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3/6/13

Mrunal [Economy Q] Difference between Subprime Crisis and Eurozone Crisis Print

[Economy Q] Difference between Subprime Crisis and Eurozone Crisis


Question via email Difference between Eurozone crisis and Subprime Crisis? Ans. Im writing for explanation purpose only. Technical details, intentionally skipped.

Subprime Crisis
First you need to understand Mortgage, derivatives and Asset bubble. Mortage You give me $10,000 loan and I sign on a paper that if I cant pay back the amount before 2045, you can take over my house. So my house is mortgaged. Subprime dude He is the borrower who is less likely to repay a loan. Because his income is low or irregular. Why would bank want to give loans to sub-prime dudes in the first place? Because bank can demand more interest rates from such people because of their bad credit history. Subprime is also in the car-loans, credit card etc. Besides when the general manager gives impossible targets to his probationary officer, So what can a man do? Just give loan to every swinging dude around. Derivative Youre a big bank, youve given such loans or credit cards to lot of sub-prime dudes and you know it well that theyre less likely to pay. So after a while, you decide to cash in your investment before these dudes start defaulting, so you repack those mortgage papers (security) and make a new security paper anyone who gives me $50,000, Ill give him mortgage papers of 5 houses = this is derivative product, because this security paper derives its value from those mortgage papers. Asset bubble
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3/6/13

Mrunal [Economy Q] Difference between Subprime Crisis and Eurozone Crisis Print

So now you sold such a derivate product to second guy, he then re-packs it with other things and makes a new derivative product sells it to third guychain continues. Here, no new asset (property or something that can generate $$) is created, basically you all are playing games with the same five houses mortgaged, blowing the ballon with new derivates. Thus the asset bubble is created. A point comes when people who took loans or did big shoppings with credit cards : they refuse to pay back and say take our houses, we dont have the money. But you cant sell the house, real-estate has collapsed, noone is ready to pay even $5000 for that house, on which you had given $10000 loan. Your asset bubble is burst, and what youve in your hand: that piece of trash paper is a toxic asset or a nonperforming asset (NPA). This is sub-prime crisis. And technically it contained, after American treasury bought all such NPAs worth $1 trillion (somewhere in 2009), but the aftershocks are still felt: American economy is not back on track yet, because that $1 trillion bailout money didnot fall from sky, nor does the dollars spend on military expenditure in Iraq or Afghanistan fall from sky.

Eurozone Crisis
Also known as Sovereign debt crisis. What happened here is the Governments of PIGS (Portugal, Ireland, Greece, Spain) were spending way too much money on subsidies, NREGA stuff and bank bailouts etc. They used to finance their spending by borrowing from the market. These nations earn most of their money from export to America and tourism income from American travelers. But the sub-prime crisis and the recession in 2008-09 meant Americans stopped going on vacations. So the airlines,tourism and export business declined, while the expenditure remained the same. Hence in a way, Eurozone crisis is an aftershock of the Sub-prime earthquake. Little concept: debt to GDP : Suppose Debt to GDP is 96% (meaning if the country produced goods and services worth $100 in a year, they already had outstanding loan-repayment worth $96) High Debt to GDP means investors loose confidence in your country. These PIGS had high Debt to GDP than other nations, hence they are in the crisis. But why only PIGS: why they ran out of money? (along with Debt to GDP %) Portugal:93% Over-spending by Government, inefficient PSUs with too much manpower (just like our Air-India).
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3/6/13

Mrunal [Economy Q] Difference between Subprime Crisis and Eurozone Crisis Print

Ireland:96% Their banks were running the same asset bubble game like the Americans. When it collapsed, Government had to bailem out. Greece:143% Overspending on Social schemes, overinflated staff in PSUs. Misreported its official economic statistics, to fool the investors in buying the Government bonds. Caught. Spain:60% Socialist Government, so lot subsidy and NREGA stuff. More on the Eurozone crisis is given on following page www.mrunal.org/economy

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