Decades of greed and mismanagement in the United States was the main reason behind the global credit crunch we are all facing. By now, we are all probably accustomed to the term "subprime mortgages," which are said to be the root of this mess.But wait, what do we mean by subprime mortgages? Subprime lending? Apparently, the financial term was only popularized by the media last year when the crisis blew out of proportions. Subprime lending involves institutions that lend money to people without the need to meet prime underwriting guidelines.
There are no standardized definitions, but it is generally agreed that a loan is subprime when it is lent to a person with a FICO score of below-680. People with this credit score most likely have a history of loan delinquency and bankruptcy--or they just don't have enough lending experiences. Thus, it is also assumed that these people will less likely to pay their debts, making the loan very risky.
So why did banks and other lending insitutisons keep on lending money to these people? Well, for one, the interest put on subprime loans are generally higher than prime rates. After all, the higher the risks, the higher the returns. Add to this lax government policies that encouraged high-risk lending, and we already have a housing bubble waiting to burst any minute. When interest rates started to rise and refinancing loans became more difficult, foreclosure rates accelerated and the bubble started to burst.
The rest of the global economy was able to invest in the US housing market due to the existence of mortgage-backed securities (MBS). When these mortgages started to default, the global economy also started to crumble.
The rest, as they say, is history.
All UPSable
