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Eco
Fundas |
Proposed
bailout of United States financial system
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Tales of quick riches, super sized gains and waves of "buy!"
orders for tech stocks have been replaced by a new kind
of speculation on Wall Street.
The problem primarily began with the United States (Federal
Reserve) keeping its interest rates very low for a very
long time, thus encouraging Americans to go in for housing
loans, or mortgages. Lower interest rates led to buyers
wanting to take on bigger loans, and thus bigger and better
homes where financial institutions saw a mouthwatering opportunity
in the mortgage market. In their zeal to make a quick buck,
these institutions relaxed the strict regulatory procedures
before extending housing loans to people with unstable jobs
and weak credit standing which resulted in non-payments
to the institutional investors who had bought the financial
securities, leading to huge losses.
A deluge of such defaults inundated these institutions and
banks, wiping out their net worth. Their mortgage-backed
securities were almost worthless as real estate prices crashed.
The moment it was found out that these institutions had
failed to manage the risk, panic spread. Investors realized
that they could hardly put any value on the securities that
these institutions were selling. This caused many a Wall
Street pillar to crumble. Now burdened with tons of debt
and no money to pay it back, the back of these financial
entities broke, leading to the current meltdown.
The problem worsened because institutions giving out sub-prime
home loans could easily securitize it. Once an institution securitizes
a loan, it does not remain on the books of the institution.
All this resulted in slowing US economy, high interest rates,
unrealistic real estate prices, high inflation and rising oil
tags together led to a fall in stock markets, growth stagnation,
job losses, lack of consumer spending, a virtual halt to new
jobs, and foreclosures and defaults.
Why Lehman Bros went bust?
America's fourth-largest investment bank Lehman Brothers
Holdings Inc has filed the biggest bankruptcy petition known
to mankind. Thus the collapse of the giant investment bank
came as a major shock for the entire world markets. Lehman's
collapse was triggered by the refusal of other banks to
do business with it because of its complex and, at times,
opaque ways of trading which led to it losing almost all
business. Housing loans made by the bank to people with
little support made these loans very risky, and when interest
rates rose, these borrowers could no more repay Lehman.
This led to huge losses, the extent of which is not yet
clear. The final straw for Lehman was the fact that both
Barclays Plc of the United Kingdom and Bank of America Corp
pulled out of takeover talks.
Why stock markets in India, fell?
Institutional investors, who had invested in securitized
paper from the sub-prime home loan market in the US, saw
their investments turning into losses. Once investments
in the US turned bad, more money had to be invested in the
US, to maintain that fixed proportion. So in order to make
up their losses in the sub-prime market in the United States,
they went out to sell their investments in emerging markets
like India where their investments have been doing well.
Since the amount of selling in the market is much higher
than the amount of buying, the Sensex began to tumble. The
flight of capital from the Indian markets also led to a
fall in the value of the rupee against the US dollar.
So to conclude, this crisis is spreading from sub-prime
to prime mortgages, home equity loans, to commercial real
estate, to unsecured consumer credit (credit cards, student
loans, auto loans), to leveraged loans that financed reckless
debt-laden leveraged buyouts, to municipal bonds, to industrial
and commercial loans, to corporate bonds, to the derivative
markets whose risk are indeterminate, etc. It has been a
total systemic failure that has its roots in the US real
estate and the sub-prime loan market.
The Federal Reserve’s 'cheap money' policy created
artificial demand for housing which drove prices to unsustainable
levels. As greed took over, dubious sub-prime liabilities
were sold to hedge funds, insurance companies and foreign
banks. And then the American financial markets were hit
by a severe liquidity and credit crunch. High oil tags,
lower spending by the corporate sector, rising unemployment,
etc added to the woes of not just the Americans, but the
entire world.
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