What was Subprime Crisis in USA – Important to Know

SubprimeSubprime financial crisis happened in USA in 2008. This crisis created deep impact on the US economy and even the world economy. This crisis triggered the economic downturn in the US economy and due to that even the world economy also. The effect of this crisis was so massive that so many financial institutions and banks became bankrupt. There was even the bear run in stock markets also due to this subprime crisis.

What exactly was subprime crisis? Okay lets discuss it in detail. Before this crisis there was bull run in the real estate market of US. The real estate prices were having increasing trend before this crisis. And interestingly everyone was believing that real estate prices can never come down. And this belief was very strong. Interestingly the incentives of  the officials of many banks and financial institutions were dependent on the sales done by them. And for banks sale is nothing but the more disbursement of loans. These bank officials were getting huge incentives for more loan disbursements.
So you must be wondering what it has to do with the subprime crisis. Okay let me discuss it. The combination of two things created this crisis. One, the increasing prices of homes and the belief that these prices will never come down And two the more disbursement of the loan by the officers of Banks and Financial Institutions. Bank officers also had a strong belief that the prices of homes will not come down. So they were confidently disbursing the loans to anyone against the mortgage of the home which he was suppose to purchase. So this created  a circular effect.
It means just because the prices of homes and real estate were increasing there was very easy and lenient disbursements of the loans, and again, as the loans for the purchase of home was easily available there was increasing trend in the prices of the homes and real estate! The bank officers were disbursing the loans without any mortgage except the home which the borrower was suppose to purchase.
Consider this example to understand this situation better. Suppose Mr A wanted to buy home. He had not even a single penny in his pocket. But still he confidently approached Bank and asked for the loan. Bank also welcomed him and disbursed him loan for home against the mortgage of the same home. Because the bank was confident (actually overconfident) that the value of mortgaged home will never come down. This itself was subprime mortgage. Means the subprime or substandard loan. And interestingly this happened everywhere on a very large scale. In fact the banks even disbursed the additional loans against the price hikes of their real estate properties. And this was too much.
So as mentioned earlier the real estate/home prices were increasing because there was easy loan available and the easy loan was available because of increasing prices of homes. And it was inevitable that this bubble had to burst at some point of time. And exactly same happened. At one point of time some of the borrowers did default in repayment of the loans, because many of them were not capable to repay loans. That is the reason the word subprime is much appropriate here. And as these borrowers were not able to repay the loans, the banks and financial institutions had to start selling these mortgaged homes to recover their loan. At one point of time there was increase in such cases, and many of the banks started selling homes to recover their money. This triggered selling pressure and the prices of homes and real estate witnessed sharp fall. And due to panic there was even more fall in prices of real estate.
So due to this interestingly the prices of the homes reduced so drastically, that the banks were not able to recover their money of their unrecoverd loan. And this created huge chaos, panic and depression in the US economy. So many banks and financial institutions became bankrupt. Because they lost huge amounts because they could not recover the money of their unpaid loans through sale of mortgage properties. In fact at one point of time the situation was so much worsen that, people lost the confidence in banks and even started thinking that their money with banks is also not safe. The whole economy was affected for a longer time and in fact the economy of many other countries was also affected very badly.
Hope this article serves the purpose to understand what exactly was subprime crisis in USA.

2 thoughts on “What was Subprime Crisis in USA – Important to Know

  • January 19, 2017 at 2:58 pm
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    Very well explained for a layman to understand.. Good.

    • January 19, 2017 at 7:41 pm
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      Thanks!!

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