Greed

[JUSTIFY]In 2006 & 2007, there were signs of stress in the financial services industry and in 2008, it started collapsing so rapidly while regulators and many others were investigating the cause of such financial meltdown. They called it subprime lending issue. What started it? Real estate was appreciating for a prolonged period of time giving opportunity for the bankers to do creative lending. The two fundamental principles under which lending institution normally function is a) to establish repaying capacity of the mortgagee by working out what is called Debt Service Coverage Ratio (DSCR) and b) the value of the assets covering the debt otherwise called Asset Coverage Ratio (ACR). In order to obtain significant market share, many financial institutions gave incentive to their executives and other mortgage brokers to bring in opportunities to lend and slowly the financial institutions were giving loans almost at the same level of value of assets that were mortgaged without even worrying about their ability to pay back the debt. Besides mortgage loan obtained by the borrowers to build their own residence, a new concept called Home Equity Loan became prominent allowing the home owners to borrow against the equity that they built in their residence. Moreover, these loans were refinanced by major financial institutions backed by federal government called Fannie Mae and Freddie Mac and hence the financial institutions get back the money that was lent again for circulation.


When the real estate values started crashing in late 2007 and early 2008, many loans that were given went much above the value of assets and the financial institutions started demanding the mortgagees to pay back a portion of the debt immediately. Unable to pay back the loan, most of the home owners surrendered their home for foreclosure. This increased the supply of houses available in the market further collapsing the real estate market. Moreover, the financial institutions were asked to quickly sell-off the real estate assets foreclosed by them at throw-away prices and record the losses in their financial statements. It is my understanding that the total estimated value of subprime lending losses is much higher than the estimates that were mentioned in public. One lead to the other, and when the financial institutions collapsed, the stock market collapsed wiping the value of many innocent investors and this economic crisis resulted in a severe recession for several quarters. The companies had down-sized their operations resulting in increased unemployment and reduced production.



The Federal Reserve and the federal government got involved to rescue so many “too big to fail” financial institutions and automobile industry by using tax-payers funds and borrowing money from the future by increasing the supply of currency. This US recession impacted several countries all over the world and the world economy faced a major crisis. Many countries are still struggling to get over from the impact of this recession including many European countries. US lost its “Aaa” rating from the Moody’s. When we review the root causes of this situation, we come to the following conclusion:


1) Lack of financial discipline among the people, who were interested in leading a life style beyond their capacity due to their unlimited desires, resulted in their downfall and bankruptcy filing. If they thought of their future and family, they would not have indulged in such lifestyle
2) A few executives and mortgage brokers’ greed to become rich by earning huge incentives recommended number of mortgage transactions outside the scope of the financial institutions
3) Financial Institutions wanted to gain market share over their competitors and hence closed their eyes about those critical ratios that they should have verified before lending
4) Regulators failed to review the financial institutions going above board in sanctioning such loans outside the norms


The bottom line, the entire world paid the price for such an irresponsible behavior by people who were not following care and diligence in practicing good financial discipline. At least after this crisis, people should understand their social responsibilities besides their duty to their respective families.
[/JUSTIFY]

 

Dear Anu,

Thank you for reading this blog and for your response.

Viswa

 

Dear Syamala,

Thank you for your valuable comments. Even though they suffer themselves by borrowing more than what they can pay back affecting their lives and their families, their actions resulted other innocent lives being affected as well. I know they don't care about others' lives when they buy villas or luxurious cars but when they pay the price for their not so responsible behavior, they are the ones who cry about foreclosure and the government is doing everything to protect them from foreclosures.

The Government should actually pay their attention to the ones who behaved responsibly.

Viswa

 

Dear Ramya,

Thank you for stepping in. You rightly said it is a web. But still people had the choice whether to get into it or not. It affected other innocent and responsible people as well. Even if they learn a lesson now, they have already put the entire world into chaos. May be the right answer is, the people are not ready for deregulation.

Viswa

 

It has become a habit now that the regulators wake up only when something blows up. There is nothing done proactively.

Viswa