Ten years ago, the US' housing finance system faced severe crisis, which in turn took the shape of global financial crisis with the country's fourth largest investment bank Lehman Brothers filing bankruptcy in September 2008. The company's collapse pulled down confidence in banks across the world. Surprising enough, even though the financial crisis originated in the US, it was among the least affected countries.
A report by The Carnegie Endowment for International Peace, published in 2009, said "although the United States is at the epicenter of the global economic crisis, it is one of the countries least affected by the financial fallout."
How did US manage to be among the least affected nations?
In 2007–2008, the US economy hit a boom and for more investments, the investors resorted to sub-prime mortgages because they believed that the prices of houses were only going to increase and that the element of risk will do no harm. The AAA credited investors had the prime mortgages while the sub-prime were those with either the BBB rating or were not rated at all.
Theoretically speaking; the riskier the investment, the higher the return — but greater the loss as well. The rate of return on mortgages were - the AAA got a three percent return, BBB got a seven percent return while the unrated investment got 10 percent.
Lehman Brothers shut their shop, the US immediately took to quantitative easing (QE) and austerity measures to pull the financial sector out of the mess before the effect of the crisis would lead to the other major financiers closing their doors for good.
The process of QE is when the central bank of the country - US Federal Reserve - pumps in funds into the distressed sector by buying all the securities of the banks and other financial institutions.
Austerity measures are strict measures where the commercial banks are not given any leverage and when the government steps in, high repo rates and restricted borrowing from the Fed becomes a task for the financiers.
“When Lehman Brothers went down, the notion that all banks were “too big to fail” no longer held true, with the result that every bank was deemed to be risky. Within a month, the threat of a domino effect through the global financial system forced western governments to inject vast sums of capital into their banks to prevent them collapsing. The banks were rescued in the nick of time,” Larry Elliot, the economics editor of The Guardian, had earlier written.
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First Published: IST