From what I grasp, the general consensus of what caused the Global Recession was the wide-spread issuance of sub-prime and adjustable rate-mortgages which resulted in unprecedented consumers in the housing market defaulting on their loans. Not to mention Wall Street bankers accepting these loans and the rating agencies giving high ratings to Collateralized Debt Obligations (CD0s) that contained these risky loans.
Wall Street bankers were selling these CDOs to banks in other countries until it was found out how prevalent the risky loans were in these CDO packages. As a result, banks in other countries stopped buying these CDOs which resulted in a credit freeze.
Wall Street banks weren’t able to sell these risk-laden CDOs so they stopped accepted risky loans from mortgage companies. Henceforth, those mortgage companies weren’t able to lend money to their prospective customers and they started going out of business.
Is all of the above correct?
What I don’t understand is why so many banks cannot grant more loans to businesses and residential customers over matters not directly relevant to the housing crisis. Even though many of these loan requests are legit and no where near as risky as the sub-prime mortgages, banks can’t grant these loans. Why?
Are these denied loan requests the direct reason why the stock prices for so many companies plummeted in October? Are these denied loan requests the direct reason why companies have to let so many people go resulting in the unemployment rate rising every month?
If so, why is this problem so hard to solve? Why don’t the banks just start granting more loans that for the most part should be legit?
My understanding is most banks are holding on to their funds to hedge against the future. See most banks also have loans out with other banks, and their ability to pay back their loans rests on banks who owe them money paying them back.
It’s like ifI burrowed $50 from you and planned on paying you back with $65 my cousin owes me. Well suddenly my cousin’s ability to pay me back is looking kinda shaky so I’m going to have to take $50 out of something else and hold on to it in case I have to pay you back before my cousin can level. Otherwise paying you back might cost more money then I have.
Imagine that only worse, my cousin could declare bankruptcy and I might not get much of the $65 back at all ever.
Well, the central factor in the above events was over-reliance on the housing market. The subprime loans were assumed to be less risky than they were, because lenders and investors assumed home prices would continue to rise. They did for a while, because all those subprime buyers drove up demand, which fueled speculation in real estate to unsustainable levels – the “housing bubble.” When they bubble finally burst – e.g., when too many people finally tried to actually extract the equity from these houses – the money just wasn’t there. Speculators couldn’t flip their houses, subprime foreclosures couldn’t be sold for enough to cover the loans, and all those complicated mortgage debt packages declined in value.
Here’s the critical part – those investments declined in value to the point where the banks holding them as assets no longer met the legal requirements. Banks must maintain a minimum loans-to-assets ratio, and these guys had stretched themselves as thin as they were allowed to. When the assets decline in value, they HAVE TO call in loans, restrict new loans, and sell stuff until the ratio is healthy again.
This is what the bailout money was supposed to do – increase assets so that banks could do business again.
There are more details – investment houses aren’t the same as banks, and they’re in this up to their eyeballs – but I think I’ve got the central issue right. If not, I’ve given someone who knows what he’s talking about something to respond to!
Considering people are still arguing about what caused the “Great Depression,” I doubt anyone really knows
Still it’s interesting and fun to blame people. Blaming people solves nothing but it makes me feel a bunch better 