Made in the U.S.A.

Have you been wondering what the hell just happened to the global economy? Let me give you some simple insight into what has caused some of the recent financial turmoil.

Here is the most important thing to understand; when it comes to lending money financial institutions should be lending money to individuals who have these five key elements required to obtain credit. 1) character (do they have integrity), 2) capacity (do they have sufficient sufficient cash flow to service the debt), 3) capital (do they have a positive net worth), 4) collateral (do they have assets to secure the loan), and finally 5) credit (your habits in repaying your debt obligations). Unfortunately these simple rules were totally disregarded over the past 10 years.

Back in the mid 1990's civil rights groups in the USA complained that poor people had less access to mortgage money to finance home ownership than the general middle class. These so called advocates for the poor had immense political clout under President Bill Clinton. With Bill Clinton as President, legislation was passed that required banks to lend to more non credit worthy borrowers.

This new legislation also required the two large US government sponsored enterprises, Fannie Mae and Freddie Mac, to buy these lower quality mortgages from the banks, guarantee them, and sell them to the public. These mortgages were then bundled into immense pools of sub prime mortgages which were sold all over the world.

Things kept ticking along because every one thought that these sub prime mortgages would never be a problem because everyone knows that real estate always goes up in value. As long as real estate values increased any chance of mortgage default would be covered up by higher home values. If a home owner couldn't make their payments they could just refinance the mortgages for more money than they owed on the original mortgage, pay off the first mortgage and live happily in their new home. Bingo, bango, bongo...no problem!

But this mortgage house of cards was built on a foundation of sand. The sand being the premise that real estate values only go up in value! Unfortunately, real estate values did not continue to climb, they stabilized and then started to fall.

Now, when these sub prime mortgage holders could not pay off their mortgages, and when they couldn't refinance, they started to default. When a lot of these mortgages defaulted, the massive pools of bonds sold by institutions started to declined in value. During 2007 only, nearly 1.3 million U.S. housing properties were subject to foreclosure activity.

There are a number of other contributing factors to our global financial problems however the over bearing issue is poor credit policies. I'll leave the final word to Alan Greenspan, the former Chairman of the Federal Reserve, who stated:

"The current credit crisis will come to an end when the overhang of inventories of newly built homes is largely liquidated, and home price deflation comes to an end. That will stabilize the now-uncertain value of the home equity that acts as a buffer for all home mortgages, but most importantly for those held as collateral for residential mortgage-backed securities. Very large losses will, no doubt, be taken as a consequence of the crisis. But after a period of protracted adjustment, the U.S. economy, and the world economy more generally, will be able to get back to business."