Subprime crisis

Introduction

Subprime is the cause of USA Economy melt down. It is the very popular news among everyone and it is become very serious then expected. It caused more damage to all the industries.

What is Subprime lending?

Subprime Mortgage Loans (or housing loans or junk loans) are very risky. But since profits are high where the risk is high, a lot of lenders get into this business to try and make a quick money.These loans are given to people who have inability to repay the loan and they don’t have stable income. For example, a person who is working on IT company earns Rs.40000 per month and he doesn’t have any other income or assets. When the bank gives him loan of some lakhs, the EMI for the month would be Rs.20000-Rs.30000. If he lose the job, there is no possibility for him to pay the EMI, he will just surrender the house to bank and go away. This is the one simple example how Subprime problem starts.

Who opt subprime lending?

Individuals who have experienced severe financial problems are usually labeled as higher risk and therefore have greater difficulty obtaining credit, especially for large purchases such as automobiles or real estate. These individuals may have had job loss, previous debt or marital problems, or unexpected medical issues, usually these events were unforeseen and cause a major setback in finances. As a result, late payments, charge-offs, repossessions and even foreclosures may result.

Due to these previous credit problems, these individuals may also be precluded from obtaining any type of loan for an automobile. To meet this demand, lenders have seen that a tiered pricing arrangement, one which allows these individuals to pay a higher interest rate, may allow loans which otherwise may not occur.


What caused 2001 recession?

Subprime problem is more severe then what we saw in the 2001 recession. The real fact is that, 2001 what happened is Dot Com Bubble followed by the recession. Since the invention of internet, there is dozens of new companies coming up with the Dot Com dreams. There is lot of hype around Dot Com is that any company can make the billions of dollars. So, people started investing more on the Dot Com companies and the prices of the share value is increased dramatically. The price of the stock market is over valued. A small company without any profit valued as a billion dollar company. Even they don’t have clear idea on how will they make profit.

To keep running the company, they are spending investors money and promising that they will make profit in future. After some period of time, investors realized that company is not making any profit and stared selling the shares. When selling shares is more than buying shares, the value of the share will be coming down. It caused sudden fall on the stock market and the companies tumble to survive. Dozens of small companies vanished and only few big companies like Yahoo, Amazon, ebay, etc. has managed to survive on the burst.

So, whoever working on Dot Com companies lost their jobs immediately, when there is increase in the unemployment will decrease the country’s GDP growth. If there is two quarters continuous fall in the GDP, it is called as recession. This is what happened in the USA’s 2001 recession. What we are seeing as Subprime is different from the 2001 burst.

SubprimeCrisis and Banking Industry

Subprime crisis has ended history of many banks in the USA. As of now 22 banks closed because of Subprime crisis. It is started with the Lehman Brothers, a 138 year old company filed bankrupt. It is followed by Washington Mutual Funds. Like this 20 other small and medium size banks fallen easily. American International Group (AIG) survived by giving the $80 billion bail out money by the USA government. Another major collapse with Citi Bank which has written off $60 billion as the bad debts. CitiBank also rescued by the USA government using bail out plan. It is estimated that USA needs atleast $800 billion required to handle the Subprime crisis.

Survival of Automobile Biggies

Now the turn is Automobile industry and it is affected more than any other industry in the USA. The major three companies in the USA, General Motors(GM), Ford and Chrysler needs help from the government to survive

The domino effect

The domino effect is a chain reaction that occurs when a small change causes a similar change nearby, which then will cause another similar change, and so on in linear sequence. The term is best known as a mechanical effect, and is used as an analogy to a falling row of dominoes. It typically refers to a linked sequence of events where the time between successive events is relatively small. It can be used literally (an observed series of actual collisions) or metaphorically (complex systems such as global finance, or in politics, where linkage is only a hypothesis).