What exactly is the sub prime crisis?
The word “prime” implies that which is optimum. “Sub prime” is that which is graded below optimum.
If Mr.Prime has a very good job, good savings and assets with better liquidity ( can be disposed off easily and profitably in a crisis situation) then he is a prime candidate for obtaining loans from any bank.
Mr.Subprime , a carpenter by profession doesn’t have a regular income (no job), no assets worth showing off, not even good friends to stand guarantee is a sub prime candidate in the eyes of the banker.
What if Mr.Subprime goes to Mr.Local Bank to buy a home for himself? It would seem that no banker worth his designer suit would touch him with a long pole. But, on the contrary some banks gleefully welcome Mr.Subprime offering him attractive loans. What is the catch?
1.He will have to pay a higher interest rate.
2. In case he fails to repay the loan, bank will assume ownership of the house he buys using the loan.
Not so bad . Looks like a win- win situation.
So where and when did the situation turn into a global “lose – lose more” situation?
For the time being lets forget Mr.Subprime who is happy with his family in his newly bought home. We shift our attention Mr.Local Banker who gave him the high priced loan.
Mr. Local Banker after seeing off Mr. Sub prime receives a few more customers and sanctions loans for some. By end of day he shuffles through his papers and realizes that he has made very good business and gives himself a pat at his back.
He collects all the loan documents, compiles them all in a file , puts a covering sheet on top and takes it to Mr. Big Banker, who is an investment analyst in a well known bank in the neighbouring big city.
Mr.Big Banker, who already has got a collection of such files from different smaller banks welcomes Mr.Local banker with a smile. Lets listen to their conversation:
(after the customary greetings, the yget down to serious business..)
Small: All these guys have taken loans from me and have pledged their property against these loans. Why don’t you take this file as my collateral and loan me some BIG money, I badly need for circulation in my bank?
Big: Ok lemme have a look at it. My insurance company needs some sort of solid proof that I have enough cash flow with me.
Mr.Big Banker then collects all those files from his huge wooden shelf , puts a covering note to it and bundles them off to his Insurance Company with a copy to his Head Office.
(hes sure to get a hefty bonus on account of this transaction!)
Mr.SubPrime, not knowing that his property deed has been bundled several times over along with a few million others enjoys his life in his newly bought house.
Not for long.
After some time, he finds it difficult to pay off his (euphemistically named ) Easy Monthly Installments. Meanwhile he notices the worried looks on several of his neighbour’s faces too! Rumours get confirmed that some of the houses in nearby plots have already been taken over by the respective banks!
And what the hell does the Bank do with these taken-over homes? They cant keep it in their safe lockers! They sell it to prospective buyers. More and more houses are being sold by banks .. Gradually, in the beginning and later on suddenly property prices falls from their actual values.
One fine morning Mr. Sub Prime realizes that the current value of the house he is occupying is just a fraction of the amount he has to pay back to the bank. He picks up the phone and tells Mr. Local Banker “ Hey you, I cant pay you back my loan amount. Do whatever you want to!”
The next morning, Mr. SubPrime and family move out of their house , Mr. Local Bank posts a notice (printed in bulk!) announcing that the house is for sale!
With more and more houses on sale, less and less of new buildings are being built. Carpenters like Mr. Sub Prime and so many other tradesmen find job opportunities getting scarcer. Lesser amount of building materials are being sold, lesser equipments are being bought, lesser income in house holds.
Supermarkets that once sold consumer goods like hot cakes are busy chasing flies( with lesser employees- most have been fired already!)
Backtracking the goods chain, its revealed that factories receive fewer orders , transport requirements are on the downslide, orders for raw materials for product and equipments aren’t generated either.
People (and institutions) short of cash turn to their savings and investments. Money is withdrawn from stock exchanges, amomh other investments. As shares go down, more people withdraw theirs from the market further driving down the stocks.Panic selling results in Share prices tumble down.
Hey ! hold on, where are the banks ? They should be having enough money to help them all out!
That’s the most “grimmest” situation of all.
Banks, small, big and medium have over the past few years loaned huge amounts of money for their clients to buy new homes. Their coffers are almost empty now but for the valueless property deeds and “House For Sale” boards hanging in front of the discarded homes!
And while Mr.Sub Prime goes homeless, his property document which has made several rounds of packaging and repackaging in all levels of banking structure (along with a few million others totaling multiples of trillions of dollars) is now worth not more than a toilet paper!
There goes an economy down the drain!