Financial and stock market failures

Sukumar has left a link to a very nice and eye-opening article on my previous post .


Though a bit lengthy, this article is a MUST READ for every individual. It talks about how individuals, financial organizations and sometimes even governments make a mess of the economical and financial systems, (or are forced to make a mess of the economical and financial systems).

The main excerpt that I think is the most important part of the article is as below:


In 2000, America faced a recession. But rather than letting the economy rebalance, the Federal Reserve decided to slash interest rates to artificially stimulate the economy—even though it knew that doing so would probably create even bigger problems later.

Consequently, mortgage rates in America plummeted and, suddenly, millions more Americans could buy homes. House prices skyrocketed: tripling and quadrupling in many areas. The bubble fed on itself as prospective homeowners, often acting more like speculators, rushed to buy homes as quickly as possible to capitalize on further price appreciation.

As home values rose, fewer people could afford traditional loans. To keep their profits growing, banks and lenders began offering easy-to-get subprime mortgages—mortgages to borrowers normally considered too risky due to credit history, income status and other factors.

Oftentimes these loans were adjustable-rate, or had initial teaser rates that would ratchet up later. Often the loans were given without any applicant background checks at all. As long as a borrower could write his own name and yearly income (regardless of whether or not it was true), he could get a loan.

And everyone was happy. Record house prices fueled a building boom and jobs were created. Borrowers were glad because they got huge loans and could purchase homes that were rising in value. Real-estate agents were pleased because the bigger the house sold, the bigger their profit. Lenders and loan brokers were cheerful too because they each got their cut of the action.

But there was just one problem: The whole boom was based on artificially low interest rates. What would happen when interest rates rose, homes stopped appreciating and borrowers had more difficulty making payments?



Here is the link to the entire article

Thanks Sukumar

Link to previous article: Changes in the index and effect of changes in index stocks