Fundamental Issues Lying behind the Sub-prime Mortgage Crisis (1): Capital Oversupply

First, let’s look at the all sources capital supple prior to the housing bubble:

1.       After the .com bubble burst, Greenspan lowered the interest rate on treasury bonds to 1%, which means cheap loans to Wall Street investment banks.

2.       “Hot money” from Japan, China and Middle East, looking for investment opportunities.

3.       Institutional investors who turned away from the low-return treasury bonds.

However, the economy didn't have enough time to recover from formal recession and the slowed-down industrial development reduced investment opportunities for Wall Street Bankers.

With the huge amount of money on hand, investment banks are desperate for loaners. They lowered the threshold of getting house mortgages to such a crazy level that people could buy a house that they couldn’t afford. Therefore, large amount of future defaults on sub-prime mortgages became inevitable.

When people started to default on house mortgages, houses instead of cash inflow piled up and made CDOs’ value shrink significantly. Therefore, investment banks couldn’t sale enough CDOs to pay back their loans and went bankruptcy; financing market was frozen and thus came large-scaled financial crisis.

So we could see that everything started from capital supply in the U.S. market. Had Fed established appropriate policies to control excessive external investment or applied more fiscal policy to redirect the funds from the capital market, the situation might look different now.

Another direct cause of the financial crisis is the over leverage of investment banks, which goes to another debate over whether we need more regulation to prevent credit crisis like this in future.