Today the whole world is affected due to the economic crisis by this way or that way, many people are asking the reason behind the crisis and many are answering the same that is Sub-Prime effect.

Here I have tried to explain the root cause of the crisis with some economic theories and how the different things are integrated with each other.

All it starts with the US it was a boom in the economic and everybody was heavily paid and the changing lifestyle pattern it came with increase in the nuclear families, that led to the increase in demand for the houses and to fulfill this demand banks came with the innovative process called “ Securitisation” that help banks to multiply there lending without changing the CAR( Capital Adequacy Ratio).

This easy credit from the banks helps to increase the demand for the housing market and prices went on increasing and as their prices where increasing the marginal cost was also increases, as the Marginal cost curve is bell shaped it increases in the beginning and then further falls.

Some what same has occurred here and real estate prices shotup and then start falling a good example can Explain this.

“Consider there is a person who is very thursty and he is willing to pay 5 USD for per bottle, as he consumes first bottle, he is willining to pay 2 USD for next bottle, and as he countinues the same he will stop some where to consume even if he is offered for very few bucks. This shows that the first bottle gives the highest satisfaction than the second and it goes on decreasing as number of bottles increases.”

In same way as the supply of houses increases, marginal cost of house went on decreasing and hence the total cost of real estate went on decrasing, and that affected the Balance sheet of banks. This led to total assets value went on decreasing and as the prices fall further lower than cost, people start to default on their loans and as banks profits where hiting that led to increase the NPA’s (Non Performing Assets. Assets which can not be recovered at balanced amount of loan), this further led to credit crunch and other sectors got affected and due to job cuts of those sectors, again defaults increases and then it turned to hawack.

And first subprime shock hit the bourses across the world in the april 2007, and then it followed by other countries, economist are hoping more to come out but pray not happen that because it will not led to Financial Crisis across the world but the 'Confidence Crisis', on which all countries monitary policies are depending, that’s why the different stimulus packages are not helping the economies to recover.

What went wrong is the lack of projection and to some extend failure of the risk management and the exotic derivative Instruments which become threat when not handled properly.

Disclamer:-

Here I tried to link the macroecomic with micro theories, but the above stated is my personal view that me be wrong, but I like to welcome some reply to improvice myself.