DFS

Who is to be blamed for the financial turmoil the world finds itself in currently. What are real causes that led to such a global crisis which has spiraled on to multiple countries, though the issue itself seems to be with the housing mortgage defaulters in the USA.

Read on for a simple explanation.

Once there was a little island country. The land of this country was the tiny island itself. The total money in circulation was $2 as there were only two pieces of $1 coins circulating round. There were 3 citizens living on this island country.

'A' owned the land. 'B' and 'C' each owned $1. Now the following series of events happen: -

1. B decided to purchase the land from A for $1 . A and C, now each own $1 while B owned a piece of land that is worth $1. The net asset of the country = $3
2. C thought that since there is only one piece of land in the country and land is produce-able asset, its value must definitely go up. So, he borrowed $1 from A and together with his own $1, he bought the land from B for $2.
- A has a loan to C of $1, so his net asset is $1.
- B sold his land and got $2, so his net asset is $2.
- C owned the piece of land worth $2 but with his $1 debt to A, his net asset is $1.
The net asset of the country = $4.
3. A saw that the land he once owned has risen in value. He regretted selling it. Luckily, he has a $1 loan to C. He then borrowed $2 from B and acquired the land back from C for $3. The payment is by $2 cash (which he borrowed) and cancellation of the $1 loan to C.
As a result,
- 'A' now owned a piece of land that is worth $3. But since he owed B $2, his net asset is $1.
- B loaned $2 to A. So his net asset is $2.
- C now has the 2 coins. His net asset is also $2.
The net asset of the country = $5. A bubble is building up.
4. B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for $4. The payment is by borrowing $2 from C and cancellation of his $2 loan to A.
As a result,
- A has got his debt cleared and he got the 2 coins. His net asset is $2.
- B owned a piece of land that is worth $4 but since he has a debt of $2 with C, his net Asset is $2.
- C loaned $2 to B, so his net asset is $2.