Current Financial Crisis - A Primer


United States at this moment is probably going through the worst financial crisis of all time. It major cause of this crisis is more or less similar to the first one. While the economy was booming, big time investors were looking for best investment with their already piling up profits. As a result most of this free flowing money was put into riskier investments, keeping in mind the expanding economy. It was noticed that high the risk, higher is the profit, however what was forgotten that it could go other way round as well, and so it did. With the end of the glorious economy entered the black recession, ready to swallow down even the meekest of investments.

Most questionable investments was subprime mortgages, which accumulated in kinds of mortgage loans which were issued with bare minimum down initial down payments, credit checks, or even proof of income. This resulted into non repayment of the borrowed amount owing to the financial crisis. As of now in totality, approximately $550 billion of subprime loans and a $725 billion of Alt-A loans, which is the next step towards being the subprime loan, are currently outstanding.

Most of these subprime loans are granted to people who do not have a very good track record of repaying them. It is granted without much of the credential checks and at much lower interest rates up to a certain time period, usually it may range from 2 to 5 years. Since the borrowers financial status is not verified, at the time of crisis these customers are the first one to default. This eventually leads to further financial crisis. As a major portion of borrowers back out from the repayment of stipulated amount leading the financial institutions in fiscal crunch. The consequence is a smooth flow of foreclosures that floods the housing market. It finally results into pouring down the price and other market overbalances. As per the latest statistics, $55 billion of subprime mortgages are in foreclosures so far, not to ignore that another $80 billion are in severe felony.

Under usual situations the damage would have stopped here: foreclosures downpour in housing markets due to subprime mortgage, particularly in regions like, Las Vegas, Miami and Southern California. Apart from these housing markets perhaps some seepage was expected in big national housing markets as well.

Under normal circumstances, this is more or less where things would have ended: A glut in regional housing stocks where subprime mortgages were most overused -- especially in the Southern California real estate, Las Vegas real estate and Miami regions -- would lead to a recession in those housing markets and perhaps some leakage into the broader national housing market. However there is another flip side to it. There are hardly any mortgages which are kept by the issuers; in fact most of the time they are sold to interested investors. This provides them with three benefits; firstly the mortgage issuer can sell his loan by making profit and then create another mortgage. Secondly, the secondary investors bring fresh source of capital in the market and thirdly, these mortgages can further be sold to new investors, creating a novel series of mortgage backed securities. So the circle goes on and on and broadens the gap further.

Financial crisis is often originated by some mistaken steps on government or traders part. However what is noticeable is that, investment, which at the time of expanding economy proves most beneficial, actually serves as a vital cause in further weakening the market during economic recession.