Leverage's Financial Crisis

Leverage is borrowing money to amplify the outcome of a deal. The financial crisis includes sub-prime mortgages, collateralized debt obligations, frozen credit markets, and credit default swaps. The way that leverage works in a normal deal is that someone can buy merchandise for 20,000 and sell it to someone else for 11,000 and they gain 1,000 in profit. However, using leverage if the same person with 10,000 goes to borrow 990,000 it will give him 1,000,000. He will then go buy 100 boxes with his 1,000,000 and sell them to someone for 1,100,00, pays back the 990,000 and 10% interest. This will give them a profit of 90,000. Leverage makes every deal better. The parties involved in the mortgage process are the broker, homeowner, lender, and
investment bank. The mortgage process works is a family wants a house they will save for a down payment and will contact the mortgage broker. The mortgage broker will connect the family to a lender who will then give them a mortgage and the broker makes a good commission. The family buys a house and they become homeowners. If one day the lender receives a call from an investment banker who wants to buy the mortgage the lender will sell it to them for a nice fee. The investment bank borrows more money, so they buy more mortgages and puts them in a box, which means every month; they receive the payments from every homeowner. A collateralized debt obligation is divided into safe (3%), okay (7%), and risky (10). It is when money comes in the top of the trade bills first then spills over in the middle, the money comes from homeowners and if homeowners do not pay and default on their mortgage less money comes in. The turning point comes when investment banks want more mortgages so they call the lender and the lender calls the broker, but the broker can no longer find any homeowners since everyone who qualifies already have one. Instead of lending to responsible homeowners they lend to less responsible ones and this is known as subprime mortgage. The process starts over again and homeowners’ default on their mortgage and investment bankers is holding a box with worthless houses. Everyone starts going bankrupt .