Thursday, August 9, 2007

Subprime mortgage crisis

I could never figure how the pretty Jessica at the front desk or the scruffy John clearing the trash at my office could afford a house or for that matter the cars they drive or the vacations they take. They don't make nearly as much as I do. Who loaned them such huge amounts of money to buy a house and how could they even afford the monthly mortgage. How the heck can they buy all these things, my middle-class Indian mind could never comprehend. Some of my questions were finally answered after the subprime mortgage crisis hit the US markets in the past couple weeks, of course, causing a lot of loss to my investments. Basically subprime loans are given to people with bad credit history i.e. people who are careless about money. We all have done our mistakes with our money but these people have really screwed up with other people's money (read loans). Banks want to give these screwed up people big loans but they also charge high interest rates to hedge against the risk that these people will screw up again. Banks think that if enough people pay higher interests then its a good strategy against the few who will default on their payments. Banks entice people by giving low interest payments for the first couple years (so the monthly payments seem artificially low) and then jack up the interest rates to absurd levels. Obviously, John and Jessica can't pay these loans so they default and their houses are foreclosed. Couple that with the housing market not doing so great (so the house cannot be sold easily again) and the bank just lost a shitload of money. So it turns out that 2 years ago a lot of subprime loans were given out and right about now is the time when John and Jessica will not pay the mortgage. Hence the current crisis. Whether or not it will cause a recession in the US economy remains to be seen. Some experts say that the US economy is not dependant on housing alone and this crisis will pass without much lasting damage. But the signs sure do point towards some major ass whooping in the near term.

No comments: