Swati : By year 2000 the Wall Street was ruled by
Dec 11 2013 12:22 PM
5 Investment Banks: Goldman Sachs, Morgan Stanley, Lehman Brothers, Merrill Lynch, Bear Stearns
2 Financial Conglomerates: CitiGroup, JP Morgan
3 Securities Insurance Agency: AIG, MBIA, AMBAC
3 Rating Agency: Moody's, SnP, Fitch
All of them were linked together by a Securitization Food Chain, which is
Home Buyers ----> Lenders ----> Investment Banks ----> Investors
In the Old System, Home Owner used to pay mortgages to Lenders which took decades to complete and lenders were careful.
In the New System, Lenders sold the mortgages to Investment Banks. These banks combined different mortgages into complex derivatives called Collateralized Debt Obligations or CDO's. Now these CDO's are sold to the investors. So now if Home Owners made a mortgage payments it goes to the Investors all over the world.
Home Owner --------Mortgage Payments ---------> Investors
Investment Banks paid rating agencies to evaluate the CDO's many of them were given "AAA" ratings ----highest possible.
So now, Lenders didn't care and started making riskier loans.
Investment Banks didn't care as they were extracting profits by selling more CDO's.
Rating agencies had no liabilities.
Subprime Loans also called riskier loans quadrupled from 2000 to 2006 which created a bubble as many home owners were unable to pay mortgage payments and investors started losing money. Millions of dollars of CDO's remained unsold. When the bubble exploded investors lost their money and life savings.
There is more to the story when AIG comes into picture with Credit Default Swaps, but I think this should answer your questions.
Thanks and Regards,