Bottom line, the entire global economy almost collapsed this week, a collapse that would have made the great depression seem weak. I will elaborate.

Lehman Brothers, formerly one of the largest investment banks on the planet, was heavily invested in short term liabilities in the form of securitized paper. Securitized paper is "deed" to receive the interest payments from loans. Securities generally do not pay a high rate of interest unless they are of a higher risk, which translates into loans for people/ businesses with poor credit ratings. People who have poor credit have to payer a higher rate of interest throughout the life cycle of the loan. Due to the enormous amount of sub prime mortgaged backed securities (SPMBS) floating throughout financial institutions, large investment firms caught wind of an idea to pull higher than normal gains; buying up these securities from the original lenders (neighbor hood banks and lenders such as Ditech) at a premium. This in turn created a demand to issue SPMBS, by giving people who ordinarily would not qualify for loans, loans. l

Many of you are probably thinking by now, "so what, they have bad paper, i dont see how this could bankrupt a billion dollar corporation." But remember, these SPMBS are also liabilities.

The money that is given to the loan applicants has to come from somewhere right? Typically, when a bank lends you money, it has the right to "create it out of thin air" via an FDIC license. What this means is, the bank borrows the money from a regional reserve bank at or around the current federal funds rate (2% currently), and then charges say 7% to the loanee. Sub prime interest rates were in the neighbor hood of 8%-15%, paying much higher returns to the holder of the set liability. It is a liability because the holder of this paper, regardless of whether the mortgage payments are being paid, still has to make the original 2% payment to the federal reserve for giving them the ok to create the money.

Now that a large percentage of investment banks were allowing short term liabilities (paper who's interest that has to be paid at a faster rate throughout a period of time) to be a very large part of their portfolio's, they in turn were making a larger amount of mortgage payments to the original lenders of the original money.

Lehman basically did not have the money to keep making their mortgage payments because foreclosures were in record numbers, and payments dropped dramatically. Another thing to point out that i forgot is when you would issue sub prime debt, you would have to pay a little bit (not much but still more) higher premium to a reserve bank (say 2 & 1/2%). The profits from regular mortgage backed securities were then used to make payments on the defaulted loan swaps. Lehman eventually ran out of money to make payments and they failed. This caused investors to pull their money out of virtually every global trading market resulting in losses of around 5% or even greater.

AIG was also a large holder of SPMBS with short term liability. The difference is, AIG was able to make their "mortgage payments" but had to issue debt to cover various costs associated with the insurance industry. This forced their tripple A credit rating to be lowered to A-. In doing so, collateral accounts that contractually required for example 10% at AAA rating, now required say 15%, 20% or even 25% collateral. This type of collateral was in the form of liquid assets held in collateral accounts. Once the rating dropped, AIG was then contractually obligated to deposit the upwards of $80 billion into these collateral accounts to stay in business by Wednesday (the 17th).

Had AIG been allowed to file Chapter 11, it would have sent a signal to all investors to pull out of investment markets due to AIG's interwoven relationship to virtually every business entity on the planet. They insured cars, houses, business, bonds, manufacturing plants, etc...

Suffice to say, this next week could have been a really fucked up period of history.