ITBHUGlobal.org: The Chronicle: All about Recession-by Abhishek Khanna (Mechanical 2007)

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(Abhishek Khanna can be reached at: ak.bond@gmail.com)

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This is not as complicated thing as you all think. I will try to keep it as simple as possible

Ever wondered about all the savings you do- Provident fund, mutual fund, the part of your provident fund maintained by the company? Now try to calculate this for each working person in your country, and then scale it up to the whole world. For a very small estimate, you can keep the figure of about $ 100 trillion. Although the number will be much above it and can only be approximated and not calculated

Now when the companies like Lehman Brothers, etc. hire people at stinking high salaries as investment managers, they want those managers to attain a growth on the investments much better than a 4% that a bank gives or about 2-3% which US treasury and municipal bonds give. And then the greed increases to show higher and higher returns on the pamphlets of the mutual funds and other funds you know about.

Now the problem is this amount of roughly 100 trillion dollars was approximated to be almost half around year 2000. So imagine, you get 50 trillion dollars in the market and you want to earn high returns on them. So people started moving towards risky investments. In spite of hiring the best people, sometimes the greed and the pressure force the people to make wrong choices.

So these guys decided to foray into a new segment, housing mortgages. Give loans to people charge them interest and get a higher return for the next 30 years. Simple! Yes it was very simple till the point the greed started getting on nerves of people.

But as you know "bade log" don’t have so much time and patience to handle such a business. So the process started in a chain .A small broker called X sells you a mortgage, he works for bank Y, so you will have to give your EMI (Equated Monthly Installment) to bank Y every month for next 20-30 years depending upon your loan duration. And then this investment banker comes and gives the whole loan amount to bank (and some incentive). Now your cheques go to this investment banker. And now this investment banker made small shares of this loan and sold them off to investors around the world.

To simplify the process, you got a loan from hundreds of people across the world and your interest gives income to all the middlemen including broker, small bank, investment banker and the final investors.

 Investors started liking it a lot because it gave much higher returns. So the brokers started selling aggressively to earn incentives, and in due course the requirement for the loans started decreasing as most of the eligible people with a good credit rating got the loan.

Money has an amazing power my friend. Every now and then the loan guidelines and credit scored required was loosened a bit. This also went for some time. And then a day came when the interest rates charged were very high and the rules very low. They started giving loans to people with bad credit or subprime people as they are commonly called.  This was the era of NINA loans

Do you know about NINA loans? That means No Income No Asset loans. Even an amateur will say "what the hell?" when he hears about this loan. The thing worked as simple as that, go to a bank and say, hey I want a loan, and they will ask you, have you got a job mate? , you say yes, and there you go, no checking, not much of documentations and the loan is yours but with a higher interest rate. If you go and talk to the defaulters of the loans many of them will laugh that the banks were fools in the first place to offer such loans, and for the borrowers, who hates money? So subprime people were getting loans of any amount they wanted but the interest rate was considerably high!

Everyone from the smalltime broker to the investment banker was minting a hell lot of money. But you know the problem with this profession? You see the stats that on an average 2% people default the loans, so taking 4 times as the factor of safety at max 7-8% people will default and that can be covered with a higher rate of interest. But the world doesn’t go by the stats. It is never sure that it will rain on 29 June if it has been raining on the same date for past 15 years!

So these guys made some CDOs (Collateralized Debt Obligations; http://en.wikipedia.org/wiki/Collateralized_debt_obligation) and securities of the mortgages and sold them to the investors worldwide. Then suddenly one day, sometime around in 2006, some wise guys found the default rate rising at an alarming rate! Sensing some danger they asked the investment banker to stop buying loans from small banks. And hence these investment bankers had many loans which they were not able to sell to the securitizers and small banks had many which could not be sold to the investment bankers. And it takes some time to stop the brokers who were selling these loans like hot cakes. Therefore everyone had some or the other toxic loans at their hands, and big investment banks had loads of them.

You know about the balance transfer facility on credit cards? The other cards charge you lower interest if you pay your payment from their card; this is just a marketing thing to attract more customers. In US people live because of this facility. They finance their loans again and again with new banks to gain some interest advantage. But suddenly because of the oversupply of homes the market price of the homes became less. And the banks are not (so big) fools to give a loan of $200K on a property worth $100K. Hence the owners were not able to refinance them and neither could they pay the awful amount of interest charged on their loans. So they started defaulting. And as the old saying goes "Kharbooje ko dekh ke kharboojja rang badalta hai"

All you could hear around was fall in home prices and default on more loans. Chain reaction as they say. And since the investments were made by almost all the major banks, so everyone is in big trouble now. They chewed more than they could swallow and hence have an upset stomach now. Many of them dead!

Kissi ne sach hi kaha hai: "Lalach buri bala hai.”

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