Sub-primed and Credit-crunched.
Read today that Starbucks was planning to close 600 stores. That was more shocking to me than Bear Stearns closing shop. Starbucks!! It has been THE hangout place for me since I started working. Read that it was the latest victim of the credit crisis that is plaguing us. Got me thinking what is this "credit crisis". Why is it one of the hottest words of the year? What caused this crisis? Who is responsible?
Apparently A decided to lend B money. B had a not so healthy credit record, yet that did not stop A from going ahead with lending the money. B decided to use the house that he was buying from this loan as a collateral. A then sold this loan it now owned, to bank C. C collected thousands of such loans, some given to credit worthy clients and some to not so credit worthy clients. C had a brilliant idea and "securitized" all these loans i.e. collected all of them, convinced credit rating agencies as well as investors that the collective loans were investment grade and sold them off to these investors, who would get periodic returns in the form of loan payments made by borrowers like B. Now, A and C received a lot of liquid money in this transaction and had to do something with it. What better than lend money to someone like B and perform the entire transaction again? With more and more money in the system, A had no option but to lower the interest rates that they would charge borrowers. B saw this opportunity and "refinanced" his loan - he borrowed more money, paid off his original loan and turned in a tidy profit.
This encouraged other non-credit worthy borrowers to borrow more - they could make money by simply borrowing!! Moreover, all other players in this game were more than willing to accomodate such borrowers. One thing that no one accounted for was what happens if the collateral loses it's value? Not many lenders will be willing to lend money, borrowers will lose their ability to refinance and without any money, they will default on their loans, leading to "foreclosures" - closing of the loan before hand, with the collateral taken away from the borrower, leading to losses to the investors. This is exactly what happened (consider thousands and thousands of borrowers, thousands of lenders, hundreds of banks and millions of investors) and we are now facing a recession. Pundits are estimating losses to go into hundreds of billions of dollars. Everyone in this big game needs to be blamed for this big mess- the borrowers, the lenders, the banks, the credit rating agencies, the investors and also the central banks who played mute spectators before it turned into a complete fracas.
With no one willing to lend anyone else any money, we have the credit crisis that is being held responsible to the closure of 600 Starbuck stores. God help us all!!!
Apparently A decided to lend B money. B had a not so healthy credit record, yet that did not stop A from going ahead with lending the money. B decided to use the house that he was buying from this loan as a collateral. A then sold this loan it now owned, to bank C. C collected thousands of such loans, some given to credit worthy clients and some to not so credit worthy clients. C had a brilliant idea and "securitized" all these loans i.e. collected all of them, convinced credit rating agencies as well as investors that the collective loans were investment grade and sold them off to these investors, who would get periodic returns in the form of loan payments made by borrowers like B. Now, A and C received a lot of liquid money in this transaction and had to do something with it. What better than lend money to someone like B and perform the entire transaction again? With more and more money in the system, A had no option but to lower the interest rates that they would charge borrowers. B saw this opportunity and "refinanced" his loan - he borrowed more money, paid off his original loan and turned in a tidy profit.
This encouraged other non-credit worthy borrowers to borrow more - they could make money by simply borrowing!! Moreover, all other players in this game were more than willing to accomodate such borrowers. One thing that no one accounted for was what happens if the collateral loses it's value? Not many lenders will be willing to lend money, borrowers will lose their ability to refinance and without any money, they will default on their loans, leading to "foreclosures" - closing of the loan before hand, with the collateral taken away from the borrower, leading to losses to the investors. This is exactly what happened (consider thousands and thousands of borrowers, thousands of lenders, hundreds of banks and millions of investors) and we are now facing a recession. Pundits are estimating losses to go into hundreds of billions of dollars. Everyone in this big game needs to be blamed for this big mess- the borrowers, the lenders, the banks, the credit rating agencies, the investors and also the central banks who played mute spectators before it turned into a complete fracas.
With no one willing to lend anyone else any money, we have the credit crisis that is being held responsible to the closure of 600 Starbuck stores. God help us all!!!
posted by ritwick at 6:03 PM
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