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FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Crisis Events and Institutional Failures in the 2007-2009 Crisis

Updated 11 October 2026 · Fact-checked

This topic covers the firms and events that turned the 2007-2009 crisis into a systemic collapse: Bear Stearns' rescue, the Fannie Mae and Freddie Mac conservatorship, Lehman's bankruptcy, AIG's CDS losses and the Reserve Primary Fund breaking the buck. To solve questions, match each event to its failure mechanism: leverage, funding runs, collateral calls or counterparty exposure.

Understand Crisis Events and Institutional Failures

The crisis began with falling US house prices and rising mortgage defaults. The losses mattered because they were spread through securitized products held by highly leveraged institutions that relied on short-term funding. Each failure below shows a different weak point.

Bear Stearns (March 2008). Bear was a large investment bank with heavy leverage and mortgage exposure. It funded itself in the repo market with short-term borrowing. When lenders lost confidence, they refused to roll over repo and clients pulled prime brokerage balances. Bear lost liquidity within days. The Federal Reserve helped arrange a sale to JPMorgan Chase and provided support against a portfolio of Bear's assets. The lesson: a solvent-looking firm can fail from a run on short-term funding.

Fannie Mae and Freddie Mac (September 2008). These government-sponsored enterprises guaranteed and held huge amounts of mortgage assets with thin capital. Mortgage losses eroded that capital, and on 7 September 2008 the US government placed both into conservatorship under their regulator, the FHFA. The lesson: thin capital against concentrated housing risk, with an implicit government backing, ended in explicit state support.

Lehman Brothers (September 2008). Lehman held large commercial real estate and mortgage positions with high leverage and heavy reliance on short-term funding. No buyer emerged and no government rescue was provided. It filed for bankruptcy on 15 September 2008. Counterparties froze, derivatives positions were disrupted, and funding markets seized up. The lesson: the failure of a large interconnected firm transmits losses and fear across the system.

AIG (September 2008). AIG's financial products unit sold credit default swaps protecting holders of multi-sector CDOs, largely without hedging them or posting adequate reserves. When the reference assets fell in value and AIG's credit rating was cut, AIG faced large collateral calls it could not meet. The US government provided emergency support in exchange for a large equity stake. The lesson: selling protection creates concentrated, one-way exposure, and rating-triggered collateral turns mark-to-market losses into a liquidity crisis.

Money market funds (September 2008). The Reserve Primary Fund held Lehman debt. After Lehman failed, its net asset value fell below $1 per share, so it broke the buck. Investors rushed to redeem from prime money funds, and funds cut purchases of commercial paper. Firms that relied on commercial paper lost funding. The government then introduced a temporary guarantee program for money market funds. The lesson: a product seen as cash-like can be a source of runs.

Key formulas to remember

Leverage ratio
Leverage = Total assets ÷ Equity
Higher leverage means a smaller fall in asset value wipes out equity.
Equity wipe-out threshold
Asset decline that eliminates equity = 1 ÷ Leverage
At leverage of 30, a decline of about 3.33% in assets eliminates equity.
Money fund net asset value
NAV per share = (Assets − Liabilities) ÷ Shares outstanding
Funds target $1.00. Breaking the buck means NAV below $1.00.
Collateral call on a swap
Collateral required = Mark-to-market loss on position − Collateral already posted
Applies when a CSA or rating trigger requires posting. Concept-level, rarely computed in full.

How to solve Crisis Events and Institutional Failures questions

Use this method for any question on a named crisis event or institution.

  1. 1Identify the institution and the date or phase of the crisis the question refers to.
  2. 2Name the business model: investment bank, GSE, insurer, or money fund.
  3. 3Find the main weakness: leverage, short-term funding reliance, concentrated exposure or collateral triggers.
  4. 4Identify the transmission channel: repo run, counterparty losses, collateral calls, or redemptions.
  5. 5Recall the official response: sale with Fed support, conservatorship, bankruptcy, government support or guarantee.
  6. 6If numbers are given, compute leverage, the equity wipe-out percentage or NAV, using the formulas above.
  7. 7Eliminate options that mix up institutions or outcomes, then confirm the one that fits the mechanism.

Quickest way: Event-to-mechanism matching

When to use it: Use for conceptual multiple-choice questions where you must link a firm to its failure or response.

  1. Bear Stearns: repo run, rescued by sale to JPMorgan.
  2. Fannie and Freddie: thin capital, conservatorship.
  3. Lehman: leverage and funding, bankruptcy, no rescue.
  4. AIG: CDS protection sold, collateral calls, government support.
  5. Money funds: Reserve Primary broke the buck after Lehman exposure, runs on prime funds.
  6. Pick the option whose cause and outcome both match the firm.

Common mistakes in Crisis Events and Institutional Failures

  • Saying Lehman was rescued like Bear Stearns.

    Both were investment banks and the events are close in time.

    Fix: Remember Bear was sold to JPMorgan with Fed support, while Lehman filed for bankruptcy.

  • Treating AIG's problem as insurance underwriting losses.

    AIG is known as an insurer.

    Fix: The trouble came from its financial products unit selling CDS and facing collateral calls.

  • Confusing conservatorship with bankruptcy for Fannie and Freddie.

    Both mean a firm is no longer running normally.

    Fix: Conservatorship put the GSEs under FHFA control with government support, and they continued operating.

  • Assuming money market funds were affected because they held mortgage securities.

    The crisis is remembered as a mortgage crisis.

    Fix: The trigger was the Reserve Primary Fund's Lehman debt, followed by investor redemptions.

  • Calling Bear's failure a solvency problem only.

    Students link failures to losses alone.

    Fix: Stress the liquidity run: repo lenders and clients withdrew funds quickly.

Worked examples

Example 1

An investment bank has total assets of $600 billion and equity of $20 billion. By what percentage must the value of its assets fall to eliminate its equity?

Show the solution
  1. Leverage = Total assets ÷ Equity = 600 ÷ 20 = 30.
  2. Wipe-out threshold = 1 ÷ Leverage = 1 ÷ 30 = 0.0333.
  3. Check: 3.33% × $600 billion = $20 billion, equal to equity.

Answer: About 3.33%

Example 2

A money market fund has assets of $9,700 million and liabilities of $0 million, with 10,000 million shares outstanding. Compute NAV per share and state whether the fund broke the buck.

Show the solution
  1. NAV per share = (Assets − Liabilities) ÷ Shares = (9,700 − 0) ÷ 10,000.
  2. NAV = $0.97 per share.
  3. The target is $1.00, and $0.97 is below it.

Answer: NAV is $0.97 per share, so the fund broke the buck.

Exam tips

  • Link each name to one cause and one outcome. Most questions test exactly that pairing.
  • Expect questions that ask which event triggered the money fund runs. The answer is Lehman's bankruptcy and the Reserve Primary Fund.
  • For AIG, look for words like collateral calls, rating downgrade and CDS protection sold.
  • For leverage numbers, compute 1 ÷ leverage quickly. It is a common short calculation.
  • Watch for distractors that reverse who was rescued and who failed.

Practice questions from Anatomy of the Great Financial Crisis of 2007-2009

Crisis Events and Institutional Failures: frequently asked questions

Why did Lehman Brothers fail while Bear Stearns was rescued?

Bear was sold to JPMorgan Chase with Federal Reserve support in March 2008. For Lehman in September 2008, no buyer emerged and no rescue was provided, so it filed for bankruptcy on 15 September 2008. Lehman's failure then spread losses and fear through funding markets.

What was AIG's role in the crisis?

AIG's financial products unit sold credit default swaps on multi-sector CDOs without adequate hedges or reserves. Falling asset values and a rating downgrade triggered large collateral calls. The US government stepped in with emergency support.

What is the difference between conservatorship and bankruptcy for Fannie Mae and Freddie Mac?

In conservatorship the FHFA took control of the firms and the government supported them, and they kept operating. In bankruptcy a firm is liquidated or restructured under court supervision, as Lehman was.

What does breaking the buck mean?

It means a money market fund's net asset value per share falls below $1.00. The Reserve Primary Fund did this in September 2008 after losses on Lehman debt, which set off investor redemptions across prime funds.