The financial crisis brought the world to its feet!
The foundation stone of the current financial crisis was definitely laid during the prior boom period, which lasted between 1996 to early 2005. Financial institutions like Fannie Mae, Freddie Mac, Lehman Brothers, Bear Stearns, Merrill Lynch et al, were enthusiastic enough to run after the lucrative sub-prime market and create an artificial buying power for borrowers. Giving no importance to financial due diligence, the lenders were quick to introduce new, riskier products with insufficient asset value as collateral. As a matter of fact, the total amount of mortgage-backed security issued tripled to $7.3 trillion and the securitised share of sub-prime mortgages increased from 54% to 75%; all thanks to the booming ‘credit derivative market’ which made risk transfer easy. The low interest rate further encouraged Americans to opt for housing loans or mortgages. But when home prices in the US began to decline in 2006-07, mortgage delinquencies rose and securities backed by sub-prime mortgages (which were widely-held by financial institutions), lost most of their value. Later on, when this housing bubble busted, three out of the five largest investment banks (once the cynosures of Wall Street) of US, failed, triggering instability in the global financial system. This resulted in a decline of capital for many banks, thus creating a credit crunch.
The foundation stone of the current financial crisis was definitely laid during the prior boom period, which lasted between 1996 to early 2005. Financial institutions like Fannie Mae, Freddie Mac, Lehman Brothers, Bear Stearns, Merrill Lynch et al, were enthusiastic enough to run after the lucrative sub-prime market and create an artificial buying power for borrowers. Giving no importance to financial due diligence, the lenders were quick to introduce new, riskier products with insufficient asset value as collateral. As a matter of fact, the total amount of mortgage-backed security issued tripled to $7.3 trillion and the securitised share of sub-prime mortgages increased from 54% to 75%; all thanks to the booming ‘credit derivative market’ which made risk transfer easy. The low interest rate further encouraged Americans to opt for housing loans or mortgages. But when home prices in the US began to decline in 2006-07, mortgage delinquencies rose and securities backed by sub-prime mortgages (which were widely-held by financial institutions), lost most of their value. Later on, when this housing bubble busted, three out of the five largest investment banks (once the cynosures of Wall Street) of US, failed, triggering instability in the global financial system. This resulted in a decline of capital for many banks, thus creating a credit crunch.
Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
and Arindam Chaudhuri (Renowned Management Guru and Economist).
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