Reasons for the International Financial Sector Banking Crisis

Credit default swaps are often so complicated and difficult to understand that these can be presented as a safe and viable investment to even sophisticated institutional investors including pension funds, credit unions mid-sized and smaller financial institutions, as well as school districts and other governmental subdivisions. CDS were often marketed to such investors under the claim that these could provide a higher return than "comparable" investments. However, the risk of the CDO's was often far greater than those investments to which these were being compared. - Credit Default Swaps (CDS) Sold as Safe are Potentially Toxic Waste, Shepherd Smith Edwards & Kantas

Reasons for the International Financial Sector Banking Crisis

October 2, 2010

eHow - With the continuing increase of economic globalization, a financial crisis in one country can often have a detrimental effect on another country's financial markets. The international financial sector banking crisis gained its footing in the United States. It began with the massive increase in U.S. securities investments by foreign investors and the U.S. housing market collapse.

Mortgage-Backed Securities

During the U.S. housing boom, the sub-prime mortgage market grew exponentially. Banks that held these loans bundled them together and sold them as mortgage-backed securities, a type of asset-backed bond. Many foreign investors and financial institutions began buying huge amounts of mortgage-backed securities, as well as credit default swaps. The credit default swaps guaranteed the investors would receive some form of payment should any of the companies suffer a significant credit event, such as credit default or bankruptcy.

Housing Market Collapse

When the housing market collapsed, it left the U.S. financial institutions that issued mortgage-backed securities and credit default swaps holding onto toxic assets. A toxic asset is an asset whose value has decreased dramatically. These financial institutions now had to pay investors billions of dollars on the swaps, leaving the companies with more liabilities than assets and forcing many banks into insolvency. Government-sponsored institutions like Fannie Mae and Freddie Mac began requesting billions of dollars in loans from the U.S. Treasury Department just to be able to cover their positions on mortgage-backed bonds they issued during the housing boom.

Foreign Markets

U.S. financial institutions were not able to make the interest payments to foreign investors on the mortgage-backed securities they owned, which negatively affected the foreign financial institutions' cash flows. This, in turn, affected the ability of foreign banks to meet their debt obligations. This series of events then led to the beginning of a global financial crisis. To avoid a complete collapse of the U.S. financial sector and a deepening international financial crisis, the government unveiled a bailout program to help pay off credit default swaps issued by U.S. financial institutions to foreign banks and investors.

Lehman Brothers and AIG

The collapse of Lehman Brothers and AIG further exacerbated the international financial sector banking crisis. Both Lehman and AIG had billions of dollars of loans outstanding to foreign banks from a number of countries around the world, including Japan, Germany, Netherlands, France and Spain. Both Lehman and AIG defaulted on those loans, leaving foreign banks out billions of dollars. Eventually, Lehman Brothers filed for Chapter 11 bankruptcy. While Lehman was under Chapter 11 protection, it did not have to make debt payments to its creditors, leading to a further intensifying of the international banking crises and leading to panic in worldwide financial markets. As a result of this panic, the U.S. government decided to bail out AIG in an effort to prevent a collapse of global financial markets.

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