The keyword here is leverage. Lehman Brothers Holdings borrowed too much money.
Lehman Brothers Holdings has outstanding liabilities of more than $600 billion, as according to the Reuters Report.
For everybody’s knowledge, Lehman Brothers Holdings really makes money by lending money for mortgage of homes. In addition, the more money that is lent, the more the profit there is.
In the years 1980s and 1990s and into the early part of 2000s, the prices of real estate really went up. Such mortgage companies like Lehman Brothers really saw the opportunity to earn additional money by giving out more loans to lenders of questionable status and who will most likely not qualify under such normal conditions. They created what they call ‘speculative mortgages’ that permitted people of questionable financial means to borrow right now at a lower interest rate and payments are lowered with the assurance of paying the loan back at a later time with such higher interest rates.
Both parties, the home buyers and Lehman Brothers, anticipated that the real estate in the USA will still continue to appreciate, thus allowing the loan borrowers to continue when their income increase as well as the value of their home. Interest rates of the new loans are fixed and made affordable to buyers.
In the meantime, the real estate market reached its highest point. The prices of real estate remained steady at ten to twenty percent a year. Those affected first were the speculators located in the areas where people were buying their second homes or what they call their vacation homes. The plan of the speculators is that they will buy now and then sell it later at a profit or what they call ‘flipping land’.
When the market became idle and declined eventually, the investors could no longer flip and began to lose money. These kinds of speculative investments soon went on the market, and the demand for the market was reduce when the investors are no longer purchasing. Investors in due course are no longer buying and there was a reduced market demand. Investors soon filled up the market with real estate properties and decreasing prices.
This situation doubled up as more and more people are into the falling market trap. In time, Lehman Brothers and other banks that extended such speculative loans hit an adjustment point and the result is an increase in the interest rate of the mortgages with the banks. Some interest rates are very severe causing loan payments to swell.
This situation was further aggravated for the rest of the economy, as the increased expected income never happened. In addition, mortgage payments severely redoubled and people eventually failed to pay their mortgages. The people who plan to refinance later learned that their homes did not appreciate but had fallen in value.
Their houses were worth less and they owed more on their mortgage loans. At present, there is no bank that would refinance since bank would not lend more than what a house is worth. This resulted to defaulting by these folks while they cannot afford to pay the new payment price and could not refinance to easier affordable terms.
High-performing banks with better conservative lending policies will likely overcome this kind of predicament. Lenders like Lehman Brothers and other banks in higher stages of speculative loans are the ones very much affected. Since foreclosure sales are now bringing in less money than what the person owed, people have properties due for foreclosing.
Losing ‘faith’ in the ability to loan repayment forced Lehman Brothers Holdings in what they call a liquidity crisis. They say, in banking you borrow money in order to make money. If no one will offer you a loan, you cannot make money and therefore, you fail.
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