The US Financial Crisis Q&A

Posted in General Real Estate

What’s behind the financial crisis?
It is a continuation of several factors including but not limited to the housing meltdown due to sub-prime lending, credit crunch, and the major factor of a “crisis of confidence”. 

What is sub-prime lending, credit crunch, and crisis of confidence?
SUBPRIME LOANS/Lending – Is the practice of lending money to a more risky borrower or riskier type of loan (no income documentation, no money down etc). When these type of loans are made the money is paid back at a higher interest rate than a conventional loan.  These loans were bundled together with good loans and sold to investment banks. So it is hard to tell how many bad loans are bundled with good loans.
CREDIT CRUNCH – Lenders/Banks tightening their guidelines, amount of money, and raising the rate at which the lend money to other Banking Institutions.
CRISIS OF CONFIDENCE – With  large well respected Investment and Brokerage Houses failing, selling themselves and going Bankrupt the public/investor was not willing to invest “new” money the firms were not able to raise the capital to stay alive.  Some of this fear was warranted however a lot of it was perpetuated by the media outlets pushing their agenda of ratings and politics.

How did this happen so fast?
Many Financial Firms became so big and so complex that it was impossible to tell at what depth their exposure to bad sub-prime mortgage loans had become. So with the “fear in the market” these firms were not able to raise new capital to stay alive. In short consumer confidence had dropped so low investors would not and did not invest new money with these firms.

What does a potential bail out mean? 
That is all going to depend on the way the Government Structures the financial assistance.  There are several things to remember 1st this will not be a “bail out” it would be better to think of it as a bridge loan.  The Government will be lending money on the potential equity of the bad mortgage loans in the market place. 2nd In the long run the Government could actually end up making money of this deal.

What is the goal of the bail out?
The Government is attempting to employ some type of program that will buy (at a steep discount) all of the bad sub-prime mortgages from the struggling financial institutions that are on the blink of collapsing. Then in the future they can sell the loans that survive at a profit that will be shared with the Taxpayers.

How will that help?
The main problem in the financial markets is the lack of lending between banks.  With the uncertainty of a Banking Institutions viability, Banks are not as willing to lend money to one another for the fear that it will not be repaid and the bank borrowing money may go bankrupt due to the unknown amount of bad mortgage loans in their portfolio. So now with the Government buying up all the bad mortgage debt, Banks will again have the liquidity to lend to one another and the consumer which in turn will spur consumer spending and buying.  This process will inject much needed confidence in the Credit Markets, financial institutions, and banking as a whole.