|
US sub prime crisis
|
Introduction:-
The
Sub prime Crisis is
an ongoing economic problem and has resulted in
reduced liquidity in the global credit market
and also the banking & financial systems. This
crisis has exposed the weakness in the global financial
system and also the regulatory framework that is
overlooking them.
Reasons for this crisis are as
follows:-
Types of
loans:-
Prime loans:
When someone goes to a bank or to any
financial institution for a loan his credibility and financial
strengths are reviewed. Based on his financial status he would
be rated. A customer who is very credit worthy and has a
consistent cash flow with which he can meet out his loan
obligations is termed as a "PRIME" customer and such a loan
would be termed as a Prime Loan
Sub prime loans:
when the credit worthiness of the
customer is not too good and he is not in a strong
financial status he is termed as a "Sub Prime" Customer. When
banks disburse loans to such customers, it is termed as
a "Sub Prime Loan" Usually the rate of interest charged
by banks to sub prime customers is very high in
comparison to Prime customers.
|
|
How it all
started:
In the past few
years, due to
high liquidity and low interest
rates on mortgage loans,
the demand for housing properties started
increasing.
What is the reason for that high
liquidity & high demand for houses? (see the above pie
chart)
Due to improvement in service sector, employment opportunities And
income levels of people have increased.
And Inflation rate has came down.
It leads to high liquidity. i.e., more cash.
US federal Bank has reduced interest rates with the intention to
provide loans to other sectors.
But ordinary people taken loans heavily for purchasing or
constructing houses.
So, Every thing is fine, what went
wrong?
-
Heavy
demand for residential projects.
-
Real
estates started huge number of projects. It has increased
the supply.
-
Due to
demand and Supply mismatch, the prices of the houses have
declined.
-
Once the
housing prices started to fall, the interest rates on loans
started to rise.
-
Most of the
borrowers were unable to make their payments on time and
also due to unavailability of refinance options default on
loans started to increase.
-
For most
home owners, their outstanding amount on the loan was much
more than the value of their houses. So, people were unable
to repay the loans.
-
And all
those houses kept for Sale. The only way banks could reclaim
their amount was by selling these homes
The high rate of
default on sub prime loans & downward movement of housing
prices
resulted in lower demands for the MBS securities (created
out of sub prime loans). The banks & financial institutions
were unable to generate the liquidity.
WHAT IS THE IMPACT
-
Banks have incurred
losses. Their earnings came down.
-
Financial institutions have gone bust or have been taken
over by bigger organizations.
-
The housing
prices have plummeted.
-
The liquidity in the
financial system has come down .
Compared to
Banks, Financial institutions have suffered huge losses
because of the following reason:
-
Banks can receive
deposits and they used to leverage their financial
position and continue to operate.
-
But Financial
institutions can not receive deposits from public, hence
they suffered huge losses.
That is the
reason for US Sub prime crisis.
Thanks for Reading
-------------------------------Jagan..
More to come soon ...keep
watching ..
|
