Lehmann Brothers

Collapse
&
LIBOR Scandal

Mortgage Cycles

Down Payment

Involvement of Investment banker

Down Payment

Investment Banker

Sub-Prime Mortgage Crisis

Down Payment

Investment Banker

Sub-Prime Mortgage Crisis

Down Payment

Investment Banker

Sub-Prime Mortgage Crisis

Down Payment

Investment Banker

$
$
$

Other institutions like

Pension Funds, Hedge
Funds etc.

Sub-Prime Mortgage Crisis

Now to earn more money Investment banker wanted more
mortgages.
But brokers couldnt find any because all those who were eligible,
already have home
They instituted a new type of mortgages.
Sub-Prime Mortgages:
No document,
No proof of income
Anyone can apply
Even if they default the value of house will be increasing and there
wont be any loss to
Investment banks
Instead of lending to responsible home owners called prime
mortgages banks started lending to sub prime mortgages
This is the turning point

Sub-Prime Mortgage Crisis

Stems from a fundamental change in the way mortgages are funded.

Traditional Model
Home Buyer
1
Mortgag
e Loan

Repayme
nts

Banks have
financed their
mortgage lending
through the
deposits they
receive from their
customers.
Limited the amount
of mortgage
lending they could
do.

Bank
Home Valuation
Income Check
1
2

Bank grants
mortgage
Homebuyer pays
bank

Sub-Prime Model

New model where

they sell on the
mortgages to the
bond markets.

Home Buyer
Mortgage
broker

This has made it

much easier to fund
Mortgag
additional
e Loan
borrowing,

Repayme
nts

Bank

Mortgag
e Bond

Rating
Agencies

Bond
Payment
s

Mortgage Bond
market

High-risk mortgage loans and lending/borrowing practices

The private sector

has dramatically
expanded its role in
the mortgage bond
market, which had
previously been
dominated by
governmentsponsored agencies
like Freddie Mac

The business proved

extremely profitable
for the banks, which
earned a fee for each
mortgage they sold
on. They urged
mortgage brokers to
sell more and more
of these mortgages.

They specialised in
new types of
mortgages, such as
sub-prime lending to
borrowers with poor
credit histories and
weak income,
undocumented
immigrants who were
shunned by the
"prime" lenders like
Freddie Mac.

Now the mortgage

bond market is worth
$6 trillion, and is the
largest single part of
the whole $27 trillion
US bond market,
bigger even than
Treasury bonds.

Between 1997 and 2006 (the

peak of the housing bubble),
the price of the typical
American house increased by
124%
While housing prices were
increasing, consumers were
saving lessand both
borrowing and spending
more.
Household debt grew from
$705 billion at year end 1974
to $7.4 trillion at year end
2000, and finally to $14.5
trillion in midyear 2008.
U.S. home mortgage debt
relative to GDP increased
from an average of 46%
during the 1990s to 73%
during 2008, reaching $10.5
trillion
From 2001 to 2007, U.S.
mortgage debt almost
doubled, and the amount of
mortgage debt per household

Sub-Prime Mortgage Crisis vicious cycle

Lehman Brothers Bankruptcy

Started as a
general store at
1844
4th largest
investment
bank in US
25,000
employees
worldwide
In 2007,
Lehman
underwrote
moremortgagebacked
securitiesthan
any other firm
$85-billion
portfolio, or four
times its
shareholders'

In 2003 and 2004,

Lehmanacquiredfive
mortgage lenders,
includingsubprimelender
BNC Mortgage and Aurora
Loan Services, which
specialized inAlt-Aloans
(made to borrowers without
full documentation).

Leverage ratio,(ratio of
assets to owners equity),
increased from
approximately 24:1 in
2003 to 31:1 by 2007.

Lehman
Brothers
While generating
tremendous profits during
the boom, this vulnerable
position meant that just a
34% decline in the value
of its assets would entirely
eliminate its book value of
equity.

Lehman's loss was

apparently a result of
having held on to large
positions in subprime and
other lower-rated
mortgagetrancheswhen
securitizing the underlying
mortgages.

What is LIBOR

London Interbank Offered Rate (LIBOR) is a benchmark interest rate based

on the rates at which banks lend unsecured funds to each other on the
London interbank market
It is computed inLondonbut reflects the borrowing costs of 18 banks,
including firms inEuropeandJapanas well as three American
institutions:Bank of America,Citigroup, and JPMorgan Chase
TheICE Benchmark Administration(IBA)took over administration from
theBritish Bankers Association (BBA) onAugust 1, 2014

How Does it Work

A representative panel of global banks submit an estimate of
their borrowing costs
The average is taken to determine LIBOR by first removing
the highest and lowest 25 percent of submissions
This rate is published at 11 am by Reuters each day
Calculated for five different currencies-the U.S. dollar, the
euro, the British pound sterling, the Japanese yen, and the
Swiss Franc
Calculated daily for seven different maturity lengths from
overnight to one year

How Does LIBOR affect the Global economy

Short Term Interest

Rates

Investors

Many banks worldwide use Libor as a base rate

for setting short term interest rates on consumer
and corporate loans. When Libor rises, rates and
payments on loans often increase; likewise, they
fall when Libor goes down
Some financial products are based on Libor;
mutual-fund companies, Hedge funds, Money
market funds and bond funds are affected by
LIBOR

Economists &
Central Bankers

Libor is also used to provide private-sector

economists and central bankers with insights into
market expectations of economic performance
and interest rate developments

Impact on India

Many Indian Companies have borrowed funds

through external commercial borrowings. Until
March 2012,this amounted to $104.4 billion. Most
of these overseas debt are linked to Libor

LIBOR Scandal

mber banks were colluding and were falsely inflating or deflating the borrowing ra
Motive for manipulating the rates

To reflect good financial health:

Benefit of Derivatives
Higher rates signal distress whereas
Traders: Traders
lower signify sound condition of the
requested the rate
bank. During 2007-09, Barclays
submitters to submit rates
submitted low LIBOR rates to ward
that would benefit their
off any concerns about its financial
trading position
health.
Timeline of the Scandal
April- May
2008
New York Fed
comes to know
about false
reporting of
ratesBritish
Regulators
Informed of Rate
Problems

June
2012
Barclays: $450
Million
Settlement:,
Barclays
accused of
falsely reporting
lower rates
2005-2009,

Dec
2012
UBS: $1.5 Billion
SettlementJustice
Deparment files
criminal charges
against two UBS
traders;

Source: The New York Times- Tracking the LIBOR scandal;

The LIBOR scandal, Review of Banking & Financial Law

Feb 2013
Royal Bank of
Scotland: $612
Million Fine;
Japanes unit
forced to plead
guilty in criminal
wrongdoing

Oct 2013
Rabobank: $1
Billion
Settlement;
Chairman Piet
Moerland
resigns

Dec
8 Financial
2013

Institutions: $2.3
Billion Fine: EU
fined Citigroup,
JPMorgan Chase,
Deutsche Bank,
Royal Bank of
Scotland and
Socit
Gnraleand 3
others

Apr 2015
Deutsche Bank
will pay a $2.5
billion penalty to
United States
and British
authorities.

Effects of manipulating LIBOR

Prices of bonds on the banks balance sheet changes

Any loans on the balance sheet tied to LIBOR will now be
paid at a different rate in the future
Student loan, mortgage backed loans will suffer from a
higher rate
Lenders of cash will receive a lower rate than what they
should actually receive if rigged downwards
Upward rigging will lead to a lower absolute return on equities

The manipulation of Libor caused Derivative payments on interest

rate swaps to be returns smaller than they should have been,
resulting in high losses to derivative market participants
Source: The Libor Scandal and Its Effects Explained , Securities &
Financial Consulting

Institutions Involved

Barclays

Bank of
America

BTMU

Citi

Credit
Suisse

Deutsche
Bank

Lloyds

HSBC

HBOS

JP Morgan

Rabo
Bank

RBC

RBS

UBS

West LB

Norinchuc
kin

Penalty payments by big banks involved in the fixing of the

London interbank rate (LIBOR) and its global variants total
about $US9 billion.
Last November, British and US regulators imposed fines totaling
$US3.4 billion on five banks- JP Morgan,RBS, HSBC, Citibank,