Wednesday, September 24, 2008

Sub-prime crisis in my word

The world financial sector is under attack . No, it's not Osama .... it's Sub-prime ... Till now a million authors might have penned the topic in various forms .. still I dare to write something about it .. a potpourri of my learning ... 

The fed rate arrived at 1% , which in central bank parlance is effectively zero .The goal was to expand money supply and encourage borrowing , which would increase the spending , investing and consequently the economic growth .And that's what it happened during that time . The global economy expanded . 

The low borrowing rate attracted all those for whom having assets of their own was a distant dream .At the same time house prices soured, ultimately increasing additional appetite for credit . 

Now home-owners select a money lender who lends them the money after checking their credit-worthiness.After the loan is disbursed the money-lenders resell this investors or Wall Street firms , which are then converted to securities and then after assigning a risk rating upon them they are sold to institutional investors worldwide . 

Borrowers with a higher-than-average risk profile because of their low credit-worthiness are charged a higher interest for their loan .This is called sub-prime .Lenders lent deliberately knowing that there will be a default and they will get the return by selling the mortgage( provided the home price keeps on increasing  ). 

The securities were bought by the investment banks which in turn financed this by borrowing from the banks itself .Thus banks' action in passing risks to others ultimately came to them which led for denial of lending and hence liquidity crunch .At the same time the home rate dropped and the default in loan kept on increasing . 

Thus the spiralling effect continues to touch each and everyone who are engaged to the mortgage either directly or indirectly . And the devil hasn't stopped yet . A lot more to come ............. 

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