Hello,
while surfing aljazeera.net there was an interesting poll of “do u think u know enough aobut the economic crisis?”. Of course around 90% said no which is very expected. Even though I am in USA, and interested in knowing about this crisis, unfortunately, whoever talks about it, doesn’t talk about how it happened and why it is affecting everybody. They only talk like u know everything already. They mentioned the “buy out” bail the congress passed lately, but never went into details of what that bail means.
i gathered some info from here and there, but i wasn’t able to find a good site to explain it fully. wikipedia got some good info though.
here is what i gathered hoping people might benefit from this and hoping if others know more things to share it with us
what caused this problem is the real estate bubble in the US. The bubble basically means that people start investing their money in real estate too much till one point it become worth less than what it actually worth. For example u might buy a house for 100K thinking that this is awesome price, but in fact it is not worth it and it is only expensive because the demand is high not because it worth a lot. so after a while people realize that houses are less that what they r sold for, so everyone suddenly stops buying houses and the demand becomes really low which makes the houses prices really low as well. Whoever bought a house already is now in trouble. of course i am talking about people who trade in houses not to live in them.
The banks give a mortgage plan to people to buy houses by paying a monthly fee instead of buying it all at once. When this bubble happened, many bought houses this way (by loan), and when the prices went down suddenly many stopped being able to pay the monthly fee. The banks ofcourse take over the house. Now theoritically, the bank didn’t lose anything since it was the house, but on reality the bank is not equipped to invest in the house itself, so having the house is worse than the monthly payments since banks need liquid money fast rather than assets.
Now this what caused the Lehmans bank to go bankrupt and another bank was bought by a bigger one. Now why the crisis escalated, because all the banks that was getting loan payments from lehmans can’t do that now so they r in trouble for lending money to the lehmans. Addiontally people are easily scared and this bankrucy scared many investors, and when some investors start pulling their money from the stock market that means demand is lower so the stock goes down which means additional people pull their money out, and the chain reaction starts.
That what happened couple of decades ago, i don’t know details of that crisis, but i know it was the worst and that’s when the “grapes of warth” story events happened. It was a similar issue, something went wrong which made some stocks go down and everybody panicked and pull out their money which destoryed many business and many people became unemployed.
ok, now the bail out plan. as i understood that the congress want to pass a decision to BUY the bad loans that the banks had taken because they were stupid. and the congress hope that after a while, those loans will be worth more so they will actually profit from this. the main issue is that the bail out plan helps the investment corporations, not the normal non-investing person. some are with and some are against. anyway it was passed recently after small alterations, not sure what they r.
ok that’s everything i know if any knows more, please enlighten us.
Muhammad add some good information, he mentioned that after the banks got the hit, they stopped loaning money to bussiness people. This move caused many bussiness to go bankrupt which escalated the problem further.
p.s: another reason why i am posting this because no one wrote a post in a while
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4 Comments
salam,
nice post. a good place to read about the problem is this article:
http://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008
wikipedia has several articles, but this seems most coherent so far.
there are several causes for the current economic recession (high oil prices, high food prices, subprime crisis, credit crisis, etc.). Below I try to summarize the subprime/housing crisis.
The “grapes of wrath” novel was about the Great Depression, which took place 1929 to ~1938.
part of the housing problem was caused by people taking what is called ARM (Adjustable Rate Mortgage) loan.
ARM usually have a low interest rate of 4-5% for the first 3-5 years, and then go to a variable interest rate after that. Variable interest rate means the interest will be whatever is common in the market. This is usually higher, and can change month to month.
The problem is that when housing prices started going up, many people thought it will keep going up (the eternal cause of economic bubbles). They calculated they can “flip” a house in 3 years, buy it now and resell it in 3 years, on an ARM loan before the high interest period hits.
Most of the people who got these loans couldn’t afford them. This means once interest rates go to market levels, they cannot make the monthly mortgage payment given their monthly income.
However, the banks were hungry for customers, and so they approved “sub-prime” loans, loans for people with “substandard” credit ability.
What happened is that these people bought houses, and then the house prices went down instead of up. thus, at the end of 3 years, they couldn’t resell the house to get rid of the loan. If they sell the house at a loss, they will be in debt to the bank for a large amount.
Usually this is not a problem - because the bank has already charged the buyers a percentage of the house. E.g., the buyers had 20% stake in the house, and the bank gave them 80% loan. So, when the bank sells the house, even if the house loses 20% of its original price, the bank can still get back its 80% share.
what made this problem so bad is that the banks were giving incredible loan deals to people: instead of requiring the usual 20% down payment, they were actually giving people up to 110% loans. This means if the house is worth $100K, then would give a buyer up to $110K loan. The extra $10K is to cover other expenses (repairs to the house, vacation, etc.).
this is why when people started defaulting on their loans, the banks couldn’t get back their money by selling the houses. If a bank has many of these bad loans, its losses grow so big it has to declare bankruptcy.
after banks made many bad loans, they do not have enough liquidity now to make even good loans. This is leading to the current Credit Crunch.
in 1929 something similar happened, when many banks gave bad loans to farmers in the mid-west. Many of these farms proved to be very bad investment and those farmers had to default on the loans… which lead to something very similar to what the government is dealing with now.
hope this helps… let us know if you find good articles about this subject.
That sux! Actually I read yesterday that in Jordan 70% of investments are in the real estate sector. This is not good, and I think if we do not do something about it soon, we will be done for.
Anyways, thanx s3d for the article, I was not very interested in knowing what is going on, but I wanted to know anyway, so this has helped to understand what is going on.
Regardless, even if the US government could manage to fix the problem soon, USA will naturally loss its position as a leading economical force in the world.
That remind me of how did USA raised to be a leading force back at the WWI and WWII eras. Europe had lost too much that USA became number one. I think China and Russia will benefit a lot from that.
this has really been useful. i have to write this essay on world economic crisis 2008 and i would really appreciate if some one could explain how this had an effect globally?
I have something to add!
Actually am reading a book about investments in the next 10 years!
The book was written 1 year ago and in it actually the writers expect what exactly happened! they said that 20 years ago this real estate booming made it a great chance for investment, i.e u would buy a house for 100000 dollars, then sell it after few years for 200000 lets say! this made a profit of 100000 in only few years! that was due to too many things!
People (common people with no real knowledge) start to find it a good investment and started to buy houses and sell later for a higher price, and the industry of loans for such a purpose flourished. But they either forgot or did not know that it is a cyclic process, i.e it will reach a peak then goes down to it minimum value then will start going up again! and the bankruptcy is due to what Mohammad said!
anyways, we can learn something from this case, u can invest in a place where the cycle has just started, such as Germany (they went through this cycle in the 90’s and going up again) or Japan (they went through it in the 80’s).
Recovery periods can take loooong times as u see, in the Japanese case they took like 30’s to start rising again, but usually it will take 10 years mini!
I think I will soon write an article on investment as soon as I finish my readings!