What you think of the subprime crisis and how it impacts todays economy - Essay Example

Gopal Pottabathni 5th April 2008 Impact of Subprime Crisis on Economy It has become a common thing for the people around the world when they hear about the downfall or foreclosure of the bank, companies, etc. What is it? Why do these banks suffer? When a bank provides loan to its customer, it may be an individual or company, when fails to recover its loan from the customer, it is burdened by the loan and its interest rates to the government and thus becomes a victim which gives rise to subprime crisis and its downfall and later foreclosure.

The subprime crisis started with the lenders in the United States providing home loans to the desired people who didn’t have the capacity to maintain the house. In obvious circumstances, the lenders mortgaged the loan security to other investors in various esoteric combinations. The adverse effects of the subprime crisis lead to hike in interest rates, which forces the Fed to raise rates to combat inflation, which has to be incurred by the common man. Economies of developing countries classified as emerging markets, are still seen by developed country fund managers as risky propositions.

So the flight to safety will see some funds pull out of developing countries. This could lead to a stock markets slide in these economies, loss of confidence and slowdown of the real economy. The other source of disruption is construction-led slowdown in the US. This could hit developing economies that export a lot to the US. The subprime crisis also places downward pressure on economic growth, because fewer or more expensive loans decrease investment by businesses and consumer spending, which drive the economy.

A separate but related dynamic is the downturn in the housing market, where a surplus inventory of homes has resulted in a significant decline in new home construction and housing prices in many areas. This also places downward pressure on growth. Crisis has caused panic in financial markets and encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities as "stores of value". Most of the recent increases in global food prices have been the result of speculation and the collapse in the value of the US dollar which is now at Indian Rupees 38.

62 per dollar. This crisis has an immense effect on the national stock markets, where the fluctuations in the market prices and shares of the corporations do create an element of doubt in the stakeholders mind and thus leading to kiosk among them. The market value chips down and which tends the financial institutions to come forward and ask for their loans given by them to the corporations. If financial institutions fail to recover the amount, their reputation is at stake. Subprime crisis does not even spares financial institutions, insurance companies, government insurers, home owners, minorities, etc.

As mentioned above, financial institutions suffer significant losses as a result of mortgage payment defaults or mortgage asset devaluation. There is concern that some insurers are turning to arson as a way to escape from mortgages they cant or refuse to pay, which is suffered in huge amounts by the Insurance companies. The subprime crisis represents the first crisis of the age of mass securitization The implication is that we should return to the simpler days of good old-fashioned banking in which commercial banks originate loans to households and firms and hold them on their balance sheets, rather than slicing them, dicing them and selling them off.

In any case, turning back the clock would not be desirable because the constellation of financial innovations referred to as securitization has real benefits for the economy. Banks should be required to hold more capital. Capital adequacy standards should be related not just to the level of bank investments but the rate of growth of those investments, and not just to the value of the collateral pledged against bank loans but the rate of growth of the value of that collateral.The reactions to the subprime crisis have sent virtually all markets tumbling.

Subprime crisis is an ongoing economic problem manifesting itself through liquidity issues in the banking system owing to foreclosures and accelerating global financial crisis presently. The effect is seen clearly world wide with the stumbling stock markets, foreclosure of branches of corporate banks, etc. Subprime crisis needs to be controlled with the support of the respective National Reserve Banks by taking some stringent measures.