Economic butterfly effect

From the sub-prime to the ridiculous: how $100bn vanished

Excerpt:

It began with low-income Americans being encouraged to borrow mortgages they couldn't afford.

The economic butterfly effect would eventually cause deals worth billions of dollars to fall apart; the first run on a British bank in 140 years; some of the most powerful figures on Wall Street losing their jobs; wild gyrations on the markets; and dire warnings that the world is on the brink of recession.

At the start of the year, stockmarkets were at six-year highs and £40bn worth of mergers and takeovers were awaiting completion. Private equity firms and hedge funds were gorging themselves on cheap money and a handful of secretive, hugely wealthy individuals were becoming increasingly influential. But it was the millions on more modest incomes who would ultimately shape the events of 2007.

As the US housing market cooled and interest rates rose, many on the bottom rungs of the economic ladder found it difficult to meet their monthly mortgage repayments.

The first real concerns about sub-prime mortgages emerged at the end of February, when Wall Street suffered its worst day since the terrorist attacks of 2001. By April one of the biggest sub-prime mortgage lenders in the US had gone bankrupt and there was talk of a full-blown crisis. Credit more broadly began to dry up as lenders became nervous.

Fear also spread as it became clear that much of the bad debt had been packaged up and sold on around the world's financial system. Nobody, not even the banks themselves, knew who owned the toxic debt.

Some otherwise arcane practices of the financial world such as collateralised debt obligations and structured investment vehicles suddenly became everybody's concern.

Comment: The scary part: "Nobody, not even the banks themselves, knew who owned the toxic debt". 2008 could be very interesting for the US Economy, the dollar, and interest rates. My own take ... all will sort out fine! Just be glad if you are not trying to sell a house!

Another view: Top economist says America could plunge into recession

Robert Shiller, Professor of Economics at Yale University, predicted that there was a very real possibility that the US would be plunged into a Japan-style slump, with house prices declining for years.

Professor Shiller, co-founder of the respected S&P Case/Shiller house-price index, said: “American real estate values have already lost around $1 trillion [£503 billion]. That could easily increase threefold over the next few years. This is a much bigger issue than sub-prime. We are talking trillions of dollars’ worth of losses.”

Comment: I checked the market value on my house on zillow.com about six months ago and then again last week. Per Zillow, my house value has dropped nearly $ 40K!