What decision did American finance organizations such as Lehman Brothers make that caused the global crisis?

Answer 1

Unfortunately, the credit crisis cannot be pinned down to a single decision (or even set of decisions) by a single entity. There are various things that caused this to happen. Here is a list of some of the things people have been blaming the crises on and how American finance organizations contributed to them. Note though, that we won't know exactly what happened for many years.

- Some say that lenders made loans to people that they knew couldn't pay. This is highly disputed. If it's true, then the lenders and the government did not make good decisions (government for not overseeing predatory lending practices). Most economists would agree, though, that this is NOT a contributing factor to our current state. A better way to say this would be:

-Banks and borrowers made ill-informed decisions. For instance, many loans were made without income verification (sometimes called ninja loans) to people with poor credit history. The banks, in hindsight, should have verified income (see the 3rd point for an extension of this). The borrowers should have known that they would not be able to repay the loan either at current rates or should the rates adjust (if they had an Adjustable Rate Mortgage).

- Fannie Mae and Freddy Mac needed better oversight. The reason their downfall was so big is because they owned about half the mortgages in the country, were extremely leveraged (2.5% of assets required as opposed to the normal 10%), and were highly exposed to sub-prime mortgages. They were exposed because they would very willingly (in fact, members of Congress urged them to) buy sub-prime mortgages from banks. The banks liked this because they still made their profit (albiet a bit less of it) and avoided risk (which is actually a good decision on their part). Fannie Mae and Freddy Mac were glad to take on their risk, as they - being funded by Congress - had an unlimited supply of cash and thus no aversion to risk. Basically, because Fannie Mae or Freddie Mac would gladly buy loans, banks were more open to giving loans to people that might not be able to repay them, because the banks could easily sell them to the governemnt funded and mandated Fannie Mae.

- Some banks were way too leveraged into sub-prime mortgages. Lehman Brothers is THE example of this. Leverage is a term used in finance that basically means using tactics that magnify your profits from a given investment. The problem with this is that it also magnifies your losses. Very basically, LEH took out loans using the cash they had on hand as a downpayment. They then took that loan money and invested it into sub-prime commercial paper. The value of that paper went down, cause LEH to owe a ton of money that they no longer had. The rest is history.