI) interventions in the foreign currency market, continued growth in advances, and earlier increase in cash reserve ratio (CRR) to contain inflation. RBI’s recent initiatives, including the reduction in CRR by 150 basis points from October 11, 2008, cancellation of two auctions of government securities, and confidence-building communication, have already begun easing liquidity pressures.The strong capitalization of Indian banks, with an average Tier I capital adequacy ratio of above 8 per cent, was a positive feature in their credit risk profile. Nevertheless, Indian banks did face challenges in the Indian economic environment, marked by a slower gross domestic product growth, depressed capital market conditions, and relatively high interest rate regime. The profitability of Indian banks was expected to remain under pressure due to increased cost of borrowing, declining interest spreads, and lower fee income due to slowdown in retail lending. Profit were likely to be impacted by mark-to-market provisions on investment portfolios and considerably lower profit on sale of investments, as compared with previous years.Conclusion:Financial stability in India has been achieved through perseverance of prudential policies which prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent. India has by-and-large been spared of global financial contagion due to the subprime turmoil for a variety of reasons. India’s growth process has been largely domestic demand driven and its reliance on foreign savings has remained around 1.5 per cent in recent period. It also has a very comfortable level of forex reserves.The Basel Committee's current and planned initiatives were intended to produce a more robust supervisory and regulatory framework for the banking sector. These efforts, which also are in support of the initiatives and recommendations of the Financial Stability Forum and the G20 leaders, included:better coverage of banks' risk exposures, including for trading book, securitization, and derivative activities;more and higher quality capital to back these exposures;countercyclical capital buffers and provisions that can be built up in good times and drawn down in stress;the introduction of a non-risk based measure to supplement Basel II and help contain leverage in the banking system;higher liquidity buffers;stronger risk management and governance standards;more regulatory focus on system-wide or "macro prudential" supervision; and Greater transparency about the risk in banks' portfolios.In discussing the Basel Committee's long-term strategy, Mr Wellink stated that "we need to establish a clear target for the future regulatory system that substantially reduces both the probability and severity of a crisis like the one we currently are working through." He added that "by providing clarity about the future regulatory framework, we will help re-establish near term confidence, reduce the risk of competitive distortions and limit the degrees of uncertainty for the public and private sector"The foreign investment showed a sign of positive development during the period 2009-10 as a result of the strong banking policies of India (RBI)References1. Annual Report 2008-09, Reserve Bank of India2. Macroeconomic and Monetary Developments: First Quarter Review 2009-10, Reserve Bank of India3. Bank Quest Vol. 80 January- March 2009, IIBF4. Economic Survey, Government of India

Short answer:Did Fannie and Freddie buy high-risk mortgage-backed securities? Yes. But they did not buy enough of them to be blamed for the mortgage crisis. Highly respected analysts who have looked at these data in much greater detail than Wallison, Pinto, or myself, including the nonpartisan Government Accountability Office, the Harvard Joint Center for Housing Studies, the Financial Crisis Inquiry Commission majority, the Federal Housing Finance Agency, and virtually all academics, including the University of North Carolina, Glaeser et al at Harvard, and the St. Louis Federal Reserve, have all rejected the Wallison/Pinto argument that federal affordable housing policies were responsible for the proliferation of actual high-risk mortgages over the past decade. [1]Before the long answer:I had to research this topic for a project, so I had this data handy to begin with. I dislike disinformation, so I hope this helps whoever is trying to learn more about what happened.Do I think dumping a ton of data from a variety of sources analyzing information will convince a reader of the clear argument this post presents? You betya!Long answer:There is no reason to believe that Fannie and Freddie Mac have not been shady institutions who we should be wary of in many regards.[2] However, to say they were responsible for the mortgage failure of 2008 would be far-fetched by any stretch of the imagination.Let's start with the biggest one:Fannie and Freddie Mac led the subprime mortgage market.But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble. Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t: the definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.[3]– More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.– Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year. [4]Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication. One reason is that Fannie and Freddie were subject to tougher standards than many of the unregulated players in the private sector who weakened lending standards, most of whom have gone bankrupt or are now in deep trouble.During those same explosive three years, private investment banks — not Fannie and Freddie — dominated the mortgage loans that were packaged and sold into the secondary mortgage market. In 2005 and 2006, the private sector securitized almost two thirds of all U.S. mortgages, supplanting Fannie and Freddie, according to a number of specialty publications that track this data. [5]Moreover, this point also papers over the fact that PLS loans have defaulted at over 6x the rate of GSE loans, as well as the fact that private label securitization is responsible for 42% of all delinquencies despite accounting for only 13% of all outstanding loans (as compared to the GSEs being responsible for 22% of all delinquencies despite accounting for 57% of all outstanding loans).” [6]Pray tell what caused the same boom and bust in these other nations?And how could Fannie/Freddie or the CRA be responsible — that only applies to the US — when you have the same, global, coordinated rise in prices? (And you can add Korea and New Zealand to the chart above). [7]Fannie and Freddie’s primary business of subsidizing conventional loans was not a driver of the housing the bubble. Indeed, conventional loans represented less than a third of all mortgage originations during the peak price acceleration years.This was a phenomenon of private-label non-conventional loan securitization.[8]Fannie and Freddie lost market volume during the boom. That is, during the boom not only did the fraction of loans securitized by Fannie and Freddie fall, but the absolute number fell. At the same time the absolute number of private-label securitizations rose.There is a simple and obvious reason for this. The development of structured products meant that for many consumers the free market offered a more attractive loan than the government subsidized one.[8]Areas with the largest collapse in home prices have accounted for most of Fannie and Freddie losses. Refer to the same graph above.This is further evidence that it was the collapse of the bubble and not betting on people who were poor credit risks that induced major losses at Fannie and Freddie.[8]Fun fact about Peter Wallace:Wallison, of course, wrote a lonely dissent from both the Financial Crisis Inquiry Commission majority report and from his fellow Republican commissioners, in which he alone blamed the global financial crisis on U.S. affordable housing policies. This argument is clearly contradicted by the facts, including the following:Parallel bubble-bust cycles occurred outside of the residential housing markets (for example, in commercial real estate and consumer credit).Parallel financial crises struck other countries, which did not have analogous affordable housing policies.The U.S. government’s market share of home mortgages was actually declining precipitously during the housing bubble of the 2000s. [9]Although I feel he does come from the right place:So, one must ask: Why should the GSEs be allowed to underwrite mortgages of up to $625,500 for homes costing about $800,000? There are many lenders aggressively competing to make the higher-amount loans, and the GSEs are not doing the job they should for low-income homebuyers.Fannie and Freddie should do a much better job of providing affordable home financing to a neglected portion of the mortgage market. And this certainly doesn’t include someone applying for a $625,500 loan.[10]the data does not support him with regards to the mortgage crisis.The major data-driven rebuttal of any of the above claims comes from an infamous paper by Pinto, which has been shown to be intellectually dishonest and a form of misinformation:Unfortunately, Pinto’s research findings relied upon so heavily by Wallison and others are false. Pinto’s work is based on a series of faulty assumptions and serious methodological flaws. Pinto’s controversial conclusion that federal housing policies were responsible for 19 million high-risk mortgages is based on radically revised definitions for the two main categories of high-risk mortgages, subprime loans and so-called Alt-A mortgages, which refer to loans with low documentation of income and wealth. Importantly, these revised definitions are not consistent with how the terms subprime and Alt-A are used for data collection, as this paper will demonstrate. [11]The Government Forced Fannie/Freddie to OverextendConservative columnist Charles Krauthammer wrote recently that while the goal of the CRA was admirable, "it led to tremendous pressure on Fannie Mae and Freddie Mac — who in turn pressured banks and other lenders — to extend mortgages to people who were borrowing over their heads. That's called subprime lending. It lies at the root of our current calamity."Fannie and Freddie, however, didn't pressure lenders to sell them more loans; they struggled to keep pace with their private sector competitors. In fact, their regulator, the Office of Federal Housing Enterprise Oversight, imposed new restrictions in 2006 that led to Fannie and Freddie losing even more market share in the booming subprime market.What's more, only commercial banks and thrifts must follow CRA rules. The investment banks don't, nor did the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans.[5]Second, it is hard to blame CRA for the mortgage meltdown when CRA doesn't even apply to most of the loans that are behind it. As the University of Michigan's Michael Barr points out, half of sub-prime loans came from those mortgage companies beyond the reach of CRA. A further 25 to 30 percent came from bank subsidiaries and affiliates, which come under CRA to varying degrees but not as fully as banks themselves. (With affiliates, banks can choose whether to count the loans.) Perhaps one in four sub-prime loans were made by the institutions fully governed by CRA....It's telling that, amid all the recent recriminations, even lenders have not fingered CRA. That's because CRA didn't bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA -- or any federal regulator. Law didn't make them lend. The profit motive did.And that is not political correctness. It is correctness.[12]Some critics of the CRA contend that by encouraging banking institutions to help meet the credit needs of lower-income borrowers and areas, the law pushed banking institutions to undertake high-risk mortgage lending. We have not yet seen empirical evidence to support these claims, nor has it been our experience in implementing the law over the past 30 years that the CRA has contributed to the erosion of safe and sound lending practices. In the remainder of my remarks, I will discuss some of our experiences with the CRA. I will also discuss the findings of a recent analysis of mortgage-related data by Federal Reserve staff that runs counter to the charge that the CRA was at the root of, or otherwise contributed in any substantive way, to the current subprime crisis. [13]There was some pressure, but not in the way most critics of FF would frame it:Also another point I don’t see brought up enough is that the GSEs had political pressures to purchase private-label mortgages in 2007 as the credit market was freezing up, in a desperate attempt to unlock it.[6]Low Interest Rates Led to Easy MoneyThere is merit to this argument: Greenspan did extent low interest rates for a historically long period of time. However, the weight this argument is given usually is a lot greater than it is worth.If you believe that the Fed kept the fed funds rate 2% below its proper Taylor-rule value for 3 years, that has a 6% impact on the price of a long-duration asset like housing. Even with a lot of positive-feedback trading built in, that’s not enough to create a big bubble. And it wasn’t the bubble’s collapse that caused the current depression--2000-2001 saw a bigger bubble collapse, and no depression. [14]Real ReasonsFannie/Freddie Collapse:It had little to do with their much-criticized portfolios, and was mostly associated with purchases of risky-but-not-subprime mortgages and insufficient capital to cover the decline in property values. [15]Financial Collapse:But these are different debates than the one this book has provoked. Contrary to many commentators on Reckless Endangerment, and to its chief claims, it was Wall Street, not the GSEs, that fundamentally caused the 2007–2008 crisis, which was driven not merely by a headlong pursuit of easy profit but also by ethically dubious practices. Morgenson and Rosner discuss a handful of these practices and raise appropriate questions about why Wall Street participants were not criminally prosecuted. [16]Derivatives had become a uniquely unregulated financial instrument. They are exempt from all oversight, counter-party disclosure, exchange listing requirements, state insurance supervision and, most important, reserve requirements. This allowed AIG to write $3 trillion in derivatives while reserving precisely zero dollars against future claims.Wall Street’s compensation system was skewed toward short-term performance. It gives traders lots of upside and none of the downside. This creates incentives to take excessive risks.The demand for higher-yielding paper led Wall Street to begin bundling mortgages. The highest yielding were subprime mortgages. This market was dominated by non-bank originators exempt from most regulations. The Fed could have supervised them, but Greenspan did not.“Innovative” mortgage products were developed to reach more subprime borrowers. These include 2/28 adjustable-rate mortgages, interest-only loans, piggy-bank mortgages (simultaneous underlying mortgage and home-equity lines) and the notorious negative amortization loans (borrower’s indebtedness goes up each month). These mortgages defaulted in vastly disproportionate numbers to traditional 30-year fixed mortgages.Many states had anti-predatory lending laws on their books (along with lower defaults and foreclosure rates). In 2004, the Office of the Comptroller of the Currency federally preempted state laws regulating mortgage credit and national banks. Following this change, national lenders sold increasingly risky loan products in those states. Shortly after, their default and foreclosure rates skyrocketed.Glass-Steagall legislation, which kept Wall Street and Main Street banks walled off from each other, was repealed in 1998. This allowed FDIC-insured banks, whose deposits were guaranteed by the government, to engage in highly risky business. It also allowed the banks to bulk up, becoming bigger, more complex and unwieldy. [17]And finally, a fun graph with regards the last point made above:With this final graph, the reader should carefully adjudicate all sources and consider data-driven, empirical results. I feel data speak for themselves.http://rortybomb.wordpress.com/2011/11/01/bloombergs-awful-comment-what-can-we-say-for-certain-regarding-the-gses/An Inconvenient TruthFannie, Freddie and YouMayor Bloomberg: ‘It Was Not The Banks That Created The Mortgage CrisisPrivate sector loans, not Fannie or Freddie, triggered crisisSome Thoughts on Tyler Cowen's Points on the GSEsGlobal Housing BoomFannie / Freddie AcquittedWhy Wallison Is Wrong About the Genesis of the U.S. Housing CrisisHigher GSE Limits Would Hit Those Who Need HelpFaulty Conclusions Based on Shoddy Foundationshttp://prospect.org/article/did-liberals-cause-sub-prime-crisisKroszner: CRA & the Mortgage CrisisIn Which I Count Things...http://business.gwu.edu/creua/research-papers/files/fannie-freddie.pdfDid Fannie Cause the Disaster?What caused the financial crisis? The Big Lie goes viral.Competition and Crisis in Mortgage Securitization

On Monday, 15 September 2008, financial markets around the world convulsed in sheer panic.In New York, the Dow Jones Industrial Index suffered one of its biggest-ever falls, falling 504 points (down 4.4%) in a single session. On this side of the Atlantic, the FTSE 100 index tumbled almost a tenth (9.9%) in the four days to 18 September. While stock markets plunged, the cost of credit soared, with credit spreads blowing out to record levels. This was no ordinary financial crisis.WHAT CAUSED THIS MARKET MAYHEM?The answer is the bankruptcy of a company, but this was no ordinary bankruptcy and no ordinary company. On Sunday, 14 September, leading US investment bank Lehman Brothers -- having failed to be rescued by a buyer or a government bailout -- went under.The bankruptcy of Lehman rocked the financial system to its core, not least because it was the biggest corporate bankruptcy in US history. With over $600 billion in assets to administer, Lehman's bankruptcy was many times more complex than Enron's failure in 2001. Also, as a leading investment bank, Lehman was deeply plumbed into the global financial system, thanks to a spider web of companies, contacts and contracts around the world.WHY DID LEHMAN FAIL?Some blame chief executive Dick 'the Gorilla' Fuld for his overconfidence and failure to recognise that Lehman faced a momentous crisis. Arguably, Fuld's battle to salvage something for Lehman's suffering shareholders eventually cost them every cent.Some commentators blame Bank of America for ending takeover talks with Lehman in favour of buying its larger rival Merrill Lynch for $50 billion the following day. Other pundits blame Barclays for refusing to buy Lehman without US government backing, in the form of emergency funding. However, one needs to look at the financial history of the firm just before it went under.Lehman Brothers Holdings from 2000–2008Under the direction of Dick Fuld, Lehman expanded its portfolio of services to include the more risky and complex financial products that were being developed during the 2000′s in the wake of deregulation of the financial industry, including, in particular, the 1999 repeal of the Glass-Steagall Act that had prohibited affiliations between commercial banks and investment banks and their activities.The following is the market capitalization value of Lehman Brothers Holdings Inc 1994–2008 (in $bn)Lehman aggressively pursued opportunities in proprietary trading (trading with its own money to make a profit for itself rather than for its clients), derivatives, securitization, asset management, and real estate. In 2000, proprietary trading comprised 14% of the firm’s total revenues. By 2006, that figure had increased to 21%. The change in business composition was accompanied by significant growth in revenues and an increase in market capitalization (see Figure 1). From 2000 to 2006, the firm’s revenue growth of 130% outpaced that of its rivals, Goldman Sachs and Morgan Stanley. During Fuld’s tenure, the firm’s revenues grew 600%, from $2.7 billion in 1994 to $19.2 billion in 2006. Equity markets recognized this performance by bidding up the firm’s stock price such that its market capitalization appreciated by some 340% over the same period. Again, this significantly outpaced its rivals' growth.In March 2006, despite rumblings that the housing market had peaked, Lehman Brothers adopted a new business strategy aimed at capitalizing on its significant experience with real estate. (Another reason may have been that the firm had previously been successful in pursuing a counter-cyclical strategy in the 1980s.) Prior to 2006, Lehman would acquire assets primarily to “move” them to third parties through securitization, but with its new strategy, as it sought greater market share and prof its, it acquired assets to “store” them as its own investments, retaining the risk and returns of those investments on its books in hopes of greater profits. The targeted growth areas were its proprietary businesses—commercial real estate, leveraged loans (loans to highly leveraged, or speculative-grade, firms that usually offered higher returns in exchange for increased credit and liquidity risk) and private equity—businesses that put more capital at risk, especially if an investment turned sour, and which were more ill liquid than Lehman’s traditional lines of business.The firm aggressively bought real-estate-related assets throughout 2006, and by mid-2007, Lehman held significant positions in commercial real estate. This made it difficult for it to raise cash, hedge risks,and sell assets to reduce leverage in its balance sheet, all critical to its health in a difficult financial environment.Even though the U.S. housing prices began to decline in mid-2006, Lehman continued to originate subprime mortgages and increase its real estate holdings as other parties exited the market. In August 2007, Lehman announced that it would close BNC Mortgage, its main subprime origination platform and its Korean mortgage business. It also suspended its wholesale and correspondent lending activities at its Aurora Loan Services subsidiary. Yet, in October 2007, it acquired the Archstone Real Estate Investment Trust, the largest residential REIT in the U.S., amid concerns from rating agencies and investors that it was overpaying for the deal. At the end of its 2007 fiscal year, Lehman Brothers held $111 billion in commercial or residential real estate-related assets and securities, more than double the $52 billion that it held at the end of 2006, and more than four times its equity. Increasingly, rating agencies and investors expressed concerns regarding these types of assets due to the ill liquidity of the market for them and to the substantial losses that other firms experienced in these categories. The constant revaluation by Lehman Brothers of these types of assets would contribute to significant write-offs throughout 2008.The Reasons for Lehman Brothers’ Collapse:Leverage concerns:During the good times, the best way to enhance your returns is to 'gear up' by borrowing money to invest in assets which are rising in value. This enables you to 'leverage' (magnify) your returns, which is particularly useful when interest rates are low. However, leverage cuts both ways, as it also magnifies your losses when asset prices fall. (Witness the recent return of negative equity to the UK property market.)A sensibly run retail bank would have leverage of, say, 12 times. In other words, for every £1 of cash and other readily available capital, it would lend £12. In 2004, Lehman's leverage was running at 20. Later, it rose past the twenties and thirties before peaking at an incredible 44 in 2007.Thus, Lehman was leveraged 44 to 1 when asset prices began heading south. Think of it this way: it's a bit like someone on a wage of £10,000 buying a house using a £440,000 mortgage. If property prices started to slide, or interest rates moved up, then this borrower would be doomed. Thanks to its sky-high leverage, Lehman was in a similar pickle.Beginning in mid-2007, real estate markets began to show signs of weakening. Lehman and other investment banks came under greater scrutiny regarding the value of their real-estate-related-assets and their liquidity. Rating agencies and analysts began demanding that the investment banks reduce their leverage. To reduce leverage, firms have two choices—to increase equity or to sell assets. While Lehman did raise $6 billion in additional capital in early 2008, it preferred to sell assets.But this strategy proved challenging for Lehman. In January 2008, Fuld instituted a deleveraging strategy to reduce Lehman’s real estate positions, but Lehman was unsuccessful at selling such assets at acceptable prices, given the slowing of the market. Also, Lehman was reluctant to sell such assets at discounted prices. Not only would it risk taking losses on the sold assets, but to do so would call into question the value of its remaining assets of similar type and compel it to mark them to market value, potentially recognizing losses.Liquidity Problems:Most businesses fail not because of lack of profits but because of cash-flow problems. Like all banks, Lehman was an upturned pyramid balanced on a small sliver of cash. Although it had a massive asset base (and equally impressive liabilities), Lehman didn't have enough in the way of liquidity. In other words, it lacked ready cash and other easily sold assets.Lehman’s long-term assets were being funded by short-term debt (e.g., repo agreements and commercial paper) and Lehman borrowed billions of dollars each day in the overnight wholesale funding markets in order to operate. By early 2008, other institutions were less likely to accept Lehman securities as collateral(or, alternatively, demanded more collateral for a given level of financing, thereby eroding Lehman’s ability to continue to carry out its short-term obligations). Following the near collapse of Bear Stearns in March 2008, precipitated by a liquidity crisis, rumors circulated that Lehman would be the next bank to go under. As Lehman’s perceived financial position worsened, it faced a higher cost of credit. Some lenders withdrew from the firm, refusing to roll over its repos, others demanded bigger haircuts (discounts), and still others refused to accept all but a narrow type of collateral, refusing Lehman’s real-estate-related assets and rendering them even more ineffective.For example, between June and August 2008, Lehman delivered an additional $9.7 billion to J.P.Morgan Chase to support its securities clearing and tri-party services (wherein it acted as agent for Lehman’s repo transactions). Also, uncomfortable with the collateralized debt obligations (CDOs) that Lehman delivered, J.P. Morgan requested additional collateral, but would only accept cash.Other lenders made similar demands, severely restricting Lehman’s access to funding. Before its failure,$200 billion of Lehman’s assets were funded with secured overnight loans, largely repos, 80% of which came from 10 institutions. Hesitation or stricter standards by a small number of lenders could (and did)cause significant funding problems for the firm.LOSSESAfter the terrorist attacks of 11 September 2001, US interest rates plummeted, causing a five-year boom in domestic and commercial property prices. This boom ended in 2006 and US housing prices have since fallen for three years in a row.Lehman was heavily exposed to the US real-estate market, having been the largest underwriter of property loans in 2007. By the end of that year, Lehman had over $60 billion invested in commercial real estate (CRE) and was very big in subprime mortgages (loans to risky homebuyers). Also, it had huge exposure to innovative yet arcane investments such as collateralised debt obligations (CDO) and credit default swaps (CDS).As property prices crashed and repossessions and arrears sky-rocketed, Lehman was caught in a perfect storm. In its third-quarter results, Lehman announced a $2.5 billion write-down due to its exposure to commercial real estate. Lehman's total announced losses in 2008 came to $6.5 billion, but there was far more 'toxic waste' waiting to be unearthed.Regulator Inaction:Lehman’s operations were subject to supervision by a number of governmental and industry organizations, including its primary regulator, the SEC, the Chicago Mercantile Exchange (CME), which regulated certain derivatives, the Office of Thrift Supervision, which supervised Lehman’s thrift subsidiary, and the New York Federal Reserve Bank (NYFED). After it filed for bankruptcy, many questions were raised about the efficacy of these agencies’ oversight. Despite reviewing daily reports regarding Lehman’s leverage and liquidity, neither agency took any preventive or corrective action pursuant to its authority. In the aftermath of Lehman’s bankruptcy filing, Anton Valukas, the bankruptcy examiner, criticized the agencies for not taking a more active role in preventing the firm’s failure: “So the agencies were concerned. They gathered information. They monitored. But no agency regulated.” (Valukas Statement, 6). He was particularly critical of the SEC, Lehman’s primary regulator: The SEC knew that Lehman was reporting sums in its reported liquidity pool that the SEC did not believe were in fact liquid; the SEC knew that Lehman was exceeding its risk control limits;and the SEC should have known that Lehman was manipulating its balance sheet to make its leverage appear better than it was. Yet even in the face of actual knowledge of critical shortcomings, and after Bear Stearns’ near collapse in March 2008 following a liquidity crisis, the SEC did not take decisive action.”IN SUMMARY...Lehman once employed 28,000 people across the world, including 5,000 in London. At their peak, its shares traded at $85, but then they were roughly at 10¢. Lehman's remains were shared out between Barclays, which bought its US broking arm, and Japanese giant Nomura, which bought its European and Asian assets. These firms, plus number-one investment bank Goldman Sachs, have profited most from picking over the bones of Lehman's businesses.In short, Lehman Brothers -- a company with a 158-year history, including 14 years as an NYSE-listed giant -- failed simply because it took on too much risk in a booming market. In the end, its move from the safety of corporate finance and M&A (mergers and acquisitions) income into the risky world of proprietary trading proved to be its downfall.Sources and Citations:The Death Of Lehman Brothers: What Went Wrong, Who Paid The Price And Who Remained Unscathed Through The Eyes Of Former Vice-PresidentWhy Lehman Brothers collapsedCase Study: The Collapse of Lehman Brothers | InvestopediaImage Source: Google.