Remember the “dirty” word sub-prime mortgages, yes, it all started with Housing industry and spiralled into world financial crisis. In this article, I will try to guide you what it actually is and what led to the current situation we find ourselves in, where it’s great news if we at least see our markets end flat without shedding more points.
Don’t worry, I will spare you of all the economic jargon that usually accompanies whenever economics is discussed, it may deprive you of all the “beautiful” terms our experts use, but hey, you are not trying to be one, right.
So, here goes my analysis.
- Three things led to Mania for House ownership, First, the interest rates were historically low, Second, After Dotcom bubble burst of 2000, Housing became best alternative to invest, and Third is the belief that Housing is safe and good investment and “Housing prices never fall”, supported by Federal Reserve Chairman and Treasury Secretary
- With this mania gripping over, everyone wants to buy a home, or refinance if they already have one, Remember, “Housing Prices Never Fall”. People who can’t afford a house, or can’t make a down payment approach Mortgage Broker, applying for subprime loans (loans having heightened risk of default) leading banks to collect bad loans.
Meanwhile people already owning a house start refinance, there by inflating the prices and making way for Housing Bubble.
- Now for the most crucial part in the crisis. The banks having given “risky” loans, pool them and rename them as “Collateralized Debt Obligation” or CDO (another economic term, just google it if you want to know more about it, and be sure to leave a comment if you understand). These CDO’s are then sold as investments to other banks, insurance companies and others alike.
- The housing mania reaches its peak, and now there is overbuilding of homes, and as you might have guessed it by now, the housing prices start to fall. So much so for “Housing Prices Never Fall”.
- Yes, the mortgages now become worth more than the homes themselves, quite naturally Home owners now cannot pay mortgages which lead to defaults.
- Poor banks who gave away loans now do not get paid and consequently CDO investors like insurance companies do not get paid either.
- Banks like Lehman Brothers fail, some are bought by others and Government rescues some like AIG, Fannie Mae and Freddie Mac.
- Banks now stop lending money, leading to crisis of confidence and stock prices nose dive.
- Finally what do we have, “GOVERNMENT BAILOUTS”. And Finally President declaring “We got a big problem”.
