Have you heard of the Credit Crisis? It is a worldwide financial crisis today, in which lots of people are inevitably affected. The cycle of the credit crisis began as a group of investors began to search for good investments to turn their money into more money. After interest rates plummeted to 1% return on investment from the U.S. Federal Reserve, investors began to look for more profitable options, and that is when they came across the deceivingly promising investment on mortgages.
Picture a family who wants to purchase a house. Family pays down payment to a mortgage broker. The mortgage broker connects them to a lender, who gives them the mortgage. The broker makes a nice commission and the family becomes homeowners. The lend sells the mortgage to an investment banker. The investment banker borrows money to invest in more mortgages, which becomes his source of monthly income. It’s a win-win for all.
As time passes, the investment banker gauges which mortgages have higher risk and which have lower risks in generating revenue. Banker charges higher-risk mortgages higher rate of return.
These low-risk mortgages are now rated as AAA-rated investment, the highest safest rating. The others are BBB or not rated. The investment bankers sell the AAA-rated mortgages to the investors who want safe investment and the BBB-rated to other banks or risk takers. The Investment banker makes lots of money from these transactions and is able to repay his loans, the money he initially borrowed to buy the mortgages.
It is transparent to understand why investors are so pleased with this business, as an alternative of the 1% return rate from investing with the Federal Reserve. So they continue to run on this cycle. They call the lenders requesting more mortgages, who then calls up the broker for more homeowners.
The predicament arises when brokers cannot find more candidates for homeownership. Lenders start adding incentives, or risks, to attract families to buy houses. With no down payment, no proof of income, or no proof of any legal documents, houses will be sold to less responsible, also referred to as sub-prime mortgage, owners. The rest of the transactions proceed as normal. The broker lender sells the mortgage to investment banker. Banker sell to investors and banks.
It is only a matter of time before the crisis strikes down hard on every individual involved in the cycle.
The subprime homeowners eventually fall back on their payments, losing ownership of their house. Once the sub-prime mortgage is canceled, the mortgage turns into a house, and the ownership of the house is transferred to the banker. One of his monthly payments turns into a house. As more of subprime homeowners default on their mortgages, more of the bankers’ monthly payments turn into houses. Now with so many houses being sold in the market, housing prices fall, and lots of homeowners sell their houses for now-cheaper options. Bankers call investors, but mortgages are not worthy to investors anymore. Broker is then out of work. Everyone is bankrupt. The investor calls the homeowners to say that their investments are worthless. And the economy begins to see how the crisis strikes rock bottom, only to levitate its way back up. It’s the crooked Credit Crisis.
*Correction: The writer of ‘Crude Oil Price & Oil Refinery Companies’ on October issue, 2017 is Brian (ByungYoon) Lee.