Economic Meltdown

Topics: Investment, Economics, Economy Pages: 5 (1694 words) Published: April 5, 2013
Monjoree Barua

Perhaps never before in recent history, has any economic development been so talked about as the ongoing ‘economic meltdown’. As it is clear no one person or institution ever understands the world economic network and functioning completely. Naturally, the fault could not be detected until the symptoms proved beyond repair. The sudden collapse of global finance giants like Lehman Brothers, AIG and battering of numerous other behemoths like Citi Corp triggered the collapse of the stock capital, affecting all US financial institutions, the effect spreading to European and Asian markets leading to worldwide credit crunch or lack of capital for daily operations, loans and expansions across all sectors and all markets. This present situation – of substantial loss of stock, money, shares being traded very low all stock exchanges, high rates for borrowing money, and low productivity due to low demand is termed ‘economic meltdown’.

How it started?
Actively supported by the government, large banks led by Citi Corp started encouraging the lower middle/lower class to seek loans to ‘own a house’ in America. While the banks wanted to cash in on the booming real estate market, the less affluent were lured by the idea of having their own houses. Since the boom in real estate appeared real and actually gave high returns, the banks forayed into lending to those incapable of repayment – the poor and the students. Loans to this category were known as NINJA loans or No Income No Jobs or Assets Loan. It was assumed, and here lies the ‘core’ of the storm the house shall always be worth more than the defaulted amount and therefore the banks would always yield profits – even in the ‘default’ case. As stated above, the US government actively encouraged this arrangement as suited its welfare agenda of ‘house for all’. Institutions like Fannie Mae and Freddie Ma, which gave unlimited mortgage based loans to individuals were supported by it. Since, this model appeared to yield high returns in less time, hedge funds started operations. The advent of huge and easy money for house loans made loan seeking very popular among the NINJA awardees. Till 2006 and early 2007, all gained. The poor had houses; the hedge funds went for a kill. The banks made sedate profits and the US was more socialist now, comfortable in the idea that in US, all will have a house of their own. House owners who had no income had to default one day. This happened in 2007. Then this became a trend and suddenly hedge funds, which cannot tolerate losses for long, started withdrawing. The banks, which had given loans many times more than they should, couldn’t do much to stop the fight out of funds. Since, the realty sector was earlier booming, investors had put in major capital in realty stocks plummeted, the realty sector no longer commanded premium. The worst point came when the houses themselves lost premium and were now worthless than the loans forwarded. This meant all loans ever forwarded were loss making. The banks themselves had taken loans to forward loans to retailers. As a result, in a free fall, all realty stocks crashed.

Role of investment banks (i-banks), hedge funds and HNI money Generally, a bank has substantial ‘liquid cash base’ on the basis of individual and corporate deposits. This is safe and has continuous supply of cash which forms the base capital of all banking operations. Investment banks like Lehman Brothers, Goldman Sachs and JP Morgan are not the usual individual ‘account holds type’ of banks. They earn as returns on the investments. They assess and predict the profitability of a project, invest a huge amount and earn profits as returns. Hedge funds made capital or money suitable for investing in high-risk high-return projects. While the i-banks and hedge funds made the mortgage market huge, the...

References: 1. “The causes of Economic meltdown in India”.
2. “ Indian Economy” and “World Panorama” . Manorama Yearbook 2011
3. “Causes of Economic Meltdown”.
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