Step-by-Step Understanding of How The Recession Began

Sunday, August 23, 2009, 8:12 AM | Leave Comment

Economists have, sometimes, different explanation of how economy reacts to certain events. A definition of an economist has surfaced: “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” – Laurence J. Peter.

Many economists have shed light on the current recession. Edgar R. Fiedler has put it wisely: “Ask five economists and you will get five different answers – six if one went to Harvard.”

How the current recession began

The current recession began because of one major event and that is the phenomenon of sub-prime mortgage and the default and bankruptcy that followed some years later. If some economists had warned about it before it actually happened, banks and consumers alike never listened or they just ignore the warning. Many folks say, greed had a big part in it on both ends of the mortgage spectrum.

The global recession began in the United States – what else is new – and quickly spread around the world. The roots of the crisis began in the middle of the past decade when a massive increase in domestic mortgage lending led to a bubble in housing prices.

  • An individual gets a mortgage loan from a broker.
  • The broker sells the mortgage to a bank.
  • The bank sells the mortgage to an investment firm on Wall Street.
  • The investment firm collects thousands of mortgages in one big pile.
  • Thousands of mortgage checks come in every month, thus generating monthly income for the investment firm.
  • The process was supposed to continue for the life of the mortgages. But of course, it did not.
  • The firm sells shares of that income to investors who are willing to buy.
  • In an ideal financial world, it was a nirvana – an ideal condition of rest, harmony, or stability – for investors.
  • In the beginning they were wonderful, safe investments – built out of mortgages with big down payments, proven steady income and money in the bank.
  • Bad times followed the good times. Those securities plummeted in value when mortgage delinquencies accelerated.
  • That created an imbalance in the balance sheets of many banks, better known as losses.
  • Banks got reluctant to extend credit – no money.
  • The U.S. financial system seized up last fall, helping the economy to grind to a near halt.
  • American consumers watched their personal net worth fall as home values declined.
  • The stock market plummeted.
  • Massive corporate layoffs followed.

In a Nutshell
Some good has come out from the consumer closet. Consumers have responded to the crisis by spending less and saving more. The personal savings rate swung from just 0.1% in January 2008 to 5.7% in April 2009, according to Bureau of Economic Analysis, June 2009.

Although increased saving may have been healthy for consumers’ personal finances, it was bad for the U.S. economy that relies on consumers’ spending for more than two-thirds of its activity. It’s a catch-22 scenario.

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