What is the credit crisis?
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What is the credit crisis?It’s a worldwide financial fiasco involving terms like: - Sub-prime mortgages - Collateralized debt obligation - Frozen credit markets - Credit default swaps
Who is affected? EVERYONE
How it has been happen?
The credit crisis brings two groups of people together => Homeowners and Investors
Homeowners represent their mortgages and Investors represent their money.
These mortgages represent houses and the money represents large Institutions such Pension Funds, Sovereign Funds, Insurance companies, etc.
Theses groups are joined together to the financial system composed of banks and brokers communally called “Wall Street”.
These banks of Wall Street are closely connected to these houses.
Beginning:
Years ago, the investors were sitting on their empire of money, looking for a good investment to turn into more money. Traditionally, they go to the US Federal Reserve where they buy treasury bills believe to be the safest investment.
But, after the 11 of September 2001, the Federal Reserve lowered its interest rates to only 1% to keep the economy strong. 1% is a very low return of investment, so the investors said “no thanks”. On another side, this means that Banks of Wall Street can borrow from the FED for only 1%. Ad to that, general borrows from Japan, China and the Middle East and there is an abundance of cheap credit! This makes borrowing money easy for Banks. Banks to go crazy with leverage:
Leverage is borrowing money to amplify the outcome of a deal.
How it works?
In a normal deal, someone with 10.000 $ buys a box for 10.000$. And then sells the box to someone else for 11.000$, for 1.000$ profit = a good deal.
But using leverage, someone with 10.000$ would go borrow 990.000 more $, giving him 1.000.000$ in hand. Then he goes and buys 100 boxes with his 1.000.000$. And sells it to someone else for 1.100.000$. Then he pays back his 990.000$, plus 10.000$ in interests = after his initial 10.000$, he earns