How Crowdfunding CAN prevent the next GFC -- Part 1
In order to make this claim that Crowdfunding can really prevent a future GFC one needs to first understand what exactly happened in the last GFC. The origins of what Australians call as the Global Fi...
In order to make this claim that Crowdfunding can really prevent a future GFC one needs to first understand what exactly happened in the last GFC. The origins of what Australians call as the Global Financial Crisis lie in the US housing market. Btw in America we don't call it the GFC, for the longest time after coming here I was wondering if GFC was an Aussie variant of my beloved KFC but I eventually caught on.
The basics of any financial problem are when you peel it to its very core very simple. People buy things which they cannot afford to pay for, for a while the "make believe" world holds up. Then the music eventually stops bringing everything crashing down.
Spurred by low interest rates and loose financial regulations lenders in the US started encouraging people to borrow and invest in a home. And what can be safer than investing in a house? After all it is the great American dream to own a home. House prices historically had generally never fallen. The population keeps increasing, land stays the same, price of a home will always go up, that was the general theory. And it did seem to hold up.
The supply of money for lending for a safe asset such as a home just was boundless. And the government was in on it. In order to promote the dream of home ownership, the US federal govt essentially backed the home loan applications of people who were considered not worthy to purchase and support a large home loan. Once the full might and splendour of the state was behind these applications suddenly these so called "sub-prime" mortgages were rich pickings.
They offered strong interest rates, and were backed by a safe asset and a government guarantee. Most ratings agencies gave them great ratings. Those who did not risked loosing their clients as the financiers threatened to refrain from using their services. Interesting how that works, an analogy would be if your test scores in college were low you can threaten to stop going to college thus reducing tuition fee intake for the college and threatening the professors pay. The professor ends up giving everyone an A.
I wish I was this smart in my college.
What followed was even more fun, bundlers started pooling together these mortgages and then chopping them into small units that could be traded and on sold to further financiers. And then people like AIG got on the game. They basically said if it is good enough for the government, it is good enough for us. They insured these contracts against a risk of failure. It was easy money and a big game of pass the parcel, the parcel here being the seemingly safe and always rising in value houses. These were the now infamous sub prime mortgage backed securities.
At one point things got so out of hand that people could get a house with no money down, defer paying mortgage for a few months and then sellout and pocket the increased value of the home. In Economics 101 there is a saying, "There is no such thing as a free lunch". This for those who were in on the game was as close to getting a free lunch.
People with no possibility or hope of being ever able to repay a loan were getting loans to buy homes which were way out of their league. The great free market had concocted a system where pieces of garbage were chopped, and then bundled together and repackaged and then sold to others who then onsold it to others. The parcel kept changing hands, the only question was when would someone open the whole thing up and find that behind all this great packaging, all that was in there was pieces of rotten garbage.
Till then the carousel kept spinning.
To be continued...
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ABOUT THE AUTHOR
Co-Founder at EstateBaron.com, Australia Crowdfunding Real Estate Platform