What is Subprime crisis?

December 5, 2008

World Economy

Subprime is the cause of USA Economy slow down.  It is the very popular news among everyone and it is become very serious then expected. It caused more damage to all the industries especially Banking, Insurance and Automobile sectors. Subprime crisis caused big loss to the banks and now it is affecting the other industries like Auto Mobile companies (GM, Ford, etc.). In this blog I will write about what exactly is the Subprime crisis and why USA banks created such a big mistake in their era. Some experts comparing this disaster with the 1930 Economy slow down in the USA.

What is Subprime lending?

Subprime 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 money.These loans are given to people who have inability to repay the loan and they don’t have stable income. For example , a person who is working on IT company earns Rs.40000 per month and he doesn’t have any other income or assets. When the bank gives him loan of some lakhs, the EMI for the month would be Rs.20000-Rs.30000. If he lose the job, there is no possibility for him to pay the EMI, he will just surrender the house to bank and go away. This is the one simple example how Subprime problem starts.

Who opt for Subprime lending?

Individuals who have experienced severe financial problems are usually labeled as higher risk and therefore have greater difficulty obtaining credit, especially for large purchases such as automobiles or real estate. These individuals may have had job loss, previous debt or marital problems, or unexpected medical issues, usually these events were unforeseen and cause a major setback in finances. As a result, late payments, charge-offs, repossessions and even foreclosures may result.

Due to these previous credit problems, these individuals may also be precluded from obtaining any type of loan for an automobile. To meet this demand, lenders have seen that a tiered pricing arrangement, one which allows these individuals to pay a higher interest rate, may allow loans which otherwise may not occur.

US Debt Ceiling Problem

What caused 2001 recession?

Subprime problem is more severe then what we saw in the 2001 recession. The real fact is that, 2001 what happened is Dot Com Bubble followed by the recession. Since the invention of internet, there is dozens of new companies coming up with the Dot Com dreams. There is lot of hype around Dot Com is that any company can make the billions of dollars. So, people started investing more on the Dot Com companies and the prices of the share value is increased dramatically. The price of the stock market is over valued. A small company without any profit valued as a billion dollar company. Even they don’t have clear idea on how will they make profit.

To keep running the company, they are spending investors money and promising that they will make profit in future. After some period of time, investors realized that company is not making any profit and stared selling the shares. When selling shares is more than buying shares, the value of the share will be coming down. It caused sudden fall on the stock market and the companies tumble to survive. Dozens of small companies vanished and only few big companies like Yahoo, Amazon, ebay, etc. has managed to survive on the burst.

Buy : Recession Challenge : This book explains very well about the challenges faced by the recession. If you want to know more about the financial crisis that has engulfed the global economy, read this book.

So, whoever working on Dot Com companies lost their jobs immediately, when there is increase in the unemployment will decrease the country’s GDP growth. If there is two quarters continuous fall in the GDP, it is called as recession. This is what happened in the USA’s 2001 recession. What we are seeing as Subprime is different from the 2001 burst.

Another global recession in 2012 is in the cards…

Subprime Crisis and Banking Industry

Subprime crisis has ended history of many banks in the USA. As of now 22 banks closed because of Subprime crisis. It is started with the Lehman Brothers, a 138 year old company filed bankrupt. It is followed by Washington Mutual Funds. Like this 20 other small and medium size banks fallen easily. American International Group (AIG) survived by giving the $80 billion bail out money by the USA government. Another major collapse with Citi Bank which has written off $60 billion as the bad debts. CitiBank also rescued by the USA government using bail out plan. It is estimated that USA needs atleast $800 billion required to handle the Subprime crisis. It is not yet over and now the Automobile companies are struggling. You can read that in the next section.

Survival of Automobile Biggies

Now the turn is Automobile industry and it is affected more than any other industry in the USA. The major three companies in the USA, General Motors(GM), Ford and Chrysler needs help from the government to survive. The discussion is going on and the decision will be taken by the next week. The fall of automobile companies will be more, so it is expected that government will come to the rescue. i will write the another post on details of how automobile companies went into trouble.


The Subprime Crisis Explained In Simple Terms Part 1These bloopers are hilarious

Summary

I hope you have enjoyed reading this article. I have referred many sites to get the knowledge of Subprime lending and once I have read a book named “Dot Com” which helped me to understand the 2001 recession in better way. It is because of the USA governments mistake, the entire world is jolting on economy crisis. It is expected that this down turn will continue for the next 1-2 years minimum. Every company is now looking for the cost cutting measures and plan to spend efficiently. This is going to be good lesson for USA Banks and they need to learn from Indian banks. Of course we are doing pretty much better than other countries. Thanks for reading this article.

Please post your comments below and i am looking for the any suggestions about the article. Please subscribe to RSS Feeds.

Book Recommendations:

If you want to learn about global economy, currency fluctuations, recession, etc. there are great amount of books in the market written by the leading experts. Ir is always advisable to follow the complete book to understand the entire knowledge on the problem. Here I am listing down some of the suggestions to buy the good books on these topics:

In the above list, last two books are written by Paul Krugman and George Soros. Paul Krugman is nobel prize winning economist who can predict the forthcoming crisis. If you are reading the Business Line newspaper, you will have the chance to read his column. George Soros is one of the popular investor in the world like who can predict the future of market. Reading their books would give you lot of knowledge on the global economy.

If you have any thoughts on the above books, please post it in the comments section. Also if you have feel any other good books on the same subject, share with us.

 

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90 Responses to “What is Subprime crisis?”

  1. Rahul Ghegadmal Says:

    really good article. it gives clear understanding about sub prime crisis in a very easy language…Thank You so much…!!

    Reply

  2. Margesh Says:

    Really it is wonderful information one need to clear his basic idias about subprime term.

    Thanks once again.

    Margesh

    Reply

  3. R PAUL Says:

    these are all very useful informations. thank u lot. please carry on giving such valuable informations regularly.

    Reply

  4. krishnas Says:

    Thank you for the comments.

    Thanks,
    Krishna

    Reply

  5. Krishna Says:

    Finally I found a website that helps me understand the financial world in simpler terms. Thanks to Krishnas.

    Reply

  6. vinisha Says:

    a good article………please do puslish more such articles…….a good job……..thank you……….

    Reply

  7. Gourab Says:

    Easiest article ever read on this critical topic……..

    Thank you Krishna….May God bless you….

    Reply

  8. Kritagya Says:

    article explained in a really nice way!!

    Reply

  9. sandeep sanglikar Says:

    Outstanding research and the inputs mention to understand.

    Simple language used to understand layman language.

    Keep going sir, it has helped my a lot .

    Reply

  10. safatali m chaudhary Says:

    good 1..after reading this article i got satisfied..

    Reply

  11. Rahul Fichadia Says:

    hello,

    it was wonderful article. It really help me a lot in understanding about sub prime crisi…..

    Thanking you

    Regards
    Rahul

    Reply

  12. akiii Says:

    really good work..hope v will get to read some more article from u in some other topic…

    Reply

  13. dhruvi rajput Says:

    hii…it was a wonderful description on such critical topic…it was a very precise and an accurate one….thankyou for acknowledgeing me perfectly on tis topic…it has save my running time

    Reply

  14. isha samrina Says:

    quite clear and simpler desription about the topic…… made me understand financial situation acurately

    Reply

  15. krishnas Says:

    Thank you for all your comments. If you want to know any of the topic please post it here.

    Thanks,
    Krishna

    Reply

  16. Suguna Says:

    After reading this Article its very clear for me what actually is the Subprime Crisis how the entire economy has effected badly

    Very Good Article Thank you so much……

    Reply

  17. Naveen Says:

    Really nice article..thank you very much..

    Reply

  18. pratik Says:

    gave very useful insight into the topic

    Reply

  19. Bhavit Salvi Says:

    Realy awesum inputs…Pls put more of these articles…Thnx a lot…

    Reply

  20. IRSHAD Says:

    this articles is given full description about sub-prime crisis. its really salutary to know what was actually happened in USA and whats a crucial reasons behind it. its really helpful…keep it up dude….

    Reply

  21. surya rajput Says:

    firstly i want to say thank you very much .. i have no idea about subcrime crices but when i read your artical i know very well what is the sub crime crices and dot com bubble crices only brcause of you … thanks again …

    Reply

    • krishnas Says:

      Hello Surya,

      Thank you for reading my blog. I have updated this post with good books on the subject.

      If you have any doubts, please post it here.

      Thanks,
      Krishna

      Reply

  22. ramu Says:

    it really good and i could easily understood what is sub prime crisis “great”

    Reply

  23. Dipak Yadav Says:

    it is very usefull for those who nothing no about the subprime crisis,and also usefull those company who may be the hunt of subprime crisis……..

    Reply

  24. krishnas Says:

    Hello Dipak,

    Thank you for reading my blog.

    Thanks,
    Krishna

    Reply

  25. Sakshi Says:

    This article help me understand the basis of subprime crisis to some extend…..so thanks for the great article.

    Reply

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