Monday, December 27, 2010

Why You Should Invest by Ravinder Tulsiani

US Sub prime Crisis and Affect on Canada by Ravinder Tulsiani

The global financial system in US, the world's most advanced economy suffered a terrible blow out that substantially led to spread of bankruptcy in major financial institutions in different countries across the globe. This, therefore, called for an immediate intervention of the world's most prosperous nations to get to the very brink of the financial crisis and resolve it as early as possible.

The prime origin for this financial melt down was the result of global credit bubble that started its work during the turn of this decade. There could be seen, what is called a financial Tsunami, witnessed as high inflation rates in real estate as well as financial assets altogether.

US Sub Prime Crisis and the Cause

Many people and economists see the present US financial apocalypse as truly American and very well generated in the US system. The housing bubble situation is caused by the dispensation of mortgage loans and high-risk mortgage products by the financial institutions in US. Following this, through the process of securitization and other means, these so called well-structured mortgage products were delegated to from the balance sheets of lenders to investors, scattered elsewhere in the world.

Now, there came a situation, when the real value of these high-risk mortgage products begins to plunge and crash. As the result, credit crunch occurred; with many financial institutions, becoming bankrupt and still many were on the verge of extinction.

Well, going by the graphs and statistics, you have just one part of story before you. US sub prime crisis had more to it. The financial scruples resulted from credit-bubble, accompanied by under-pricing of the risk, and all this happened when the new financial schemes became much in vogue, blowing out the regulatory measures. The risk management measures were totally ignored.

It was a global event, and not restricted to US alone, but US had to bear the real brunt off late. The precursor of global financial crash was in a way related to recovery made from 2001 economic slump. It was the time, during which there was dramatic growth in the income, and people started to take huge loan amounts and indulged in the investments. During this time, there was also abrupt shift in the trade balances amongst the nations of the world, where surpluses increased in Asian markets, and America saw deficit in surpluses. In most of the countries, the credit bubble meant to be phenomenally high real estate prices, paralleled with high returns in the equity markets.

With the 9/11 incident in 2001, there was high rate of spending and investment, and at the same time, the need for more and more yield, provided the impetus to institutional and retail investors to invest in higher risk financial products. They were confident of taking more and more risks and eventually, record low
commercial and corporate spreads over government yields.

This also provided the momentum in non-traditional financial products, such as financial derivatives and complex structured products, met the demands of investors by providing higher returns at a time of low traditional yields. As the result, calculating market risks became more difficult than ever. The financial innovation further resulted in leveraging the balance sheets of financial firms, and finally, with changing times, it outshined the power of regulators to move up.

Credit Crunch

On one hand, though the traditional regulatory environment had all the protocols to put a check on conventional retail banking, there were major discrepancies in other aspects of financial system, The new innovatively styled financial products witnessed coming up of a parallel shadow banking system, wherein investment banks, hedge funds, pension funds, and other non-retail bank entities provided credit to households and businesses. Many warnings were made about these trends, but none were heeded and the much popular credit crunch is just before you.

The US housing bubble burst took place as the prices reached their record levels in June 2006. However, the present credit crunch came into being just 15 months ago. As the result, even the world's biggest financial markets in the prosperous nations have been significantly on a roller coaster ride.

The financial losses resulted in completely distorted balance sheets, with capital assets nose-diving and the liabilities remaining almost at constant levels. A natural shift towards the cash hoardings was seen as the relief to provide balance to financial institutions balance sheets.

Furthermore, due to high probabilities of not having financial assets with the institutions, there was a sense of unfaith prevailing on lending between different financial institutions. All this market trends resulted in high funding cost to financial institutions to create an artificial increase in credit rates, as seen in London Interbank Offer Rate (LIBOR). This rate was much higher than the government rates, and eventually, credit became less available and more costly to bear.

About the Author

Ravinder Tulsiani is a published author who has written about personal finance, real estate, self-help and online marketing.