BACKGROUND: Primary causes of the financial crisis

Sep 12, 2009, 3:42 GMT

New York - The fall of US investment bank Lehman Brothers on September 15, 2008 unleashed shock waves that shook the financial markets and destroyed trust in the banking system.

The crisis lead to unprecedented government intervention in the markets as it developed into the worst global recession since World War II. The causes of the disaster are numerous. The following is a look at some of the factors behind the crisis.

- Cheap money: After September 11, 2001 the US Federal Reserve pursued a policy of drastically sinking interest rates. Rising housing prices combined with the low rates prompted millions to use their homes as ATMs. Homeowners were allowed to pay off fixed interest mortgages early and refinance without penalty into cheaper loans.

- Spending spree: Many homeowners refinanced their homes in order to purchase more real estate, automobiles, furniture or high-end goods like televisions. The spending spree pumped up the economy in the US and abroad fuelled by the over-inflated dollar. Asia saw demand for its exports increase.

- Declining adversity to risk: Rules for getting a mortgage were loosened under political pressure to make homeownership open to ever more borrowers. Subprime mortgages for borrowers with poor credit were given to buyers who could good not afford their loans. The combination of an over supply of homes and attractive interest rates began to tip the real estate market. Many homeowners overdrew their credit lines were not able to pay it back.

- Complicated financial products: Bankers on Wall Street created complicated financial products to bundle together millions of subprime mortgages and sell them to investors. But when the housing market collapsed, investors were left holding what became known as toxic debt.

- Greed: The more risky investments that bankers sold, the higher bonuses they received. They were not punished for losses, causing them to promote ever larger risk.

- Rating agencies: Credit rating agencies gave top rankings to investments that had not earned it. They were often paid by the companies whose investments they were rating.

- Lack of regulation: Entire areas of the financial world operated without rules as new financial instruments were created by hedge funds and investment banks, which did not fall under the regulations of traditional banks. Government oversight did not warn of the risk until it was too late and other warnings went unheeded.

- The bubble bursts: When the housing market collapsed, leading to the failure of the so-called mortgage backed securities it was too late to change course. The downward spiral quickly brought down banks, leading to the collapse of Lehman Brothers on September 15. The financial industry took a deep hit, with losses in the trillions of dollars and a loss of confidence in the banking industry. The damage quickly grew into a global recession.