What led to the Housing Crisis and the global credit crisis

Yesterday, we attended Entrepreneurship class. And what happened was a lecture on the current global credit crisis, how it came about and what he thinks should be done about it. He made it really simple. Let me see if I can summarise it down here.

The basic problem was the belief that land prices will always be going up. In 1980s, the banks came up with the Home Equity Loan. What it is is giving people extra credit for the increase in the value of their property. As a result, people started to spend on credit, and lived a life of luxury with things that they actually could not afford. This was the start of the consumption culture. As a result of the consumption culture, several countries (companies and individuals, may I add), became rich. One such country was China.

Fast forward to (maybe) 2007. At this time, there was 70trillion (huge amount, of which China had about 1 trillion) of (real) money waiting to be invested in low risk investments. There was huge supply of money.

At this point, let us talk about small local banks. Before, small local banks owned the risk when they lent money. However, small local banks were able to sell the loans to bigger banks or investment institutions. So, the risk they took was between the time they gave the loan and the time they sold the loan to the bigger banks. As a result of the huge supply of money from those who had become rich, investment banks started calling the small local banks and asking for more loans to be sold to them. At this time, small local banks had run out of credit-worthy individuals to lend money to. So, they became more lax. Investment banks also did not bother to check if these individuals were credit-worthy or not. They just wanted to fulfil the needs of the owners of the 70trillion.

The supply of money still continued to be huge. So, the small local banks introduced many schemes, laxer and laxer with each scheme to entice people to get the loans. And obviously, some people (or MANY people) took the money and just could not pay. Later, investment institutions noticed a problem (finally) and told the middlemen that they weren't going to buy anymore loans. The entire system started collapsing.

The credit crunch = banks are now afraid to lend money out. They don't know how big the damage is from the mortgages, so they are afraid to lend money for fear that they will lose even more money. Worse still, it is the companies that they are refusing to lend money to. Companies sometimes rely on loans to tide by cash-tight times. This situation may lead to a difficulty in operations, and meeting operation expenses.

The whole world depends on companies for economic growth. If companies have difficulties in meeting their expenses, that's not a good sign for economic growth...

What Prof Tracy feels should be done is... let the market correct itself instead of having (stupid) [no, he didnt say stupid, but Alex feels strongly about it, enough so that I'm influenced by it] bailout plans... He says, it's just too bad those owners of the 70trillion are going to lose all that money. But it's important that the market corrects itself!!! We need to learn that we cannot buy on credit. We cannot own things that we can't afford...

Hmm, basically, that's in a nutshell, the 80minute explanation... I found it to be fascinating. Always have found such information to be fascinating. haha, maybe one of the few times I didn't daydream in class. Haha.