FAQs on the US turmoil

Why did Lehman, Freddie and Fannie and the other banks get into these difficulties?

The root problem for Lehman and others affected was not realising that the US was in a housing bubble and therefore, once the bubble burst, there could be major losses. A secondary factor was the way the underlying mortgages were engineered into complex securities such as Collateralised Debt Obligations (CDOs), which became impossible to value once house prices started to fall.

The problem in a bubble is that almost everyone starts to believe the underlying ‘mantra’. During the tech bubble, the mantra was that “the sky is the limit for the new economy”. During the housing bubble it was that “national house prices never fall.”

Image: This combo of undated file photos shows US finance giants Fannie Mae and Freddie Mac and Lehman Brothers and insurer AIG.

Also see: Origin of sub-prime crisis | The $700-b bailout czar

Text: Business Line

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