Collapse of the Housing Market, Collapse of Lehman Bros.

Since the financial industry will be taking this weekend to decide the future of Wall Street firm Lehman Brothers, this would seem an appropriate time to consider investment company's role in the subprime mortgage crisis. After all, from the implosion of hundreds of lenders, to the failure of Bear Stearns, the selling of Countrywide, and the latest Fannie Mae and Freddie Mac bailout, the collapse of Lehman is just the latest in a string of previous giants in the subprime industry going under.

Lehman Brothers had been one of the most prestigious names on Wall Street, playing in the world financial flows among such other firms as Bear Stearns, Citigroup, Merrill Lynch, Credit Suisse, and others. Lehman, along with Bear Stearns, though, led the way in subprime mortgage lending and securitizations of these loans into bonds salable to other end investors.

After the terrorist attacks of September 11, 2001, the largest Wall Street firms began reacting to the Federal Reserve policy of low interest rates and cheap fiat money by purchasing billions of dollars of subprime loans. These were most likely bought from nonbank mortgage companies, which borrowed money from companies like Lehman in order to make loans and quickly resell them to Wall Street.

In fact, Lehman very nearly owned this market, as other players like Merrill Lynch were late arriving to the subprime lending and securitizing game. Lehman Brothers and Bear Stearns were the major players in subprime, extending money in the form of warehouse lines of credit to nonbank lenders, buying the mortgage products, turning them into asset backed securities (ABS), and then selling these bonds to end investors like insurance companies, pension funds, local governments, and foreign banks.

Although the media portrays the credit crisis as if the largest Wall Street firms are simply unwitting victims of the subprime lenders and greedy homeowners who have decided to do nothing to stop foreclosure on speculation houses, the banking giants are counting on the ignorance of the public on at least two major points. Lehman participated in both of these games, drastically increasing their own exposure to the risks.

First, the Wall Street firms provided vast amounts of assistance to mortgage companies (subprime and otherwise) in going public. From managing their initial public offerings (IPOs) to giving the corporations loans in order to make subprime mortgages, Lehman could be involved with a lender from beginning to end, all the while hiding its role from actual home buyers. After helping companies go public and extending them lines of credit to make mortgages, Lehman would often buy the mortgages in order to securitize them and generate even more fees from the sale of the new bonds.

Second, as the hysteria for subprime loans grew during the early part of the 2000s, Wall Street firms would often become the owners of residential mortgage lending or loan servicing companies. Bear Stearns owned the notorious EMC Mortgage, while Lehman owned Aurora Loan Services. Conveniently, anyone who had a loan through these companies would not be able to connect the name of the lender to the Wall Street firm it was backed by, insulating the investment companies from negative publicity on the part of the subprime lenders they owned.

Hedge funds that invested heavily in subprime mortgage bonds were also often managed by the largest Wall Street firms. After all, unless the banking giants could control at least some of the money going into these securities, it would be difficult to increase demand artificially and convince municipalities and public pension funds to become investors. The credit crisis itself is popularly believed to have begun in August 2007 when two Bear Stearns hedge funds collapses due to a lack of confidence in its subprime mortgage holdings.

With the government takeover of mortgage giants Fannie Mae and Freddie Mac due to insolvency, it should come as no surprise that the investment firms most involved with the Government Sponsored Enterprises (GSEs) would also face collapse. When the GSEs experienced a wave of investigations and regulatory constrictions in the aftermath of the discovery of accounting regularities in 2003, Wall Street stepped into the void to provide securitization and purchase of mortgages.

With Fannie and Freddie's hands temporarily tied and unable to buy as many loans in the secondary market as were being originated, Lehman and others searched for or created new buyers. From selling mortgage backed securities (MBSs) to the GSEs to opening trading desks dedicated to purchasing unsecuritized whole loans from Savings & Loans and nonbank lenders, Wall Street could create mortgage bonds and sell them without the help of Fannie and Freddie. These loans would be packaged into MBSs and sold to investors with Structured Investment Vehicles (SIVs) taking the place of the government enterprises, with Lehman generating fees at every level of the process.

So, this is the company that all of Wall Street and Washington will be spending this weekend deciding the ultimate fate of. Whether it ends up in bankruptcy, is absorbed by another investment giant, bailed out by the Federal Reserve or the Treasury, or allowed to move forward with its "restructuring" plan, the firm has left an indelible mark on the US housing market. The smart money has left Lehman by now, just as it had left the subprime industry before its collapse; now the sharks must decide how best to dispose of the carcass and leave shareholders and the public with the responsibility of cleaning up the mess left behind.

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Nick writes daily articles on how homeowners can save a home from foreclosure. Visit his site to read more articles on how the process works: www.yousaveforeclosure.com/

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Collapse of the Housing Market, Collapse of Lehman Bros.

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