In 2008–2009 most of the industries in the world have entered into a deep recession as a result of the financial crisis that had its origins in impulsive lending practices and distribution of mortgage debt in the United States. Sub-prime loans losses in 2007 exposed other risky loans and over-inflated asset prices. With the growing losses, a panic developed in interbank lending. The unstable financial situation caused a sharp increase in oil and food prices.
Housing sector of America for the past few years should be analysed carefully to understand the main causes of financial crisis. Real estate boom in US has changed the overall outlook of the economy. Availability of home loans was very easy to the people because of low-interest rates and large inflows of foreign funds. As a result more customers started approaching banks for home loan and it leads to increase in demand for property and further leads to increase in home prices. Because of increase in money supply, banks gave enough money to their customers as loan and relaxed their credit procedure.
The marketing executives were offered huge bonus and incentives to find potential home buyers in US. The main focus of every lending institution is to promote loans to as many potential customers as possible. Usually banks will check the customer’s repaying capacity before granting loans. That was ignored several times because of housing boom in USA and everybody was bothered only about the selling of house loans. As a result, many people with low income and low credit repayment capacity were granted housing loans by neglecting all the principles of credit procedure. These kinds of loans were known as sub-prime loans.
Subprime loans were very profitable part of their investment portfolio for banks and were anticipating a very high rate of return in view of the increasing home prices. Even though the interest rate is higher by 2% lenders expected a minimum amount of return. And if borrower could not pay his loan amount lender has the right to sell the property attached as security. Financial crisis also cause liquidity crunch in banks.
Sub-prime borrowers understood the situation and found it difficult to repay the loan amount by selling the properties. At that time the home prices in US started declining rapidly but interest rates suddenly increased. And the customers could not afford to pay the high interest rate. As a result many of them failed to repay their home loans and vacated the house. Even in this situation, lending companies tried maximum sell the properties and recover the loan amount. But they did not get any positive result. Finally, they end up in an option to write off losses on these loans. Later government came up with various financial packages.
“The effects of these losses were huge. Global banks and brokerages have had to write off an estimated $512 billion in subprime losses so far, with the largest hits taken by Citigroup ($55.1 billion) and Merrill Lynch ($52.2 billion). A little over half of these losses, or $260 billion, have been suffered by US-based firms, $227 billion by European firms and a relatively modest $24 billion by Asian ones. The crisis has also seen Lehman Brothers – the fourth largest investment bank in the US and the one which had survived every major upheaval for the past 158 years – file for bankruptcy. Merrill Lynch has been bought out by Bank of America. Freddie Mac and Fannie Mae, two giant mortgage companies of US, have effectively been nationalized to prevent them from going under. Reports suggest that insurance major AIG (American Insurance Group) is also under severe pressure and has so far taken over $82.9 billion so far to tide over the crisis.”
Financial crisis has created a fear among the investors and institutions all over the world. Most of the industries in the US were running smoothly only because of the capital assistance they were getting from the banks. So this financial crunch has severely affected the manufacturing and business industries that are in need of huge day-to-day working capital. Now it is a tedious process to get loans from banks. (Reasons for global recession: In plain simple.