You have to pay a 19 dollar dinner bill at a restaurant - tip is already factored in so there is no movement at all up or down. There is an ATM across the street and $19 in your account - yet you have no money on you. They only take cash. No problem though, because you can use your banks ATM for no fees and its right across the street. The minimum amount the bank lets you withdraw from the ATM is $20, the tellers are gone and the bank itself is closed.

You see your identical siblings across the street (who have all been through this exact same situation and know what it's like). you ask to borrow one dollar to facilitate the transaction from one of them, as it will take a maximum of 5 minutes to take money out of your banks ATM, and give them back their dollar when you are done paying the bill - maybe even the pennies you find on the way back to them if they cajole you.

Then, Suddenly, both of your identical siblings get skittish - and don't give you a dollar. Even though you promise to give them money back as you know you have enough - and they know you have enough. You simply cannot get your hands on it in time because of the ATM situation. The resturant has no money (for some reason) and no one else has any money (they are depending on your paying the bill to pay their nightly wages etc etc).

Because of this - you can't pay the bill at the restaurant until the bank opens. Because of this, you have to pay the restaurant owner the next day, having cost them extra time and labor to deal with your BS. You are forbidden from eating there again.

In this situation:

Lehman is "you"

The other banks are the identical siblings

The ATM scenario is to illustrate the failure cascade, which spreads through tons of lending and intertwined contract and obligations. In essence, liquidity crisis is like having a blockage in the circulatory system, as it depends on flow.

(http://www.autoadmit.com/thread.php?thread_id=2256829&forum_id=2#23204487)

Banks and other financial institutions contributed to the collapse, funding their additional leverage with off-balance-sheet transactions, exotic investment vehicles consisting of complex, structured products containing mortgage-backed securities. The securitization of third-party debt and the creation of derivatives was encouraged by the risk management practices in financial firms, their regulation, and their supervision. In this period of boom, lenders relaxed their standards, most notably in the U.S. “subprime” mortgage market. Throughout the credit expansion that preceded the crisis, investors and, perhaps most importantly credit rating agencies, ignored the risk. For example, the rating agencies would often rate the financial instruments backed largely by subprime mortgages as safe investments despite their riskiness.

Mortgage delinquencies began to increase when the over-inflated U.S. housing market weakened. This eroded the collateral for the mortgage-backed securities, causing the holders of these securities to incur large losses. Credit rating agencies eventually downgraded the mortgage-backed structured products, further leading investors to lose confidence in the ratings of a wider range of structured assets. Many institutional investors financed the acquisition of mortgage-backed securities and other derivatives with short-term commercial paper packaged by banks for investment by money market investors. These banks discovered in August 2007, that money market investors were no longer willing to continue holding such commercial paper. Although sponsoring banks had built up liquid resources (that is, cash) to cover the potential insolvency of the mortgage-backed vehicles, the rapid devaluation of mortgage-backed assets created unprecedented levels of illiquidity and banks became unwilling or even unable to lend to other banks.

This lending seizure led to interest rate spikes and a rise in risk premiums for credit default swaps. The reduction of funding to leverage borrowers exacerbated the situation and led to further contraction. Economic uncertainty in the debt market generated valuation losses in broad asset classes in many countries. With little or no transactions occurring in the marketplace, banks were unable to value their own holdings. The concurrence of these events caused an economic panic.

- Ughh (c) - All rights reserved (no plagiarizing).

Read the "Financial Crisis Inquiry Report" from the National Commission of the Causes of the Financial and Economic Crises in the United States.

Lehman was a major subprime lender and "Lehman executives regularly used cosmetic accounting gimmicks at the end of each quarter to make its finances appear less shaky than they really were. This practice was a type of repurchase agreement that temporarily removed securities from the company's balance sheet. However, unlike typical repurchase agreements, these deals were described by Lehman as the outright sale of securities and created "a materially misleading picture of the firm’s financial condition in late 2007 and 2008" - Wikipedia

(http://www.autoadmit.com/thread.php?thread_id=2256829&forum_id=2#23204931)