Global financial crisis is very wide subject and yet much talked about recently. Almost all the countries in the world are affected by the current financial crisis, the wealthiest to the poorest, one way or the other. Economists are of the opinion that the global economy is under a down-turn arising out of this crisis, from which the recovery is not possible in the immediate future.
Any financial crisis, in a country or around the world, will have immediate repercussions like – soaring cost of living; loss of employment potential; dearth in raw materials for production purposes; crash in stock markets and erosion of public credibility in financial institutions such as banks. The current financial crisis is no exception, as one can see from the news reports worldwide.
The factors that triggered the present crisis, according to financial analysts, are the chain reactions starting from the housing market bubble in the United States, commenced during the later part of 2006. The US dollar was the market leader for decades and yardstick for conversion in currencies and world trade. When once it fell from that pedestal, it created devastating impacts in the economy of the European, Asian, African and Australian continent countries of the world.
The spark of US housing bubble and thereby the present financial crisis started this way. During the period from 2000 to 2005 there was real estate boom, following the US government’s policy to provide home for the homeless, to meet the common American dream of owning a house. Mortgage lending banks stepped up their activity in granting home loans to applicants liberally.
Funds for issuing home loans were available in surplus, since other countries outside US seized the opportunity available in the US housing market and invested heavily on mortgage-based securities, floated by the financial institutions. Apart from the prime lending of banks and financial institutions for borrowers, sub-prime lending activity also flourished by refinancing the mortgage loans, already borrowed by aspiring home owners.
When more and more demand was created by these new home buyers, home sellers cashed-in on the demand-situation and inflated the prices of residential as well as commercial properties disproportionately. Property prices in prime locations like California, Florida, Georgia, Arizona and Nevada sky-rocketed as never-before.
The lending institutions, observing the steady upward trend of pricing of properties were confident of return of their capital with interest, over a period of long term, extending up to 30 years. During these boom years, home loans were issued for the asking to one and all, based on this misplaced confidence. Avoidable laxity prevailed in scrutinizing the home loan applications. Home loan officers turned a blind eye to the credit worthiness of the applicant; the repaying capacity of the borrower based on household income, and allied conditions for granting public deposits with banks, as home loans.
On the other hand, sub-prime lenders targeted those with negligible or doubtful credit history to grant home loans for higher interest rates.
The home loans being available on easy installments of repayment; adjustable rate of interest on mortgages, which were small at the beginning during the initial years of repayment; and negligible amount to be paid up-front for receiving the home loan -were the factors that induced many people to go in for home loans and buy properties, even at inflated prices. Some of the home loans were beyond the borrowers’ financial reach.
When once the interest rates went up – partly by the down-turn of US economy and partly by adjustment of interest rates after the initial years of repayment, the pinch was felt by millions of US home loan borrowers. They found all of a sudden that the monthly repayment installments were ballooning way out of their budget. This resulted in borrowers defaulting in repayments and the expected inflow of funds to the lending institutions dwindled month after month.
The mortgage lenders had to initiate action to retrieve their capital, invested in the properties, through foreclosure process. During such foreclosure processes, which were long-drawn ones, the capital and interest thereon were blocked in the assets as “dead-weights” in the books of lending institutions. There were no funds to issue fresh and further home loans and the credit crunch started to show.
For want of new buyers, the inventory of properties in the real estate market was mounting month after month. Due to this drop in demand, housing prices crashed dramatically. The stagnation in real estate business caused many repercussions in other markets such as consumer loans, credit card and auto loans.
Panicked by the housing bubble in the US, investors from other countries started withdrawing their investments all at a time. Thus the financial chaos ended in closing down of major financial institutions and banks, such as Lehman Brothers in US, unable to bear the loss of billions of dollars.