Financial World

Turmoil in the Financial World

By Ronilo D. Perez

Almost all of us, especially parents with several children, who are enrolled in various exclusive private schools, are concerned, even obsessed, with financial security. Parents, who have high-paying jobs or who are entrepreneurs in their own right, make it a point to save a large part of their take-home pays or incomes in prominent banks and make sure that their kids and their families are covered by life-healthcare-educational insurances. Even their beautifully-built palatial homes are covered by fire insurance and suchlike.
But what if one day these financially-secured families wake up and find out shockingly that their banks and insurance companies have closed shop suddenly and that their savings and insurance coverage are in danger of vanishing into thin air. This scenario has already happened in 2007 and 2008 in the U.S. During this period of time, home sales in the U.S. are simply good business. Banks/Lending institutions are lending money to home buyers even to those who have low credit ratings or those so-called high-risk home buyers. Lending companies are simply charging them higher interest rates than those home buyers with good credit ratings.
The upheavals in 2007 and 2008 in the financial sector, in the U.S., stem largely from rising defaults on subprime mortgages. What are these subprime mortgages all about? They are simply types of collateralized loans to home buyers with low credit ratings for the purpose of financing home acquisitions. These types of mortgages usually charge higher interest rates for the simple reason that these kinds of home buyers have higher chances of defaulting on their loans. Thus these higher financial charges reflect the lenders' higher risks.
The financial upheavals that took place, in 2007 and 2008 in the U.S., have caused unprecedented instabilities in the financial markets worldwide. The financial crises were so severe that U.S. Congress was forced to pass Emergency Economic Stabilization Act to buy off $ 250-700Billion of Assets in the banking/lending sector.
The Federal Government and the nine largest banks in the U.S. have agreed to acquire the preferred stocks of these financially-troubled banks, making them overnight stockholders of these institutions, thus de facto owners of these cash-strapped institutions. And because of unbridled and un-regulated lending to high-risk clients, a good number of world-renown financial institutions, such as the Lehman Brothers, among them, have filed for bankruptcy. Even the prestigious AIG was bailed out by the U.S. Government, allowing it to obtain a term-loan $ 85 Billion to enable it to survive financially.
Before the economic upheaval, the housing market in the U.S. have enjoyed unprecedented economic boom, construction of homes have expanded for several years and thus home prices have risen exponentially. And because of these unprecedented economic prosperity in the housing sector, home buyers were encouraged to engage in speculative buying and selling of houses, making it good investments.
To illustrate this point, supposing a home buyer would acquire a home for $ 2.5 Million and because of rising home prices, he/she can sell it for $ 3 million after only several months have passed since its acquisition. Aside from this speculative buying and selling of homes, because of this economic boom, home buyers have developed this propensity to re-finance their home acquisitions to increase their wealth. For instance, a home buyer would acquire a $ 2.5 million via subprime mortgage say with a five-year amortization period. After several months, home prices would soar sharply that this piece of home would now fetch a price tag of $ 3.5 million. The home buyer, taking advantage of this favourable situation, would re-finance his new home acquisition by applying for a higher loan with the same bank but this time the home-owner can avail of a $ 3.5 million mortgage from his bank instead of the previous $ 2.5 million mortgage.
Thus these unbridled lending spree, especially through home-buyers with weak credit ratings (i.e. subprime mortgages), led to the near-collapse of financial sector not only in the U.S. but also worldwide as the impact/reverberations of capital flows are felt around the world.
There is the so called interdependence among financial institutions such that the impact of financially-distressed major banking institutions in the U.S. quickly reverberates and is felt by several banks in many countries worldwide.
U.S. Congress has enacted several measures to regulate the financial sector in order to prevent it from running amok in the near future. U.S. Lawmakers have now implemented regulations over Wall Street transactions, thereby sending 'laissez faire approach' to business into oblivion.
If there is a moral lesson that we can learn from this financial episode, it is that we should never put our financial security in the questionable hands of the financial pundits of these world-class, power-hungry prestigious institutions.
Instead we should place our monetary security in the capable hands of regional financial institutions known for their integrity in the capital world.