Saturday, Jul 02, 2022
Outlook.com
opinion

Blind Man's Bluff

The meltdown holds up a mirror to market fundamentalists

Blind Man's Bluff
Illustration by Sorit
Blind Man's Bluff
outlookindia.com
-0001-11-30T00:00:00+05:53

The mystifying feature of financial crises is 'contagion'. A problem in one industry or region can leap and escalate to others, like an influenza epidemic. The present crisis began in the US housing market. Starting eight years ago, there was a large expansion of loans to homebuyers in the 'sub-prime market', that is, the segment of borrowers who are considered 'high-risk'—people with uncertain incomes, for instance.

There were two factors behind this credit expansion. Mortgage companies discovered the art of packaging bundles of different mortgages and selling them off to large investment banks. These miscellaneous bundles were difficult to value, leading to genuine miscalculations and the under-estimation of risk. But there was another, less understood problem. Each lender calculated that, in the event of a default, it would foreclose on the mortgaged property and recover much of the loan. When, comforted by this, lots of mortgage companies and banks began extending credit to the sub-prime market, one important constant changed.

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