Financial Crisis The Recession - 1336 Words

FINANCIAL CRISIS 2007-2009 Introduction: The 2007-2009 financial crisis is generally considered to be the worst since the Great Depression of the 1930s. It famously led to some major financial institutions such as Lehman Brothers to collapse while many others including HBOS and the Royal Bank of Scotland had to be bailed out by the government. The stock market crashed, unemployment escalated and we were plunged into a recession sometimes referred to as the Great Recession. Although the recession is now considered to be over, its effects can still be felt in the form of high rates of unemployment and an incredible rise in our country’s debt. This essay will aim to succinctly and coherently explain what happened during the 2007-2009†¦show more content†¦The banks see an opportunity to connect investors to home owners through mortgages. They buy mortgages from the mortgage lenders (with the money they’ve borrowed at low interest rates) and make collateralized debt obligations or CDOs. CDOs enable the b anks to split up mortgages into 3 categories or â€Å"tranches†: safe, medium and risky, which means they can sell to investors seeking any level of risk from low to high and therefore any level of reward. Each category has a credit rating, assessed by agencies (who are paid by the banks). These ratings proved to in fact be far too generous, claiming that investments were safer than they actually were. The investors can now invest their money in the seemingly safe tranche of the CDOs and mass investing starts to occur. So much so that everyone who is eligible to take out a mortgage already has. When a mortgage defaults, the lenders get the home owners’ house and because houses were always increasing in value, lenders are in certain respects covered in the eventuality of defaults and start to introduce risk to their mortgages. Instead of lending to responsible home owners through prime mortgages, the lenders lend money to irresponsible home owners through sub prime mort gages. These subprime mortgages don’t require down payments or proof of income. This is the turning point of the financial crisis. An important aspect to point out is that the