Financial Cry-sis | 2007 to 2010

(This is the 4th in the series of blogs that I will be writing in an attempt to brush up my general and business specific awareness, improve my thinking, and of course, to substantiate the raison detre of my blog: s p a c e. For starters, the blogs will be intensive in facts and figures, with justifiable opinions, added here and there.  Content will be sourced from Wikipedia and other miscellaneous sites. Intention will be to repackage the information into simpler forms)

FINANCIAL CRISIS

Disclaimer: I am uninitiated and unqualified. Any undulations in facts should be excused unconditionally.

A Quick Look

• Recent Financial Crisis - lasted from 2007 - 2010 (though wiki says 2007-present)

• Triggered by - Sudden realisation (announcement) by US banks that they had little money left.

• Resulted in - Collapse of such 'large' banks (with tiny liquid deposits) & Consequent 'bail-out' of banks by 'benevolent' national governments; downturns in stock markets around the world (people stopped 'banking' on others with/for their money)

• Affected agents - Housing industry, Consumer Wealth, Economic Activity, Key Businesses, Government Pockets

• Solutions - Market based (e.g.-trading in bonds) and Regulatory solutions (stricter financial policies/conditions for banks)

• Officially ended - In 2008 - but some people enjoyed spreading the after shocks - (especially some miserly Indian  firms who had been longing to cut jobs and salaries) 

What Happened Basically

Housing Bubble Burst:
See now, people like buying big nice plush homes, without having much money to buy them. What do they do? They take 'home-loans'- because interest rates are low and nice and loans are easy to get. And so, the 'sale' of houses grows in 'account-books'. Thus, the real-estate market 'sales' and housing market 'sales' and construction/builders' market sales 'grew'. And other global financial institutions and investors started investing in such 'growth'. No one thought that the newly married guy and his wife, taking the loan, and living on credit-cards, have little ability to pay it all back.


Soon what happened? Two interesting things: Some people took a 2nd loan to pay back the first one. And slowly, the debt burden grew and grew. The banks realised that they had given away the 'precious' deposits of 'trusting' consumers/depositors/investors to 'untrustworthy' borrowers. How would they pay back! Forget paying back. They did not have enough money to give 'new' loans. The 'cycle' of borrowing and lending was jammed!

All this happened because the 'lending' policy was weak and everyone chose to overlook it.  The big shots had little 'vision' and 'awareness'.  Soon, there were large scale evictions (people were dragged out of their homes), foreclosures (bank wanted to get its money back- even if partially - by selling the house). Now, these things led to 'Fall in Housing Prices'. They plummeted. The bubble burst. Boom. Or rather.. Phushh ~

Many people cried - those who had been lured into investing in real estate. All this was pretty large scale! Trillions of US dollars they say. And I like to imagine that is an understatement. :P

Loans Were Easy to Get:
There was a dot-com bubble (some other time) in US in 2000, and of course the very famous September 11 attacks. All these made Federal Reserve feel that deflation will occur (they were right in their guess :P). So they thought, to increase money circulation, interest rates should be lowered. They were, thus lowered. And so, there was this very high demand for more home-loans. Now, where from will the banks get money, to give more loans?


Note that the US had a great trade deficit (was not able to pay for imports). So what it did? It printed 'papers' - Treasury Bonds, and asked Foreign Countries to 'buy' the bonds for a high price. US used this money to finance its imports.  Now we Asians are good with our money. We Save a lot. And there is a great tendency to buy government bonds. So there was great demand. After all the US government was offering it. This lowered interest rates. (Just as high demand increases prices). Our money was well used by US banks to give more risky loans.

Later the Federal Reserve thought, let us now increase interest rates. People are no longer discouraged by September attacks and dot-com bubble. The economy is healthy now. And then, ... it happened. Phushh ~

But, if not for Asian oil-rich countries and savings-rich Asians, it would have been PHUSHHH~

Other Bad Practices by Financial Institutions: 

• Sub-prime lending (giving loans to people with bad track record with debts)
• Weak and fraudulent underwriting practice (risk avoiding policies, documents and verifications were not present)
• Fraudulent lending by attracting consumers into dangerous loans through 'apparently' low interest rates.
• US government had deregulated the market a bit too much. It overestimated the 'maturity' and 'strength' of its financial institutions. Too big to fail. It thought.
• Increased debt burden : Example - In 2007, if an average American had $100 as disposable income, his debt was $127.
• Financial innovation and complexity: US banks came up with strange abbreviations - CDO, MBS, ARM, etc. All these were basically euphemisms for 'we are careless-but you can't see'. People couldn't speculate the risks correctly.

What It All Led To

• Commodity prices fluctuation: When there is less money in the market, and people do not 'intend' to buy/spend, prices fall. People stop being extravagant and spend less. Cash in hand becomes more important than comforts, as they witness so many people losing money in risky investments. First, the prices fell in 2008-2009, then they rose high in 2009-2010 as the demand recovered. I have no idea, if this interpretation is right.

• Impact on Financial institutions: Several major institutions either failed, were acquired under duress, or were subject to government takeover. These include Lehman Brothers, Merrill Lynch, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia and AIG.

• Bank Runs: Fear spreads, and spreads like fire!! When people came to know that their money was not safe in banks, they ran and queued up in long lines at the ATMs and at the Bank counters, to get all their money OUT!! This further pushed the banks into deeper trouble.

• Wealth Reduction: Federal Reserve or any country's central bank is called 'a lender of last resort'. Federal Reserve became the 'lender of only resort', and in some cases, the 'buyer of last resort'.  A lot of the nation's wealth was spent in bank bail-outs.

• Global contagion: US banks' risky debts were bought and traded by corporate and institutional investors globally, and thus the 'links' in the chain were formed, leading the crisis into other continents.

• Emergence of Arabian Cushion and strong belief in the markets of Developing Countries: The Asian nations were flying high on their Kaleen, powered by great surpluses from oil exports. 

The name Goldman Sachs: Despite the crisis of 2007, Goldman Sachs (global investment banking and securities firm) was able to profit from the collapse in the sub-prime mortgage bonds,  by short-selling the 'securities' backed by mortgages. Actually 'mortgages' are a 'hedge' against loss, so securities have a high demand when backed by them. But people did not realise that the mortgages were 'sub-prime' (undependable) and thus spent on them. So now you know, how some people could have made the money that everyone else lost.