Subprime crisis

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Avinasheswar (Querist)
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28 April 2008 It is heard subprime lending is a normal thing in US. Then how come it became a crisis this time? Where did the crisis start?

CA. Yayati Tyagi

CA. Yayati Tyagi (Expert)
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15 May 2008 hi, from your question i assume that you know what the subprime lending is and will write in short.

actually excessive subprime lending led to a bubble in property prices in US. every person wanted to take home loan even if he did not have regular source of income to repay it. financial institutions gave them loan on mortgage of their homes presuming that if borrowers could not repay, then they could realise loan by sale of house.

when every body started buying home on loans then home price shoot up as simply high demamd raises price of a commodity. on the basis of increasing value of homes, financial institutes also excessively increased limits of loans.

but after price reached at peak, people realised that these homes are not worth to buy at such high prices. so, new demand went down and prices started to fall. when margin of loans went down, institutions started to call borrowers to repay some loan, in which people failed and institutions were forced to book loss in their books, as they had to show their assets (loans) at market value, which was very down now. US economy was also facing slow down from some time,so income of many borrowers went down and they found themself unable to repay installments in time.

so, this led to a credit crisis in US because financial institutions fall short of cash for new loans. this crisis is now affecting the whole world, as US has gone into recession due to this crisis. this crisis is believed to be started in start of 2007 but became severe in jul-aug 2007 approx.

(i have simplified the things and also have not described sub-prime securities, which played central role in this crisis, to avoid excessively lengthy reply. so, some experts may feel to add some more in reply, they are welcome)