roobaroo

Prakash: That was some good hot cup of tea!!

Suresh: ok!! lets continue, Now as the interest rates rise, EMIs being variable also increased. Since most of them couldnot afford to pay them back at revised rates, they began to default. The losses of the same were passed onto the financial Institutions who bought the "financial securities" as converted by the brokers. But these losses were not detrimental enough to disturb the US economy initially in times of American economy doing well and soaring housing prices. More and More financial institutions jumped into the Mortgage Market in their zeal to make quick money. This was a arena trading to the tunes of trillions in US markets by 2007 end.

Prakash: The problem started when the Mortgage banking Bubble burst. A slowing US economy, high interest rates, unrealistic real estate prices, high inflation and rising oil tags together led to a fall in stock markets, growth stagnation, job losses, lack of consumer spending, a virtual halt to new jobs, foreclosures and defaults.
Now with defaults stacking up financial institutions relying on them for payback of loans lost their liquidity status. The Securities lost their worth because of a devaluation of real estate prices as most of money was invested in that.

Suresh: Vicious cycle!!

Prakash: Indeed, the firms lost the credibilty to handle the risk. Because of this, the consumer spending further decreased leading to a hurdling of funds with no spending and thus a crumbling of these firms with their backs broken and no funds to cover the risk thus generated.

Prakash: hey Suresh, can u please summarise it for me?

Suresh: the whole crux lies in that a financial asset invented by Mortgage Brokers/Institutional Investors for which money was taken from large banks were repaid out of the securitisation of the same by converting them into financial securities thus hitting them back again. So it was these banks who lost the money with investors trading on it and making profits out of it. The Norms were relaxed down to earth because the investors didnt have to worry about the repayment of loans. So a bad financial system which actually became very popular for its bulk returns had to burst when overinflated. It has been a total systemic failure that has its roots in the US real estate and the sub-prime loan market.

Prakash: Thanks Prakash, it was really nice to be informed by you on this.