Wednesday, March 26, 2008

Sub-prime crisis, dollar depreciation, Credit crunch, US recession, Nosedive of Indian indices, Fed rate cut, rising oil prices….what’s the connection

Currently the financial market through out the world is going through turmoil. It started with the sub-prime crisis. The US banks and financial institutions gave loans to credit unworthy borrowers at high rates. Rising housing prices in the US prompted the borrowers to assume mortgages, thinking that they can refinance at more favorable term later. But the housing bubble which began in 2001 and peaked in 2005 started deflating in 2006. As a result, the sub-prime borrowers defaulted in paying back the loan. They were either unable (as the interest rate was high) or unwilling to pay resulting in foreclosure (taking over of the property by the lender). The bank and other financial institutions, i.e. the mortgage lenders securitized the mortgage payments and credit/default risk and passed it to third party investors via Mortgage Back Securities (MBS) and Collateralized Debt Obligation (CDO) to corporate, individual and institutional investors spread across the globe. As the value of the mortgage assets declined, these investors faced significant losses. Major Banks and financial institutions around the world have reported losses of U.S. $170 billion as of February 2008. Bear Stearns, the Wall Street invest bank is one of the prominent examples.