People always talk about fall out in the U.S market as made the Indian market run in turmoil Why is these so???? And what was the reason for these biggest every economical crisis that as caused around the globe.
It all started in the mid 2003, interest in the United States fell as low as 1%. People used this as an opportunity to take home loans to buy property. Since demand far exceed the supply,this ensured that real estate prices started to rise. Bankers saw lower interest rates as a chance to expand the market. They started to give out home loans to even those who would not have got home loans in the normal scheme of things. This market was came to known as subprime market.
Then these loans were adjustable rate home loans(ARLs) of two types. Interest-only ARLs involved paying only the interest for the first few years. This period could vary anywhere from 3 to 10 years. Only after that did principal repayment kick in. The other kind was payment option ARL. In this, a low interest rate was charged in the first year. Once the first year was over, the interest applicable on normal home loans was applicable. However there were no free lunches. The unpaid interest or the difference between the interest rate that a subprime borrower paid on the payment option ARL and the real rate of interest on other home loans kept adding to the principal outsatnding. So initially a lower interest rate was charged. What these meant was the borrower had to pay a lower equated monthly instalment(EMI) and this ensured individuals borrowered. The higher EMI kicked in only after sometime. The borrower thought that since real estate prices were on the rise, he would sell out before the higher EMI kicked in. However that didn't happen. Real estate prices became very high and after a certain point, people just stopped buying. What these meant was the subprime borrowers looking to sell out could not find any buyers. When could not sell out, and higher EMIkicked in, the only remaining option was to just stop repaying the EMI.
These simply busted many financial institutions, all the banks who had given out home loans securitised their loans. What they did was issue financial securities and sold them off to WALL STREET firms. Every time borrower repaid the EMI, a major portion of it was passed onto these firms. This ensured that banks giving out the home loans did not face any risk of default. But once the home loan borrowers started defaulting big time,the WALL STREET firms that had bought the financial securities ended up holding just pieces of paper.
So how these WALL STREET impact us, WALL STREET firms invest all across the world. Because subprime borrowers started to default, these firms started to face losses. In order to make good these losses, the firms had to sell out their profitable positions in market like INDIA and CHINA. When they decided to sell, there were not many buyers and so the stock markets fell.
I guess the above passage doesn't clear about the firm losses in INDIA. Now let me talk about leverage, how that as implemented this. Well in order to spice up teir returns from finanacial securities issued on subprime loans, WALL STREET firms borrowed money, but unlike you they obviously had to pay interest on the borrowed money. But the returns they had to pay was much lower than the returns expected from investing in the finanacial securities. Once the sub prime borrowers started defaulting on their EMIs, the money stopped coming in. And the WALL STREET firm ended on the loss of leverages which they had considered in making profit on the money investment. Also the money lenders who had given money to these WALL STREET firm wanted their money back. One of the way to give the money lenders money back was to sell out financial securities, but by then the word had gone out and no one wanted to buy these securities. So in order to repay these lenders, the firms had to sell their investments in other parts of the world, which led to stock markets in INDIA also going down. And those who could not repay their lenders simply went bust or were bought out at throw away prices.
It all started in the mid 2003, interest in the United States fell as low as 1%. People used this as an opportunity to take home loans to buy property. Since demand far exceed the supply,this ensured that real estate prices started to rise. Bankers saw lower interest rates as a chance to expand the market. They started to give out home loans to even those who would not have got home loans in the normal scheme of things. This market was came to known as subprime market.
Then these loans were adjustable rate home loans(ARLs) of two types. Interest-only ARLs involved paying only the interest for the first few years. This period could vary anywhere from 3 to 10 years. Only after that did principal repayment kick in. The other kind was payment option ARL. In this, a low interest rate was charged in the first year. Once the first year was over, the interest applicable on normal home loans was applicable. However there were no free lunches. The unpaid interest or the difference between the interest rate that a subprime borrower paid on the payment option ARL and the real rate of interest on other home loans kept adding to the principal outsatnding. So initially a lower interest rate was charged. What these meant was the borrower had to pay a lower equated monthly instalment(EMI) and this ensured individuals borrowered. The higher EMI kicked in only after sometime. The borrower thought that since real estate prices were on the rise, he would sell out before the higher EMI kicked in. However that didn't happen. Real estate prices became very high and after a certain point, people just stopped buying. What these meant was the subprime borrowers looking to sell out could not find any buyers. When could not sell out, and higher EMIkicked in, the only remaining option was to just stop repaying the EMI.
These simply busted many financial institutions, all the banks who had given out home loans securitised their loans. What they did was issue financial securities and sold them off to WALL STREET firms. Every time borrower repaid the EMI, a major portion of it was passed onto these firms. This ensured that banks giving out the home loans did not face any risk of default. But once the home loan borrowers started defaulting big time,the WALL STREET firms that had bought the financial securities ended up holding just pieces of paper.So how these WALL STREET impact us, WALL STREET firms invest all across the world. Because subprime borrowers started to default, these firms started to face losses. In order to make good these losses, the firms had to sell out their profitable positions in market like INDIA and CHINA. When they decided to sell, there were not many buyers and so the stock markets fell.
I guess the above passage doesn't clear about the firm losses in INDIA. Now let me talk about leverage, how that as implemented this. Well in order to spice up teir returns from finanacial securities issued on subprime loans, WALL STREET firms borrowed money, but unlike you they obviously had to pay interest on the borrowed money. But the returns they had to pay was much lower than the returns expected from investing in the finanacial securities. Once the sub prime borrowers started defaulting on their EMIs, the money stopped coming in. And the WALL STREET firm ended on the loss of leverages which they had considered in making profit on the money investment. Also the money lenders who had given money to these WALL STREET firm wanted their money back. One of the way to give the money lenders money back was to sell out financial securities, but by then the word had gone out and no one wanted to buy these securities. So in order to repay these lenders, the firms had to sell their investments in other parts of the world, which led to stock markets in INDIA also going down. And those who could not repay their lenders simply went bust or were bought out at throw away prices.
