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What is subprime crisis? How it caused financial mayhem?

September 25, 2008

Text: Rediff Business Desk

The current upheaval in the global financial markets has caused more mayhem in a fortnight than the world has seen in its entire economic history.

Although there are many reasons responsible for bringing the world to the doorstep of financial doom, the main cause of this financial disaster is said to be the ‘sub-prime loan.'

So what is this sub-prime loan? And why has it caused global panic? If it is related to the American housing sector, why should it affect Indian and other markets?

A sub-prime loan

Sub-prime mortgage loans (or housing loans or junk loans) are very risky. But since profits are high where the risk is high, a lot of lenders get into this business to try and make a quick buck.

Sub-prime loans are dicey as they are given to people with unstable incomes or low creditworthiness. These individuals are not financially sound enough to be given a loan when judged under the strict standards that should normally be followed by a bank or lending institution.

However, there's more to it. Let us simplify this issue to understand better how sub-prime loans work and how they brought the world down to its knees. Read on. . .

Image: An advertisement for home loan modifications hangs on a suburban telephone pole in Moreno Valley, California. The number of unsold properties has hit an all-time high in places like Moreno Valley. | Photograph: David McNew/Getty Images

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