CAUSE AND EFFECTS OF WALL STREET FINANCIAL MELTDOWN

Basically it's a story about how easy credit and flawed regulation triggered a financial crisis, as Federal regulatory authorities failed to heed warnings from IMF against high house prices and excessive credit. Initially the problem was simply shortage of liquidity, as banks were holding securities whose values were falling but were unwilling to sell mortgaged securities at loss. Financial institutions fearing erosion of security base was not willing to lend further credit to cut short their already huge losses. Till low capital base generated profits, issue of bonuses in credit worked okay in good times but left little margin in bad times. With front-running Banks like Lehman Brothers borrowing heavily over $35 for every dollar of equity,the problem of mounting cash losses now reflected directly on solvency of financial institutions as Equity was grossly undercapitalised to meet out payment obligations.  

From the late 1990s following the collapse of information technology bubble corporates cut back on mega projects, while government curtailed public expenditure to increase budget surpluses for availing opportunities in emerging markets. Though world economies recovered, corporate investments in industrial countries did not pick up to the extent warranted by growth. The excess of savings over actual investment lead to so-called savings glut, which then pushed surplus money into the housing sector.  With fresh investments pouring into residential construction, housing prices started to rise, giving better returns. Though growth in prices was not limited to USA alone, but the first signs of crisis manifested in USA, as essentially greed for higher returns in US financial sector prompted issue of skewed incentives and bonuses in mortgages to low-credit buyers and issued highly rated securities against these packages which foreign investors were willing to buy.  Though signs of window dressing was felt by investors, the borrowers continued to service their mortgages in view of easy availability of credit and constant appreciation in house prices. The regulators too taking a myopic view were convinced that market forces would take care of growth by itself without much supervision. But once prices stopped rising, borrowers began defaulting and the securities issued against mortgages became horribly untrue in value for recovery of debts. 

The impact of securities losses on the global economy is bound to have cascading effect the world over. As US represents a third of the global trade, if US demand shrinks, obviously global demand will also be reduced. Another spillover is that foreign financial institutions largely in Europe hold substantial quantities of undervalued US securities. As these losses come to light, European financial institutions will also get into red and finally confidence world over will get eroded.  Although it's been more than a year since the sub-prime problem surfaced, no solution is in sight for restoration of investors trust in financial markets. The present situation is like a vicious circle - as banks have been burdened with losses, their assets valuation has nose-dived, thus funding gets harder to come, which in turn further contracts credit. This will drag other banks and corporates into the downward spiral. Such a downturn could trigger loss of jobs, further eroding property values which could further trigger a new series of mortage defaults. Besides  corporate defaults there could also be defaults on credit cards, student loans, car loans etc.  

To avoid the ongoing credit contraction immediate bailout measures from the treasury are required to balance off the illiqued assets, so that institutions can again raise capital and become willing to lend again. The situation is such that either you suffer and perish your assets / investments in the present crisis or bear the cost of reviving viable financial institutions for the benefit of a sounder economy.