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  The Return of the Finance Crisis: What the Lehman Bankruptcy Means for Germany

The Return of the Finance Crisis What the Lehman Bankruptcy Means for Germany

By Stefan Schultz in Hamburg

Part 9: The Cause of the Global Finance Crisis

The bursting of a speculative bubble in the US real estate market triggered the international finance crisis. With interest rates low in recent years, US banks frequently offered poorly secured loans for the purchase of homes or construction -- so-called subprime mortgages.

At the end of 2006, key interest rates began rising in the US. Demand sank and real estate prices began to slump -- by as much as 25 percent today. This created a situation in which a growing number of subprime borrowers were no longer able to make their interest payments.

Reckless constructs only served to exascerbate the situation. In order to refinance themselves, mortgage companies often bundled their loans with new forms of subprime bonds that were sold to investors worldwide -- to Chinese and European banks, for example.

The bundled loans were securitized and turned into assets that could be traded on stock markets. The problem was that these assets contained bad mortgage loans bundled in with the good ones. Buyers seldom knew the true content. Unable to assess the risk of the asset, they had to rely on the rating assigned to it by a rating agency.

Experts had warned about the danger of such financial constructions early on. As long as enough market participants believe in the value of such structured products, one can trade in them. But the system breaks down when confidence in the such products evaporates.

"It had to happen," former International Monetary Fund Chief Economist Kenneth Rogoff told SPIEGEL ONLINE. You can't just make money out of thin air like this."

Then in mid-2007 ever more subprime loans defaulted. Confidence in the paper which was supposedly covered by mortgage deals collapsed, as did their market value. As a result banks had to wrote down the value of those papers in their books, and thereby booked drastic losses.

Rogoff said the crisis wasn't over. But these finance products based on fancy rocket science and derivatives just aren't coming back, and that's very painful.

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