TheSelfStarters.com

Tag:Technorati Tags: credit crunch, global financial crisis, money

It had been raining for the past 24 hours and the weather is cool. It is comfortable but the wet weather discourage venturing outside as I usually do on a Sunday with the family. The photo below was taken at 3.00pm in the afternoon. Dark clouds can be seen and more rain is expected.

Well I took the time to update this blog. The last blog post was in 25 April 2008. Hmm…almost 6 months had wizzed by and just how event’s in the world had turned up. In august we had the Olympics in Beijing and now the global financial crisis that is ripping through out the world.

This is the issue that had bothered me very much. Yes, I am personally affected, as my investment had suffered a large drop in value in the last few months, the lost was quicker in the last few weeks when Lehman Brothers went under. I am not in the US , but the collapse of had reverberated to my part of the world.

I want to understand what happened. What caused my investment to drop in value when the things are happening on the other side of the globe. As I started my search for answer, I typed this into Google search page. This is what I typed “where did all the money go?” and clicked on a number of the results, one of them is as reproduced below. The author explained that it’s the mortgage crisis which started the present crisis. I had bold the lines in the articles which I feel is answering my question.

With the Treasury and the Federal Reserve desperately throwing in unprecedented sums to stem the ongoing financial crisis, ordinary people have a right to ask, “How did these big financial institutions lose all this money? Where did it go?”

The money went various places. Losses on residential mortgages are the precipitating factor in this crisis, a fancy term for “the straw that broke the camel’s back.” They are far from the only cause. But let’s start there.

Mortgage lenders made loans liberally at low rates of interest, lower in retrospect than the levels needed to cover the risk of the loans. Easy money boosted housing prices, motivating builders to build more and bigger houses than the market could sustain in the long run.

So real resources, such as building materials and construction workers’ time, went into houses that were not needed or that were bigger than their owners would be able to afford if the economy soured. This is part of where the money went.

Cheap refinancing induced people to take equity out of their houses and buy boats, go on cruises, pay down credit card debt (and then go out and charge more) or simply buy clothes for the kids or pay medical bills. As a society, we consumed more than we should have relative to what we produced and to long-run prospects for our personal finances. This is a second chunk of money.

Financial firms packaging mortgages or investing in them booked big profits, often before the profits were actually realized. They paid big dividends to shareholders or partners and big bonuses to CEOs and traders.

These people bought Jaguars, built mansions in Connecticut and bought vacation homes around the globe. Some of the money went for cocaine and hookers, although probably much less than legend would have it. Prudent ones socked much away. (Treasury Secretary Henry Paulson, a former CEO of Goldman Sachs, has an estimated net worth of $700 million.) This is a third chunk.

Some of the losses may be only on paper. Someone who bought a mortgage-backed bond for $10,000 and tried to sell it now might get only $2,000. The investor “lost” $8,000.

It will be a real loss if the bond must be sold now. If not, the value may go back up. But the bond may never be worth $10,000 again, and with a sour economy, tighter credit and expected high inflation, it may not regain much at all.

For a highly leveraged hedge fund or investment bank that bought $1 million in such bonds using $50,000 of company money and borrowing $950,000, a 5 percent decline in the value of a bond wipes out all equity.

Such leverage means that even moderate drops in the value of these securities can break an investment bank.

Losses in a financial sector that took on enormous leverage outweigh actual write-offs of bad mortgages several times over. This isn’t a complete list, but if you want to know where the money went, it is a start.

Economist Edward Lotterman teaches and writes in St. Paul, Minn. Write him at ed@edlotterman.com.

Source :- http://www.idahostatesman.com/business/story/537213.html

So what essentially Mr Lotterman was saying is, due to the earlier easy lending and cheap credits, this has created an imbalance of demand and supply especially in the houses sector in the US. Well this is basic economics is at play here. Anyway I gathered from the article, part of the answer of where the money, the real money had gone is : -

1) Money gone to material cost and workers pays building new houses that nobody buys or where there is no demand.

2) Money gotten from refinancing due to the cheap borrowing rates. The money from here is used to buy everyday stuffs, pay credit card bills, medical bills. Generally it’s used and consumed.

3) Money in the form of big dividends to shareholders or partners and big bonuses to CEOs and traders before actual profits were realized. Hmm…sound like GREED here. And the money paid to these people goes into high item purchases or building expensive houses.

4) Some hoard the money away and is not circulating in the system. Is this worsening the credit problem?

5) Money losses on paper like share or bonds. This has got to do with values

Well like Mr Lotterman said, the above is a good start to know where the REAL money had gone. I will post more on this subject again. Anyway the rain had abated a little but definitely not over yet, like the current financial crisis.