Recession is a tough concept to define. But one pretty simple way to identify the recession is negative GDP growth for two consecutive quarters. Most people, even the Fed Chairman, Ben Bernanke, think Recession is on the way...
Well, this is really a bad news. but i cant understand one thing, how come people in America, all the Wall Street analysts, who are supposedly smart, missed to foresee the housing bubble? So this goes to say, nothing is completely foolproof.
A little background on Subprime crisis. In US, banks lend people money based on a very complex algorithm, that calculates every citizens "credit score". It takes into account, the number of previous defaults, your credit card transactions, house you live in, the car you drive, etc,etc and finally give a "Credit Score". Above 700, then you are in the Prime Market. You wont have any problem gettin a loan. But the tricky part is when you are below 700. That is the Sub-prime market. Basically a market with many defaulters, people who dont repay the loan properly. You might think, why in the world, do the banks lend money to people who they know are not going to repay the loan. That is where the Wall Street Analysts come in.
(Of course, we dont have any such complex system in India. SEBI and Satyam computers keep track of all the defaulters. The simpler the better, dont you think? )
When you lend money to someone, who you know is not going to repay properly and when the person also knows that and he is desperate for money, the banks have a leverage. They can charge him high interests. Really HIGH interest rate. In these kind of loans, the risk is high, but the returns are also high. Basic Risk analysis principle. Well, that is clear enough, why the banks lost billions and billions of money in this crisis. But how come Investment banks lost money?
The banks and mortgage companies issued "Mortgage backed Securities", as a measure to "distribute" the risk and eventually reduce the risk in their part. So basically all the companies which had invested in these securities lost all the money. Bear Sterns is a company that specialized in such securities. That is why the company went bankrupt. The crisis is not over. We are not even half-way thru it. The worst is yet to come.
Most banks are writing down their profits, which affects the Stock Market heavily. This it not the big problem. The biggest problem is that, people loose confidence. When they loose confidence in the system, they stop spending. When people stop spending money, the retailers stop stocking the products, the manufacturers stop producing the products. Can you see the negative cycle here ? This will lead to economic depression, which usually follows a recession.
This is seriously going to affect everything. There is a famous saying, "When America sneezes, we catch a cold". I am telling you, this is so true. When America sneezed, even pudukkottai (my hometown, soon going to be erased from the map of Tamilnadu, on the grounds of "practically non-existent" principles) caught a cold.
We cannot hope to avoid the crisis. We can only hope to get past this crisis atleast by 2009.
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