Financial crisis: How it started and propageted

Greed is the main reason of so may problems in everybody's life. Greed sometimes incurs small losses and sometimes can incur huuuuuuuge. This greed is the root cause of recent financial crisis. It was greed of individuals and that of investment banks which caused financial turmoil across the world.

So how did it started and what was the flaw in basic financial system. Banks provide loans to individuals in lieu of some mortgage from borrower's side. Investment banks got this fantastic idea of earning money according to which they will pay all the money to the bank which bank provided to a borrower along with interest rate and they will take mortgages from bank in lieu of that. After taking mortgages from banks, investment banks created one special type of debt instrument and released it in the market to public at a little bit lower interest rate than what they paid to banks. I hope you are not getting confused. Lets take one example to illustrate this:

If a person A borrows 2 million from bank B at 10% interest rate then investment bank will give 2 million to the bank in one shot along with 7 to 8% interest. Now benefit which bank will get in this process is that they got their full money immediately along with interest and they can again lend this money to some other borrower. And this process repeats. Again bank will lend this money to someone else and again will sell it to investment banks. Investment banks will raise debt instrument from mortgage and will sell it to public. Now there are few questions here.

What is benefit to banks in doing so? Well, banks immediately get the money which they landed along with interest and they can again lend money which they got from investment banks.
What is benefit to investment banks in doing so? They gave money to banks which is 1-2% lesser than that of actual interest rate. There is more benefit to them which i will explain later.

Immediate consequence of this was sharp rise in real estate prices and loan defaulters. Since this cycle of lending was repeating again and again, there was lot of money available for lending and lot of people were putting their money in real estate hence it's prices were shooting up. Also number of defaulters were increasing because banks wanted to lend money (since they had access liquidity) as much as possible so they were not checking financial status of borrower properly.

hat were investment banks doing of mortgages given by borrowers and how were they getting money which they were supplying to banks. Investment banks created a special kind of debt instrument from mortgages and released it in the market. People were getting very little interest rates in their bank deposits and investment banks were ready to give them more than that so public gave money to investment banks in lieu of debt instruments at a interest rate which was more than that of public was getting from banks but lesser than that of investment banks paid to banks. This was another benefit which investment banks had.

There was one more entity involved in this cycle. That was insurance firms. Investment banks got insurance of borrowers' mortgages which they got from banks.

This cycle was accelerating itself. Outputs of this cycle were acting as inputs to accelerate the cycle. For example money was taken from public through debt instrument path and it was reaching to them through bank path.

This wheel was rotating very fast but things started getting worse. Defaulters started growing and insurance companies started going into BIG losses. This in turn reduced value of debt instruments and investment banks started going into losses. Public also started going into loss because value of debt instruments decreased. This situation started worsening and today we see consequences of this. Lehman failed and AIG also failed because Lehman had got insurance from AIG. This whole cycle broke into a big financial crisis which we see now and it all happened because of greed of individuals and that of investment banks.