What is subprime crisis? How it caused financial mayhem?
The current upheaval in the global financial markets has caused more mayhem in a fortnight than the world has seen in its entire economic history.
Although there are many reasons responsible for bringing the world to the doorstep of financial doom, the main cause of this financial disaster is said to be the ?sub-prime loan.'
So what is this sub-prime loan? And why has it caused global panic? If it is related to the American housing sector, why should it affect Indian and other markets?
A sub-prime loan
Sub-prime mortgage loans (or housing loans or junk loans) are very risky. But since profits are high where the risk is high, a lot of lenders get into this business to try and make a quick buck.
Sub-prime loans are dicey as they are given to people with unstable incomes or low creditworthiness. These individuals are not financially sound enough to be given a loan when judged under the strict standards that should normally be followed by a bank or lending institution.
However, there's more to it. Let us simplify this issue to understand better how sub-prime loans work and how they brought the world down to its knees.
It all begins with an American wanting to live the famed American dream.
So he seeks a housing loan to give shape to his dream home. But there is a slight problem. He doesn't have good credit rating. This means that he is unable to clear all the stringent conditions that a bank imposes on an individual before it sanctions a loan.
Since his credit is not good enough, no bank will give him a home loan as there is a fear that the chances of a default by him are high. Banks don't like customers who default on their payments.
But lo!, before the American dream can ...