The world’s financial markets tumbled, stumbled, and crumbled on Monday, Sept 15. Stocks in the United States, Japan, Russia, India, France, United Kingdom (the list goes on!) came crashing down. A lot of the world’s money just vanished when Lehman Brothers and Merrill Lynch, two large American investment banks, said that they were in trouble.
So how can two American companies affect the rest of the world so much? Let’s step back a couple of years. The world economy was booming, people were making more money, and they were spending more money. When people have more money, they invest it in what they think will bring back even more money. Now home prices in the United States were going up, and American home loans became a good way for people all across the globe to invest their money.
Wait, how does a loan work? Let’s say Johnny wants to buy a Wii. The Wii costs $300, but Johnny only has $50. So Johnny goes over to a bank and borrows $250 to buy his Wii. In return, Johnny has to pay back the bank the $250 over the next few years, plus some extra money (which is called “interest”) for letting him borrow the money. The bank tries to make sure that Johnny will be able to pay it back. So it checks how reliable he is, how much money he makes, and if he has paid back loans in the past. If Johnny can’t pay back his loan, the bank takes back the Wii and sells it off. If Wii prices are still above $250, the bank recovers its money. But what if prices have fallen to $200? In this case, the bank ends up losing some money.
Now back to home loans. It turns out that while lots of people all around the world had invested their money in home loans in the United States, many of the people who borrowed the money weren’t reliable enough to pay back their loans. And then home prices started falling! So now the banks that made all those loans are in trouble, as are the people who put their money in those banks.
This is a simple view of what basically has happened recently. The troubled news from the two reputed American banks meant that many banks and the savings of many people across the world could be in trouble. This sent world markets tumbling. Governments around the globe and especially in the United States are trying to figure out what they can do to help the situation!