When the US subprime crisis got unearthed it was clear, the US economy is going for tough times ahead. People in the financial system knew this is just the beginning. Bear Stearns and Freddie Mac - Fannie Mae had pioneered a story that had a long way to go. The fall of Lehman Brothers and the discount sale of Merill Lynch came as a shock only to those who weren't that acquainted with the economic affairs . Not many people knew that Merill Lynch and Lehman brothers were having tough times since last 5 years and their fall was almost inevitable. But one question strikes every mind, where did the money go ? What sparked off a completely scarcity of funds. Who took away all the liquidity ?? Is the common man responsible?? or the poor bank regulations and creditibility checks ??
The US subprime crisis refers to the liquidity crunch suffered by American banks due to non recovery of money lended as housing loans to millions of common men and various other investment firms in America.
Every man strives for a good house , good food and decent living. But not everyone can afford these basic amenities .To achieve them, many decide to opt for credits or loans. An investor friendly atmosphere in the early 21st century in US, supported this idealogy; and facilitated easy grant of loans that too to at low interest rates. Many people and firms in US opted for this methodolgy, believing that they would writ them off when the maturity time comes. Banks thought the booming economy would result in good returns for their investments and so facilitated providing these easy loans to the common man without even carrying out their credibility check. A lot of money travelled from banks to the hands of common man, finally reaching the real estate owners. Various foreign banks also wanted to encash the investment opportunities in developing America and offered their liquid assets to American Banks in exchange for financial instruments hoping good returns.
Many new houses and societes got constructed during this period in various parts of US . When the supply is greater than demand the cost of commodity decreases, a well known law in the business, also governed in this context. The real estate rates started to decline.
On the other hand, the gradual increases in Fed Reserve Rates forced the banks to increase the housing loan interest rates. The common man was not in a position to bear the new interest rates and many collapsed, financially. This forced the banks to go for foreclosures and collaterals went for sale in many cases. But since, the real estate rates had dropped the recovered price was much lower than the money lended. This led to money crunch for banks and soon there were huge bad debts reflecting in their balance sheets.
Everybody would be thinking by now, that the real estate owners were the real benefitters, but story is yet to end. The real estate agents invested the money in buying more land and erecting new buildings of countless floors. But due to several foreclosures and banks refusing to lend easy money to te investors now, the real estate business got badly hit. The housing prices went to new shocking lows. The whole money from the system got swallowed up.
Since US banks had deep roots in other banks around the world, shivers went across the continent. The much stable European banks which had lended money to their US counterparts also got hit. European banks and lenders like Fortis and B&B succumbed to the sub prime pressure. ABN assets already resulted in cash crunch for Fortis, with the US downslide, it was edging towards a certian closure.
The investors lost confidence in the booming Western economies and they started pulling off money. Stocks rolled down badly . Financial majors like Goldman Sacchs and WaMU had 20 % shed off in a single day on the Dow Index.The whole economy could feel the jitters.
Due to poor economic conditions the spending scaled down too, adding to the woes. Decrease in spending affected the sales of even the well established core businesses. The economy was heading for a slowdown.
Meanwhile, to safeguard the economy under attack, US Fed offered bail out packages for many economic giants like AIG, which if collapsed would have left the common man. But those who did not have their luck went down. Lehman Brothers filed for bankruptcy and Merill Lynch got sold at discount. Similiarly in Europe, Governments stepped in to rescue the majors. Fortis, Bradford & Bingley Plc, and Hypo Real Estate Holding AG, all three got nationalised. Belgium, Netherlands and Luxembourg govts came out with bailout packages for Fortis, whereas B&B was rescued by the UK govt. It was the Dutch govt that provided the much needed glucose to the Hypo real estate.
Though the govt tried their best by pumping in huge cpaital into the markets, they could not win over the confidence of investors, who continued sucking out money from the financial markets. The global ecomomy was heading for a meltdown.
It was the lust of common man, poor banking regulations, Fed rates hike and open economic systems that led to the debacle and its vast influence which is sure to get a complete page in the black book of history. Its after effects would be long lived and a lot of learning is to be taken.
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