Financial Crisis: Little Myth – Terrible Nightmare

Financial crisis refers to the situation when financial institutes start losing their values or when there is a rapid down fall in the financial sectors and financial markets. It is one of the crucial issues that have to be taken seriously. Broadly speaking, investors start to loss their confidence in stock market, bond market and foreign investment, huge increase in the withdrawals by the depositors from their accounts, currency is getting devalued, prices of most commodities increase rapidly, negative factor of behavioral finance that demoralize the investor, poor governmental policies & procedures and continuous negativity in the GDP all leads to a state toward financial crisis.

Sub-prime mortgage scheme is the major reason that fueled the recent financial crisis. Basically, it is a scheme in which banks provide the loan to the customers with very low or no conditions. For conventional mortgage, banks have their several requirements to sanction the loan. To avoid these hurdles for those who have larger than average risk of defaulting, U.S banks introduced the scheme of sub prime mortgage. Another feature that distinct the sub-prime from the conventional mortgage is, in conventional mortgage customer has to pay same amount of interest for the whole time period of payments while in sub prime mortgage banks charge very low interest rate initially and after the completion of mentioned time, the interest rate raised to the amount which cover the discount provided by the banks in the initial period. In the beginning, bank didn’t hesitate to give loans to the customer without any investigation and proper documentation and borrowers started to take loan without any future planning. But when the initial period completed, people refused, not only to pay back the interest but also the principle amount and returned back the mortgage asset to the banks that led the banks toward the liquidity crisis, which ultimately shook investor confidence in credit market. The other affects of financial crisis includes decline in the asset values, central bank tighten the credit policies that decreased the flow of cash in the business community and general consumer and the society suffered the loss in term of jobs, output and wealth badly.