The Hong Kong index dropped by 8% at close today, following a 5.5% drop yesterday. Japan's Nikkey index dropped 5.1% after a 3.9% drop yesterday. India's index dropped 9.8% within minutes of opening, at which trading was halted for the day. The situation hasn't been very different for the other Asian financial markets, European markets, or obviously, the good ol' Amercian markets (which were spared the agony on Monday and were closed for MLK day).
What does this all mean? And what does this mean to your average joe, who has nothing to do with this whole financial market nonsense? More than you think, actually; you see, the world's diving into a worldwide recession, and somehow or the other, you will get affected.
You might have heard the words "subprime mortgage crisis" or "credit crunch" sometime within the last year, whether flipping through TV channels, reading the business section in newspapers, and so on. The United States banks have been very happily giving out home loans to risky customers over the past few years, which has turned out pretty profitable; you see, in the US, you can refinance a home loan whenever the value of your property goes up, and take some extra cash out. This has been the case for the past few years, and even the risky clients end up paying because at worst case scenario, they refinance a higher value property, get some cash out, and pay off their debt (including credit cards, car loans, other small loans, etc).
Life was good in the States; the value of properties was rising, everyone was spending, there was a lot of cash around, everyone could get a loan, and this in turn stimulated the world economy. Countries like China would produce and produce, to have all their products bought up by the USA. Everyone lived in harmony, and thought it would last forever.
But in 2006, the subprime mortgages (risky loans) didn't keep the dream alive. Sooner or later, property prices stopped rapidly increasing, the riskest mortgage customers stopped paying their loans because they couldn't refinance, some houses were reclaimed by the banks and placed for sale. This in turn slowed down the growth of property prices, because now you have many houses being sold; basic rule of economics, increase supply, price is reduced. And again, with the prices not increasing, more risky customers started defaulting, leading to more houses being reclaimed and sold, lowering the price further. The cycle repeated, and got more and more severe.
Forward to mid 2007, and the situation had started getting severely out of hand. The big banks started reporting big losses from loan defaults, and the reduced price of properties they had previously mortgaged, and with that CEO after CEO was fired. People stopped spending; after all, the big spenders that used to refinance to get more money to support their spending habits couldn't do that anymore, and started defaulting on their car and personal loans, as well as credit cards. The situation escalated, and by the end of the year, ridiculous billions of dollar losses were reported on the financial statements of the big banks, and the small banks. More CEO's were fired. The pot was bubbling in the US, but some people figured the worst was over.
Far from it.
With their spending habits cut, people stopped buying. This affects not only the US economy, but the world economy, since the US is the world's biggest consumer economy; the Chinese sell less, the Japanese sell less, the Europeans sell less, the world sells less. And again, the effects of the big recession in the States spreads to the other banks in the UK, Europe, and the rest of the world, which have started signalling losses. The global financial markets are in trouble, and slowly but surely, we're heading into economic meltdown. The world economy, which was up and running a good year ago, is now struggling. Companies make less money, people start getting fired, jobs are lost, crime rates increase, and so on.
It's like a giant train-wreck, all in slow motion.
So what's the solution? Well, the US has been struggling trying to stimulate the economy by cutting interest rates, month after month, but with no real result. Financial support has been provided by the big investors, but again, no real result. The global recession seems inevitable, and all efforts to save it are pretty much just delaying the effects.
Things don't look too good right now, and the domino effect is well on it's way. What can you do? Not much, considering you don't have billions of dollars to invest in the global economy (if you do, gimme a call), but ultimately, it's just a downhill rush from here.