The belief that the US market and economy is known for its optimum capitalization of whichever opportunity comes their way, was further reinforced by the roll-out of the Sub Prime Loans in the year 2007-2008.
It was indeed a novel scheme to begin with, but had
far-reaching consequences not only for USA but for the entire world economy.
The all-powerful and influential USA went onto to face an
economic turmoil which created further fiscal disturbances in countries largely
dependent on exports from the US.
What Triggered This Novel Scheme?
The 2007 real estate market saw a boom like never before.
Everyone wanted to invest in property, but those who had access to credit
facility in terms of loans from financial institutes had an upper hand over the
people whose credit rating was low due to lack of job security, non-repayment
or delayed repayment of previous loans.
Nevertheless, the desire to invest in real-estate was
mutual. Coupling the aspirations of the masses along with the profit motive,
the banks in the USA introduced the concept of the Sub-Prime Loans.
What are Sub-Prime Loans?
They are Loans given by Financial institutes and Banks,
to those individuals who have a poor credit rating, don’t qualify for a loan or
those with lack of job security.
These loans enable the masses to fulfil their aspirations
in terms of purchasing their desirable assets.
Short-term Impact of Sub-Prime Loans:
These loans provided further stimulus for borrowing. The
increase in number of investors benefited the already flourishing real-estate
market.
The driving force for the banks was the rate of interest
that was increasing because on one hand the demand for the loans kept
increasing but on the other hand there weren’t enough players in the loan
sector to meet that demand. However, later the lucrative profits drew several
banks to jump onto the bandwagon of sub-prime loans.
The banks that were rolling-out the scheme were able to
recover their loans even with higher rates of interest because the borrowers
also witnessed a surge in rent and resale prices.
The Borrowers were not only satisfied by their
aspirational purchases but were able to improve and establish better credit
ratings by timely repayment of their loans. The timely and efficient payback
behaviour would act as a precedent and leverage their cause for future lending’s.
Long Term Impact of Sub-Prime loans:
Jumping onto the bandwagon in an early stage may be
beneficial, but at a later stage it may not be as remunerative owing to
over-saturation.
The same thing happened with the Sub-Prime Loan sector,
the popularity of the innovation gained ground with the all the banking players
thus, supply overshot the demand and from there the downfall begun.
The rates of interest along with the property prices took
a hit. The real-estate business was no longer as rewarding. Property rents and
resale value depreciated.
Owing to all these reasons, the borrowers were finding it
increasingly difficult to repay these high interest mortgages. Number of
defaulter loans shot up. Only those who previously had good credit rating were
able to repay in full, rest of the loans became non-performing assets for the
bank.
The severity of the defaults was such that many
well-known banks had to declare bankruptcy.
One such financial institute was The Lehman Brothers, who
were the climax of the sub-prime crisis when filing for bankruptcy.
Impact on Indian Economy:
The Indian economy was not severely affected because
India’s GDP was dependent on its own domestic sources and not on exports
from the USA. In the early 2000’s, India’s exposure to the mortgage market was
also negligible compared to other developing countries.
What did affect the Indian economy was that the fiscal
deficit went from 2.7% to 4% in one financial year. India was faced with a
fiscal deficit as well as a current account deficit (CAD).
The further increase in the CAD was responsible for the
devaluation of the rupee.
Indian banks and financial institutes were also faced
with the problem of loan defaults and non-performing assets.
India released NRI bonds in the hope of improving the
fiscal deficit scenario and for the purpose of increased cashflow in the nation
to sustain the sinking economy.
Who is to be Blamed for this Market Crash?
Whenever something goes wrong, everyone starts pointing
fingers at each other. When that something that goes wrong includes money, the
intensity of the problem increases 10-fold, attracting global attention.
A similar thing happened in 2008, but there isn’t one
person, one bank or one financial institute to be blamed for the market crash.
It was a collective creation of the world’s central banks, lenders, credit
rating agencies, underwriters and investors.
The disastrous market crash of 2008 led the New World
into a large-scale recession. People lost their jobs and their life savings.
Banks were forced to declare bankruptcy. Investors lost out on huge profits.
This market crash of 2008 had indeed been a reminder for
all those big-players of the market to be prudent while dealing with people’s
money and judiciously come up with inventions whilst keeping current market
trends in mind. The study of the longer run and futurist trends also should
form an important criterion while rolling-out new ideas.
The 2008 housing market crisis still holds relevance as
it sets a precedent for the major- players in the financial set-up.
Written By - Tushna Choksey
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