Lumuhuku

Arbitary Obsessionist's Blog : Ambition is redundant. In life, mission is everything.

Step by step Process of World Economy Destruction

with 3 comments

I was reading this article on Moneycontrol, about why everyone is loosing money in the stock market. Its an interesting read…so thought I would share it with everyone…

It all began with the sub-prime crisis.

2001-2005: House prices in the US begin to rise rapidly. Banks lend aggressively and create a sub prime industry.

Sub-prime lending refers to lending (at slightly higher interest rates) to people who may not be eligible for a loan under normal circumstances. Maybe they don’t have a regular job or income, or have defaulted in the past.
Banks traditionally did not lend to such people due to high risk of default. But since these loans were mortgaged against property and property prices were rising continuously, banks started doing so. If customers defaulted, they could sell the mortgaged property.

2005: The booming housing market halted abruptly in many parts of the US.

2006: Prices are flat, home sales fall.

February 2007: Sub-prime industry collapses in the US; more than 25 sub-prime lenders declare bankruptcy, announce significant losses, or put themselves up for sale.
While they were lending, banks did not factor in the possibility of a fall in property prices. When the Federal Bank (the US equivalent of RBI) started increasing interest rates, the sub-prime borrowers started defaulting and banks started selling off the mortgaged properties. As more and more properties came into the market for selling, the property prices fell.

August 2007: Many leading mortgage lenders in the US filed for bankruptcy

March 2008: Bear Sterns falls.

September 2008: Lehman Brothers file for bankruptcy. Merrill Lynch sells off to Bank of America.

Between 2001 and 2006, the US financial markets had developed a new product – a bond securitised against the mortgages.

In simple terms it means that the mortgage banks borrowed money against the mortgages on the condition that they would repay to lenders as soon as they recovered their mortgages. The lenders in this case were financial institutions (like Bear Sterns, Lehman and Merrill Lynch) who in turn sold retail bonds to individuals.
Sadly, the repayment never happened. And institutions like Bear Sterns, Lehman, Merrill Lynch and AIG were the casualties. Since the mortgages were not honored, the banks could not repay these financial institutions who in turn could not repay retail investors.

So now you know why all this is happening and I think this is bound to take time before things turn for better.

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3 Responses

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  1. […] Read the rest of this great post here […]

  2. A very lucid post which elucidates how the world’s strongest economy is facing a situation where some of its behemoth financial institutions are either bankrupt or looking for covers through bailouts.The economical hegemony of these financial giants has created a scenario which is seen by some pundits as another great depression!!
    The content of post aptly qualifies its cover by explaining the causes sequentially in a concise and still comprehensive way.
    Needless to say that the manner in which the content is presented addresses the causes of wall street meltdown in a way that it could even be understood by naives.
    There has to be some brain and lot of creativity involved involved in this!!!

    abhinav srivastava

    September 20, 2008 at 8:34 pm

  3. great work dude..really helpful for a novice like me ..i surfed the net but it was ur post that finally quenched my thirst for an answer to great american crisis

    gaurav

    September 22, 2008 at 2:29 pm


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