Hundreds of billions of dollars were disbursed in this gamble.

ZEE BUSINESS BEST B SCHOOL SURVEY

In case the jargon is intimidating, the explanations are not. Financial institutions lent money to sub-prime borrowers – people whose ability to repay their loans was in doubt. This was done deliberately because everybody gambled that housing prices would keep rising. Hundreds of billions of dollars were disbursed in this gamble. The sub-prime mortgages were then bundled into packages and traded as financial instruments. Despite the stark lessons offered by the ‘real estate’ angles of the 1991 meltdown in Japan and the 1997 meltdown in East Asia (when institutions gambled on property prices rising forever), virtually all American banks and financial institutions partied as if there was no tomorrow. In 2005, the increase in home equity loans was six times higher than growth in real wage based incomes in America! During the same year, American households splurged $110 billion of borrowed money – most of the debt coming through the sub-prime route. Something had to give. By 2007, sub-prime borrowers started defaulting and by the end of 2007, the trickle of defaults had become an avalanche. That’s when the Domino effect took over and starting with Bear Stearns, financial institutions started tumbling one after the other. Lehman Brothers and AIG are the most recent; certainly not the last.


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Source : IIPM Editorial, 2008
An Initiative of IIPM, Malay Chaudhuri and Arindam Chaudhuri (Renowned Management Guru and Economist).


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