Real Clear Truth

Many people have assumed that the subprime mortgage crisis only effects homeowners and the lending institutions who are hurting because of home foreclosures. But the subprime mortgage crisis is actually having a global impact on a much larger fanancial system then just lending institutions, or just the ones in trouble for making too many subprime loans.

For an overview of why the subprime mortgage crisis effects the global financial market, read this article here from the NY Times (from four months ago). There has been an explosion in recent years of new finance vehicles like “derivatives and structured products”. They are popular because of “their ability to help businesses and investors spread out risk” to many parties. These vehicles have enabled investors to earn returns of around 40% even when interest rates have been very low and they have helped banks grow by enabling them to invest more of their capital than they could previously (because they no longer need to hold as much capital in reserve as they used to, because now they have less risk to cover, because they have spread that risk out to others around the world using these new financial instruments).

However, because these financial instruments are so new, investors are not as confident in their longterm stability, and the subprime crisis has shaken the faith of investors in the way the market has used these new instruments. Ultimately then, this crisis is causing a lack of confidence in the markets and especially in these new finance vehicles, and that produces a shortage in liquidity, or the amount of money that is available for lending — not just to home-owners but to corporations, governments and really anybody.

And that leads to the possibility that this will cause a real melt down in the global finance system. Read this article here, that basically says the global bankers have about two months left to get this straightened out and if they make major missteps along the way (not expected but possible) then the “crisis may make 1929 look like a ‘walk in the park’”.

Please note I am no expert in economics, but it is helpful to read articles like the ones I have linked to. Wisdom begins with understanding. Foolishness is compounded by ignorance. Let’s try to gain a measure of understanding in matters like these that effect the entire world. Yes?