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Kimberly Amadeo

Five Years Ago Today: Lehman Brothers Bankruptcy Signals New Bottom for Economy

By September 16, 2013

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Today is the fifth anniversary of the start of the 2008 financial crisis. Here's a reprint of the blog post that recorded it as it happened.

Hank PaulsonThis weekend, U.S. Treasury Secretary Henry Paulson finally said no to further Wall Street bailouts. As a result, Lehman Brothers investment bank filed for bankruptcy, Merrill Lynch sold itself to Bank of America, and AIG turned to the Federal Reserve for emergency funding.

Paulson said no to government protection for some of Lehman's $60 billion in uncertain mortgage assets in a weekend negotiation with potential buyers Barclay's and Bank of America. The two suitors walked out of government-sponsored talks yesterday.

Paulson was unwillling to let the government take on all risk in the financial markets, thereby letting banks off the hook for making bad decisions during the Subprime Mortgage Crisis. Paulson felt that the government bailout of Bear Stearns and Fannie Mae and Freddie Mac was enough. (Source: The Economist, Nightmare on Wall Street, September 15, 2008)

How It Affects You

As a result, U.S. Treasury bond yields fell further as investors fled to the relative safety of these Government-backed investments. (Bond yields fall when demand for the underlying bond rises, since the government can afford to pay less in interest on products that are in high demand.) Although fixed mortgage rates usually closely follow that of Treasury Bond yields, fear of further bad mortgages are keeping these rates high, which is not helping the housing market.

The Dow dropped nearly 350 points in morning trading. If financial banks' stock prices continue to fall over the next week or so, then it could causes a downward spiral as more banks find they cannot raise enough capital to stay in business. The next few weeks will tell whether this is, in fact, a market bottom or only the beginning of further financial collapse for U.S. financial industry.

However, one thing is certain - that the U.S. banking model is flawed. Banks in Europe, Latin America and Asia were not allowed to have as much exposure to CDOs and other banking derivative products, meaning they are not in as much danger of bankruptcy. The U.S. financial sector has lost its pre-eminence which will now further shift to financial centers in the rest of the world. Or so we thought at the time. Instead, most were also contaminated.

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