The Economic Crisis in America
The whole world is now is in a grip of anxiety due to the economic crisis USA is going through. Economists are deeply worried about the economic fall out which in turn will have a direct bearing on almost every country. Call in the globalization effect; call it by any name; but ultimately every country will have to pay for the economic follies of this global economic power house known as the United States of America..
The warning bells were ringing about a year and a half ago. But then the wise men who controlled the economy thought otherwise and these economic mandarins chose not to heed the warning signals which were emanating from the length and breadth of the country.
Bank after Bank has been going bust since the liabilities are much larger than the assets held by the banks (in most of the cases mortgage documents would now fetch a fraction of the amount lent). We in India would call it a “home loan” or a “housing loan” whereas the Americans call it “mortgage loan”.
Suddenly during the middle of the year we were all flooded with newspapers and English news channels talking about “sub prime crises”. Like every one else I was stumped by this new phrase. Having worked in commercial banks for more than three decades, I was only aware of prime lending rates. But “sub prime” was something which was new to me. After going through various economic magazines and newspapers, I could decipher what this sub prime subject was. Sub prime crises arose due to home loan defaults. Sub prime lending was basically made to those borrowers who had a history of poor repayments. This was made up with higher rates of interest charged to the customers. The logic was that out 100 borrowers even if 20 defaults, the money invested would be recovered along with good returns by way of higher interest paid by the honest borrowers. But this alone did not satisfy the ( greedy?)American Banks since they saw a huge boom in the housing ( which in fact was happening )and consequently a bigger market for mortgage loans. The valuation of property was shooting up. The property which cost, say $50000.00 had doubled up within less than a year. The same borrowers again qued up to the Banks who had lent money to them with valuation certificates showing higher value on the same property. These banks promptly lent may be another $40,000.00 against the same property. In most of the cases, these sub-prime borrowers blew up the money going on holidays or in non productive expenditure. They started defaulting on payment of the installments. When the Banks issued notices to these so called sub-prime borrowers, they promptly vacated their homes or apartments and sent over the keys of the apartments/homes to the banks concerned. By the time the property market in America had already crashed. The banks were left with very large number of houses and apartments in hand without buyers.
Now one need not guess how so many top banks in the world collapsed like a pack of cards. The Americans are known for innovation. But his piece of innovation hit them very badly. As if this was not enough they again went to another innovation. The banks instead of keeping their mortgages in their own books, sold these to investment banks in Wall Street (New York). They in turn sold these as securities of various denominations in the market. Gullible investors went on a buying spree. Since these were traded in the market, these too had a market value ( that is over the face value; that is if one security was valued at $10.00, it could be trading at may be $12,$15 or $20 like share prices). On paper these securities were backed by mortgage of property which apparently gave these securities a sense of respectability. But the later events brought out the real story. The mortgage securities were now trading at a discount. Like if it was initially trading at $12 or $15 or $20, investors were willing to dump these for may be, as low as $3 or $4 as the case may be. These created pressures on the investment banks since they had to make provisioning for the depreciation.
One after the other these banks fell and some had to be nationalized by the US Government. Two of the nationalized corporations, Fannie May and Freddie Mac are the biggest mortgage lenders in the world. Also nationalized was AIG ( American Insurance Group), the biggest insurance company in the world. There is a talk among our Leftist friends that these natioalisations are a cover to help the rich shareholders. Northing is farther from truth. The US Government has acquired these corporations at almost zero cost. These take overs are meant to prevent financial panic and also to ensure that the American economy does not have a free fall. No one wants a repeat of the Great Depression of the thirties in the last century.
The whole world is now is in a grip of anxiety due to the economic crisis USA is going through. Economists are deeply worried about the economic fall out which in turn will have a direct bearing on almost every country. Call in the globalization effect; call it by any name; but ultimately every country will have to pay for the economic follies of this global economic power house known as the United States of America..
The warning bells were ringing about a year and a half ago. But then the wise men who controlled the economy thought otherwise and these economic mandarins chose not to heed the warning signals which were emanating from the length and breadth of the country.
Bank after Bank has been going bust since the liabilities are much larger than the assets held by the banks (in most of the cases mortgage documents would now fetch a fraction of the amount lent). We in India would call it a “home loan” or a “housing loan” whereas the Americans call it “mortgage loan”.
Suddenly during the middle of the year we were all flooded with newspapers and English news channels talking about “sub prime crises”. Like every one else I was stumped by this new phrase. Having worked in commercial banks for more than three decades, I was only aware of prime lending rates. But “sub prime” was something which was new to me. After going through various economic magazines and newspapers, I could decipher what this sub prime subject was. Sub prime crises arose due to home loan defaults. Sub prime lending was basically made to those borrowers who had a history of poor repayments. This was made up with higher rates of interest charged to the customers. The logic was that out 100 borrowers even if 20 defaults, the money invested would be recovered along with good returns by way of higher interest paid by the honest borrowers. But this alone did not satisfy the ( greedy?)American Banks since they saw a huge boom in the housing ( which in fact was happening )and consequently a bigger market for mortgage loans. The valuation of property was shooting up. The property which cost, say $50000.00 had doubled up within less than a year. The same borrowers again qued up to the Banks who had lent money to them with valuation certificates showing higher value on the same property. These banks promptly lent may be another $40,000.00 against the same property. In most of the cases, these sub-prime borrowers blew up the money going on holidays or in non productive expenditure. They started defaulting on payment of the installments. When the Banks issued notices to these so called sub-prime borrowers, they promptly vacated their homes or apartments and sent over the keys of the apartments/homes to the banks concerned. By the time the property market in America had already crashed. The banks were left with very large number of houses and apartments in hand without buyers.
Now one need not guess how so many top banks in the world collapsed like a pack of cards. The Americans are known for innovation. But his piece of innovation hit them very badly. As if this was not enough they again went to another innovation. The banks instead of keeping their mortgages in their own books, sold these to investment banks in Wall Street (New York). They in turn sold these as securities of various denominations in the market. Gullible investors went on a buying spree. Since these were traded in the market, these too had a market value ( that is over the face value; that is if one security was valued at $10.00, it could be trading at may be $12,$15 or $20 like share prices). On paper these securities were backed by mortgage of property which apparently gave these securities a sense of respectability. But the later events brought out the real story. The mortgage securities were now trading at a discount. Like if it was initially trading at $12 or $15 or $20, investors were willing to dump these for may be, as low as $3 or $4 as the case may be. These created pressures on the investment banks since they had to make provisioning for the depreciation.
One after the other these banks fell and some had to be nationalized by the US Government. Two of the nationalized corporations, Fannie May and Freddie Mac are the biggest mortgage lenders in the world. Also nationalized was AIG ( American Insurance Group), the biggest insurance company in the world. There is a talk among our Leftist friends that these natioalisations are a cover to help the rich shareholders. Northing is farther from truth. The US Government has acquired these corporations at almost zero cost. These take overs are meant to prevent financial panic and also to ensure that the American economy does not have a free fall. No one wants a repeat of the Great Depression of the thirties in the last century.
