On the Credit Crisis - Essay Example

What most people understand is that greedy banks encouraged people to take out loans that they could not afford to pay, and now they are looking at a windfall of foreclosures since the people are falling way behind their mortgages. What completely befuddles everyone is the fact that how can a singular unit of the mortgage business cause so much chaos? How could the whole subprime mortgage business send stock markets plummeting, leaving Bear Stearns in ruins, and send the country’s economy into a rapid downward spiral?

Apparently, the confusion is not limited to consumers alone. Even seasoned financial and investment professionals are seemingly in the dark as well. It seems that the financial crisis has shown Wall Street habitués several hitherto unheard of instruments. A good example would be a “liquidity put”, a contract so obscure that even the best analysts in the industry had never heard of it. As it is, the housing crisis traces its beginnings roughly a decade ago when real estate seemed like a real steal.

 Conditions were favorable – an influx of global investments into the mortgage business made it very easy to get a housing loan. The suddenly flush marketplace had mortgage rates plunging, and numerous new innovations were introduced to entice more buyers. The problem was, these same investors were demanding higher returns to match their booming Asian market and oil revenues. The market’s solution was a newfangled idea at the time, something called a subprime mortgage. These were loans given to people with bad credit, and who were really stretching out their incomes to take out a loan.

These loans would offer low initial rates as a come-on, and would later saddle homeowners with significantly higher rates as the loan progressed. These investments were then put together into the formerly obscure “Collateralized Debt Obligation” - a highly leveraged instrument which promised big gains and came with tremendously high risk. Simply put, these investors were making $100 million bets with only $1 million of their own money. If their investment rose to $101 million, they earned $1 million.

  The risk involved was very high, and the peculiar thing was so many institutions ended up getting a piece of it because the U.S. housing market seemed like a sure thing.  For instance, banks apparently sold very complex insurance policies on the mortgage debt. With so many parties involved, it is no surprise that once the bubble burst everyone was on the hook. Hence the freefall that has embroiled the financial markets for nearly a year now. Personally, I feel that it would be helpful for people to be well-informed about the housing crisis.

It is one of the most pertinent and talked-about topics of the day, and yet it seems that oftentimes people do not know the real score. This is a very serious issue with potentially serious repercussions, and knowing what precisely is going on would be a tremendous plus in making better informed fiscal decisions in the future. As the article conceded however, given the complexity of the financial instruments involved this may be easier said than done. If Wall Street professionals are having a hard time with it, everyone else may be hard-pressed to know what a “liquidity put” is.