The immediate cause of the present world financial crisis is the combination of declining housing values and the excessive extension of subprime and other variable-rate mortgages to people by banks and other financial institutions which assumed incorrectly that housing values would continue rising forever, enabling the mortgage-holders to re-finance. As housing prices fell and mortgage rates rose, foreclosures resulted in losses by the mortgage holders. In many cases the mortgages were not directly held by the banks that issued the loans but were repackaged into securities sold by larger financial institutions.

Lehman Brothers faced an unprecedented loss as a result of large investments in subprime and other lower-rated mortgage tranches (meaning that as homes were sold to recover losses on subprime loans they would get paid off last or not at all). On September 15th, Lehman Brothers announced it would file for Chapter 11 bankruptcy protection.

With Lehman's collapse those who held insurance like policies called credit default swaps (CDSs) on Lehman were owed nearly $400 billion by insurance companies and other financial institutions which had sold the CDSs. The money owed relates to the value of losses by Lehman but since CDS holders are not required to have any assets related to what was insured, the value of the payoffs could be much higher than Lehman's actual losses. CDSs are not regulated so it is not transparent as to who owes how much due to the Lehman collapse and to whom the money is owed.

One large issuer of CDSs on Lehman was American International Group (AIG). Faced with a need to pay more than they held in in cash, AIG was loaned $85 billion by the Federal Reserve on September 16th. This was not enough to cover what was owed and they have now obtained billions more in loans from the US government.

Lehman's collapse also had a major impact on the commercial paper market which consists of short term loans to major corporations and other banks to fund operating expenses. Such loans normally come from money market mutual funds which were seen as a safe way to store money with only a slightly higher than in federally insured bank accounts. On September 16th, the Reserve Primary Fund, a large money market mutual fund, lowered its share price to the point where share holders lost money. Such losses are rare enough that it caused banks and money market account holders to panic resulting in a large movement out of money market accounts and into safer forms of savings (like cash and government bonds). By the morning of September 18th, money market sell orders from institutional investors totaled $0.5 trillion. Due to the movement of investors out of money market accounts and the movement of money market mutual funds out of commercial paper, banks started demanding a higher rate of interest for loans to businesses and other banks. This in turn made the housing crisis worse since many mortgage rates are tied to interbank loan rates such as the three-month London InterBank Offered Rate (LIBOR).

Two of the major corporations involved in securitizing mortgages in the US are Fannie Mae and Freddie Mac, stockholder-owned corporations chartered by Congress. On September 7th, the Federal Housing Finance Agency (FHFA) announced that due to the subprime crisis, Fannie Mae and Freddie Mac were being placed into conservatorship of the FHFA. In the CDS market, the standard contracts typically used between parties to a swap define the action of placing Fannie Mae and Freddie Mac into conservatorship to be equivalent to bankruptcy. Fannie and Freddie have approximately US$ 1.5 trillion in bonds outstanding and one estimate of CDS payments owed is $500 billion.

In late September, a major banking and financial crisis emerged in Iceland with its currency the krona, dropping 30% against the euro. On October 9th, the Icelandic Financial Supervisory Authority took control of the country's biggest bank . All trade was suspended on the Iceland Stock Exchange and many individuals, companies and municipalities in Britain which held billions in Icelandic banks are now unable to withdraw funds. Britain responded by freezing many Icelandic assets in Britain. Combined with the problems in the US, the Icelandic crisis spread many similar problems to Europe.

Worldwide, banks and companies have been demanding more cash due to the difficulty in obtaining short term loans and the need to pay off losses like CDSs. The need to pay more for mortgages and problems with banks such as those in Iceland (and WaMu and Wachovia in the US) have also caused many individuals and companies to move their money into more liquid assets (such as accounts backed by the federal government or even cash). To do this, people have had to sell stocks, bonds, oil futures and even gold. The result has thus been that the value of all such assets have fallen and stock markets all over the world have been crashing. Unlike other such crashes investors are mainly selling to get cash to pay off debt rather than just selling because they think the market is overvalued. This could result in a large bounce when the credit market unfreezes, but the process will likely restart if new financial institutions default and more CDSs need to be paid out. With fear over the state of the economy worldwide, consumer confidence is now falling as well. With lower sales of all goods, people assume companies will sell less in the immediate future, making it hard to value companies by their existing profits. By the end of Friday October 10th, stock markets in the Europe, Asia, Australia and the Americas were down over 20% for just the last several weeks with many down over 40% for the past year.

Related Local Events:
Oct 17th San Jose Talk On Global Financial Meltdown By by Sharat G. Lin
Protest - No Wall St. Bailout: (Oct 19th | Oct 20th )
Oct 21st: Revolution Books Discussion of "The Financial Meltdown and the Madness of Capitalism"

Related Posts: Stop The Wall Street False "Nationalization" Tax Money Bailout Of Failed Banks | Washington's "shock" over AIG's post-bailout junket | Wall Street demands free hand with funding from US Treasury | Noam Chomsky: Exposing the Un-Democratic Face of Capitalism | After the Meltdown, A Saner America | This American Life Overview Of The Economic Crisis | Oct 10th: Worst week for global markets since 1929 | The Demise of Neoliberal Globalization | DN: As Stocks Plummet Across the Globe, Bush to Host Emergency Finance Meeting At White House | Naomi Klein: Wall St. Crisis Should Be for Neo-Liberalism What Fall of Berlin Wall Was for Communism | Mumia: Fall of the House of Capital? | Lehman sought millions for execs while seeking bailout | Carnage: Seven days that shook the world | Oct 6th: Markets plummet amid banking fear | A £516 trillion derivatives 'time-bomb' | On the edge of the abyss | Traders' worst fears realised at Lehmans auction | The Ideological War Continues

Chaos Around The Globe: As Iceland Reels, Finance Minister Explains Crisis | International financial crisis exposes vulnerability of Indian economy | DN: European, Asian Markets Plunge as Recession Fears Spread Worldwide | As share market plunges, political crisis in Thailand deepens | Australian share market's "black Friday" | Turkish manufacturing sector hit hard by financial crisis | World financial crisis leads to auto industry layoffs across Europe | British Government To Partially Nationalize Banks | UK council salaries hit by bank collapses | Financial crisis: global recession

Wikipedia Coverage: Oct 10th:Global markets plunge | Oct 9th: Markets down across the world; Dow Jones falls below 9,000 | Oct 8th: Central banks worldwide cut interest rates | Oct 7th: Stock markets worldwide continue to fall | Oct 6th:Worldwide markets fall precipitously

Wikipedia Background: Economic Crisis Of 2008 | Subprime mortgage crisis | Global financial crisis of September–October 2008 | Icelandic Financial Crisis | List of bankrupt or acquired banks during the financial crisis of 2007–2008

Past Indybay Coverage: Protesters Demand No Bailout of Financial Industry Debt