If you have been following the financial markets for the last 2 weeks – you should have gone half crazy by now. The markets have crashed currencies have lost value, banks have closed down…Unbelievable – only a month back everything looked fine!
What exactly happen?
People have been quick in blaming the government and the banks – the downtrend in housing prices… , But till date I haven’t seen anyone point out the real reason. The real reason being “CREDIT CARDS”
If you look closely – all the problem started from the US. Look closely at the US economy – it is a Credit Card economy! Each and every person has to have at least 1 credit card, and all the transactions are done on credit card. So what is so bad about credit card? There is nothing bad about credit cards – as long as you have the money to repay. But that is not the scenario in most of the cases. People are actually living beyond their means.
It is a huge difference between swiping a card at a supermarket and take out the cash and counting it and giving it. When you take out the money and count it a give it – you actually feel it. But with swiping – it is as easy as just signing a piece of paper!
So what happen – well people who did not have the money – started spending the credit – based on the assumption that they will repay it using their income for next month. But nobody seems to think about next month’s expense…So before long they are neck deep in credit and unable to pay. Solution – apply for a second credit card!
All this starts very early in life – by the time someone get’s out of College – they already have a huge Students loan, then once they get into a job – they buy a car – another loan – they get married – they get a house – a housing loan and a second car loan, they have kids – they take a loan for health care and another for schooling…and it goes on…
Starting from the individual – the whole society is living off loans – the US government has a balance sheet deficit of over ten Trillion Dollars (that is quite a lot of zer0000000000000s).
This is not something restricted to the US – UK and Australia are neck deep in this problem. Rest of the world is following…
Lately in India also I have seen this trend catch up. With the IT companies being lavish with their employees – people are getting used to living with easy money. I am sure most of you are being harassed by CC agencies to take a CC – they even offer you gifts to open a CC account.
Like everything else – you need financial discipline if you want to stay out of trouble. IF you don’t have the money – don’t spend it!
Posted by JMJ
CREDITS are the actual problem…not the Credit Cards! Credit cards was their in the US for a long time now…so long time..back from 2000! Its long 8 years now & why such a crisis now due to credit cards??
This crisis is created by BANKS & their thirst for PROFIT…the attitude of PROFIT…Again Profit…Again & Again Profit! They gave loans to poor Americans against properties & they were not able to repay loans! By the time property market fell down & banks failed to retrieve their money…which led many banks to file Bankruptcy (LEEMAN & MERRYLLINCH)
I hv written in detail abt this in my blog, if you are interested take a look
http://www.jojojoson.com/?p=32
Govt.of US also did a fault by removing the REGULATIONS on US stock markets (unlike SEBI) which add pace to this crisis!
Comment by jojo — October 16, 2008 @ 2:01 am
I think the actual culprits are banks who give credit cards to anybody and everybody without any mortgage. They dream about the huge intertest they are going to get from defaulters!!
Comment by abdunni — October 16, 2008 @ 8:37 am
Yes abdunni, I agree with you. Banks offer too many loans, with their focus completely on the interest gained.
Comment by Trailblazer — October 16, 2008 @ 12:04 pm
@ everyone
Yes the banks are major culprits in this scheme. Everyone wants to profit – well the Banks became greedy and tried to slit open the golden egg laying duck by issuing so many credit cards/loans/OD.
And what accelerated this down fall is the easy money – no financial discipline! Once you give people access to easy money – they are always going to end up in trouble. Cause – easy money = no value.
Jojo’s post does go in depth to explain the same problem.
Comment by JMJ — October 16, 2008 @ 12:38 pm
I am not sure if you guys are aware – The capitalist way of banking is based on a flawed concept. Basically a Bank can lend around 100 times the amount of money it has. ie. if the bank has 10 bucks it can lend 1000 bucks.
Also about US – the Federal Reserve (the central bank of US) is a partly private owned and partly government owned Institution. And with the de-regularization in the Banking sector – the US government has lost most of it’s say in the Banking system.
So whenever the US Government wants money – they borrow it against Government Bonds from the Feds. And since the Gold system was scrapped long long ago – the Feds are basically printing money – against nothing! (Just think what you can do – if you can control money) Now with a more than 10 Trillion overdraft – the US Govt has basically sold the country to the Feds…
Watch this video to understand more (Part 3):
http://www.kenneyjacob.com/2008/07/24/worlds-most-scaring-conspiracies/
Comment by JMJ — October 16, 2008 @ 1:00 pm
Credit cards didnt create the problem.. Sub Prime credits created all the problems where Loans were granted on mortgages to customers witjh bad credit history or to ppl whwere risk is more. due to low income..!
Comment by Cijo — October 16, 2008 @ 6:21 pm
@ Cijo
Sub Prime is another term used for people with bad financial history – credit cards included.
The reason I blamed CC as the root of this problem is cause CC is the one thing through people started getting easy access to credit – all the other things came later – the home loans and car loans…And I believe we have still not seen the full face of this problem – cause the first to be hit were the home loan people – soon it will hit the CC people also – and then it will be really bad – cause a lot of people now transact on their CC on credit!
We still have not hit the bottom – but when we do – it will be really bad…
Comment by JMJ — October 16, 2008 @ 7:25 pm
Let me tell you how this housing bubble contributed the most to the problem.
For a few decades, the house and property prices were just going up in the US. Except during a few small recessions when the prices became stagnant (but never went down), through out the whole period, the prices were going up. This led to the assumption that prices will always go up regardless of anything.
Once this false assumption is in place, let us see how the lenders and the consumers used this.
Traditionally, and like what is happening in India (or ‘was’?), banks never used to lend money over a certain percentage of the property value. (About 50-60%). Also, the ability to pay back the loan was a major criteria in approving a loan.
With the false assumption of an ever-rising house/property prices, the lenders as well as the borrowers ignored such basic safeguard against foreclosures.
Banks were willing to lend money for a house with zero money down because they thought in a couple of years, if the customer defaults on the loan, the house will be worth much more and the bank can still make a profit.
However, this ever rising property/house prices was a bubble. The prices were rising just because there were people who were willing to buy a house at a rate above the current rate because they speculated that the prices will further rise and they can make a profit. I will post a anecdotal story that explains this.
Anyway, this rising bubble meant two things
1) Banks started lending to people with no down payments.
2) Banks started lending to people with bad credit history / no ability to pay back (Sub Prime Lending)
This dangerous behavior was based on nothing but a speculation that the house prices will always go up and even if the loan defaults, the banks will make a profit.
Comment by Domestic Avalanche — October 16, 2008 @ 9:32 pm
However the bubble burst suddenly…. The prices started dropping.
This meant that an awful lot of people owed more to the bank than what their house was worth. This accelerated the foreclosures because this imbalance would reflect on the calculations of the payments and the mortgage payments increased a lot, and the residents thought it is better to let it go for foreclosure because the house is not worth as much as the loan amount.
The subprime loans were hit the most because the initial payment only accounted for the interest on the loan and that is all the borrowers could afford. When the prices dropped, again the banks had to start making them pay the principal which became more difficult resulting in more bankruptcies.
Comment by Domestic Avalanche — October 16, 2008 @ 9:44 pm
So, these delinquencies resulted in banks losing big time money and nobody is sure which bank is about to go bust. This led to banks not willing to lend to each other because they are afraid that the bank you are lending to will go down with these mortgage issues. Even if the bank you are lending to is not directly linked to the mortgages, they may have lent money to some other banks that may go bankrupt and this may lead the one in question too into a bad shape.
Comment by Domestic Avalanche — October 16, 2008 @ 9:50 pm
These all lead to the final problem. The American economy is a consumer economy that thrives on consumer spending. So where do these customers get their money?
The answer lies in second mortgage, third mortgage etc. At at time when house prices are going up, in a few years, you would be owing much less than what the house is worth. This thing will help you get a second mortgage on the house and spend the money on a Big Screen Plasma TV, A Vacation, or just a holiday shopping spree. When the house prices went down, this source of money for the American consumers dried up because
1) The prices are down and there is not much gap between the worth of the house and the existing loan to make an extra loan
2) Banks started tightening the criteria for loans.
This led the the American economy to plummet with less money being spent by the consumers.
Comment by Domestic Avalanche — October 16, 2008 @ 9:54 pm
The story for Indian economy is two things
1) Let us be very careful when we decide whether to make Indian economy a purely consumer spending based economy.
2) Be careful, be extremely careful at the rising property/house prices that we have. There will be a bust after every boom. Watch out for that. The rise of house prices can be explained by the following story.
Comment by Domestic Avalanche — October 16, 2008 @ 9:56 pm
A very interesting story about bankruptcy explains the problem USA is facing currently ::
====================================================================
Once there was a little island country. The land of this country was the tiny island itself. The total money in circulation was 2 dollars as there were only two pieces of 1 dollar coins circulating around.
1) There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.
2) B decided to purchase the land from A for 1 dollar. So, now A and C own 1 dollar each while B owned a piece of land that is worth 1 dollar.
* The net asset of the country now = 3 dollars.
3) Now C thought that since there is only one piece of land in the country, and land is non producible asset, its value must definitely go up. So, he borrowed 1 dollar from A, and together with his own 1 dollar, he bought the land from B for 2 dollars.
*A has a loan to C of 1 dollar, so his net asset is 1 dollar.
* B sold his land and got 2 dollars, so his net asset is 2 dollars.
* C owned the piece of land worth 2 dollars but with his 1 dollar debt to A, his net residual asset is 1 dollar.
* Thus, the net asset of the country = 4 dollars.
4) A saw that the land he once owned has risen in value. He regretted having sold it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollars from B and acquired the land back from C for 3 dollars. The payment is by 2 dollars cash (which he borrowed) and cancellation of the 1 dollar loan to C. As a result, A now owned a piece of land that is worth 3 dollars. But since he owed B 2 dollars, his net asset is 1 dollar.
* B loaned 2 dollars to A. So his net asset is 2 dollars.
* C now has the 2 coins. His net asset is also 2 dollars.
* The net asset of the country = 5 dollars. A bubble is building up.
(5) B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for 4 dollars. The payment is by borrowing 2 dollars from C, and cancellation of his 2 dollars loan to A.
* As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2 dollars.
* B owned a piece of land that is worth 4 dollars, but since he has a debt of 2 dollars with C, his net Asset is 2 dollars.
* C loaned 2 dollars to B, so his net asset is 2 dollars.
* The net asset of the country = 6 dollars; even though, the country has only one piece of land and 2 Dollars in circulation.
(6) Everybody has made money and everybody felt happy and prosperous.
(7) One day an evil wind blew, and an evil thought came to C’s mind. “Hey, what if the land price stop going up, how could B repay my loan. There is only 2 dollars in circulation, and, I think after all the land that B owns is worth at most only 1 dollar, and no more.”
(8) A also thought the same way.
(9) Nobody wanted to buy land anymore.
* So, in the end, A owns the 2 dollar coins, his net asset is 2 dollars.
* B owed C 2 dollars and the land he owned which he thought worth 4 dollars is now 1 dollar. So his net asset is only 1 dollar.
* C has a loan of 2 dollars to B. But it is a bad debt. Although his net asset is still 2 dollars, his Heart is palpitating.
* The net asset of the country = 3 dollars again.
(10) So, who has stolen the 3 dollars from the country? Of course, before the bubble burst B thought his land was worth 4 dollars. Actually, right before the collapse, the net asset of the country was 6 dollars on paper. B’s net asset is still 2 dollars, his heart is palpitating.
(11) B had no choice but to declare bankruptcy. C as to relinquish his 2 dollars bad debt to B, but in return he acquired the land which is worth 1 dollar now.
* A owns the 2 coins; his net asset is 2 dollars.
* B is bankrupt; his net asset is 0 dollar. (He lost everything)
* C got no choice but end up with a land worth only 1 dollar
* the net asset of the country = 3 dollars.
************ **End of the story; BUT ************ ********* ******
There is however a redistribution of wealth.
A is the winner, B is the loser, C is lucky that he is spared.
A few points worth noting -
(1) when a bubble is building up, the debt of individuals to one another in a country is also building up.
(2) This story of the island is a closed system whereby there is no other country and hence no foreign debt. The worth of the asset can only be calculated using the island’s own currency. Hence, there is no net loss.
(3) An over-damped system is assumed when the bubble burst, meaning the land’s value did not go down to below 1 dollar.
(4) When the bubble burst, the fellow with cash is the winner. The fellows having the land or extending loan to others are the losers. The asset could shrink or in worst case, they go bankrupt.
(5) If there is another citizen D either holding a dollar or another piece of land but refrains from taking part in the game, he will neither win nor lose. But he will see the value of his money or land goes up and down like a see saw.
(6) When the bubble was in the growing phase, everybody made money.
(7) If you are smart and know that you are living in a growing bubble, it is worthwhile to borrow money (like A) and take part in the game. But you must know when you should change everything back to cash.
(8) As in the case of land, the above phenomenon applies to stocks as well.
(9) The actual worth of land or stocks depends largely on psychology (or speculation).
Comment by Domestic Avalanche — October 16, 2008 @ 9:57 pm
@DA
You have rightly pointed out where it all started from – but there is a lot more to come…
Just over speculation on the US economy -
Fuel prices have dropped drastically!
Foreign exchange market has gone crazy!
Investors are pulling out money not only from banks – but also projects and pulling out of countries!
Stock Markets have already crashed big time…
Job losses all over…
there is more to come…
Comment by JMJ — October 16, 2008 @ 9:59 pm
Absolutely,
And think of it, the only way for these companies to perform well is if the customers start spending more, and they do not have the money for doing that and nobody is willing to lend the money.
We’ll see how we can come out of this spiral.
Comment by Domestic Avalanche — October 16, 2008 @ 10:03 pm
@Domestic Avilanche,
Great story!
Comment by dhanesh — October 17, 2008 @ 6:35 am
Great story DA. combined with that – just think what all those evil accountants and CEO’s were doing by hiding all the losses on the balance sheets and showing the investors big profits on the income statement!
Comment by JMJ — October 17, 2008 @ 11:32 am
@JMJ
That is another aspect. They were cooking the books to delay the reporting of the losses for so long because they assumed the housing markets will pick up and they can dilute the losses later when big profits come up…
However, they just accumulated and when the critical mass was reached, the companies just started failing…
Comment by Domestic Avalanche — October 17, 2008 @ 7:08 pm