What causes global economic downturn
Greed and malfeasance were their modus operandi. National Bureau of Economic Research.
The crisis was the result of credit creation but the culprits were the central banks. This was a short-rate phenomenon, not a long-rate phenomenon.
The rapid rise in prices began in the late s even while rates were flat or slightly up. This is because nominal incomes were rising. Most of the rise in affordability took place from The Fed cut its benchmark rate from 6. During this time, the 30 year mortgage rate also fell, but only by bps, not bps.
In mid the Fed began to slowly raise rates back up — and prices stopped rising. The long rates kept falling but the prices stopped going up. These were largely put in place beginning in mid — after most of the price rise had taken place. Another factor — delinquency rates had plummeted to record lows, and stayed at record lows until late We can look back now and conclude that delinquency rates fell because the Fed was lowering the bar not everyone took the max, and so payments temporarily declined even as debt was rising and because most of the cash-out refis left cash available for debt service prior to its being spent.
But at the time, banks and investors took the falling delinquency rates and rapidly rising collateral values as signals to adjust their lending standards. The payment shocks came in when ARMs re-set. And how much do you blame the banks for that? What exactly is it that you would have expected the banks to do? Not make loans that had been made possible by virtue of Fed policy?
Keep in mind also the mechanics of how rate policy works — the Fed buys as many securities and in whatever amounts are required to make the rate happen, and the rate is set to make certain economic objectives happen.
On the supply side, single-family-detached-home developers are financed on a project-finance basis — i. The overbuilding contributed greatly to the crash. There are no red herrings, no changes to bank lending standards, nothing at all to muddy the water on the supply side — it was pure credit-expansion bubble as described by Mises and Hayek decades ago.
Also, the Chinese like other investors were reading the same delinquency rates and collateral price appreciation as the banks and making the same misinterpretation, that these were independent factors exhibiting strength, rather than temporary blips driven by the initial injection of fiat credit.
Keep in mind also where that money came from — US homeowners who took advantage of the refi-with-cash-out boom in the early s spent a lot of that money on goods imported from China… Those same dollars were then reinvested in US mortgages.
If it was the Fed, how did Europe experience a housing bubble?
The ECB also cut rates, and their bubble was pronounced in countries whose mortgage markets were characterized by floating or short-rate mortgages and long amortization periods, like Ireland and Spain. One could re-write the lending structures to thwart Fed policy but then, why have the Fed policy?
Too bad the crooked big banks were bailed out by the taxpayer- thieves and crooks! They got away with it! If one just study the economy in places where the currency is the original currency and where the police force is mantained at low pay than one can understand that when the government fights crime there is no recession and even the fuel is at low cost. When they change the currency whatever massonic alliance they are using to call for military like police, such alliance becomes an aggression against traditional police force and all of the people because the military unions start to work against the people and any arrest they make becomes highly illegal.
In fact they never arrest those working for the police force for the simple reason that they know they are at fault and the criminals become their only target. They also know that a policeman is paid on a 24 hour basis and such indian like paycheck cannot guarantee loyalty to the government. Taxes grow higher not only because they need more money due to bad lack and natural disasters but also because they use taxes to punish anyone that does not obey to a wrong system.
People get sick easier and kids die into the hospitals. Shame on them because they have become the goats slave of the goat of the satanic cults where people really dress like animals. We send news updates and videos fortnightly and keep your data private. How Banks Create Money 2. Create money for people, not financial markets! The report is weak and inconclusive, with no clear root causes. So other than making for a nice history of the worst financial crash since the Great Depression, the report will have little impact.
I skimmed all three versions, and frankly they all contain truths. The criticism of the majority report that it is more a list of problems than a report on root causes is fair. Relying on judgment rather than an exhaustive investigation, let me try my best to suggest root causes and implied solutions. To identify root causes, it is essential to take a systems approach to the problem, which assumes human frailties, be they hubris, greed, or incompetence. It is of little use to say the crisis happened because human beings, bankers and regulators, were not perfect.
It is the height of folly to suggest that a solution rests in improving human decision-making next time. Only systemic change will generate a different outcome. Six directions for solutions.
Not one root cause is linked to bad or corrupt decision-making by bankers, regulators, central bankers, rating agencies, or simply bad guys. We will always have such human failings and should plan for it. As banks began to give out more loans to potential home owners, housing prices began to rise. Lax lending standards and rising real estate prices also contributed to the real estate bubble. Loans of various types e. As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities MBS and collateralized debt obligations CDOwhich derived their value from mortgage payments and housing prices, greatly increased.
As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses. Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy.
Total losses are estimated in the trillions of US dollars globally. While the housing and credit bubbles were building, a series of factors caused the financial system to both expand and become increasingly fragile, a process called financialization.
US Government policy from the s onward has emphasized deregulation to encourage business, which resulted in less oversight of activities and less disclosure of information about new activities undertaken by banks and other evolving financial institutions.
Thus, policymakers did not immediately recognize the increasingly important role played by financial institutions such as investment banks and hedge fundsalso known as the shadow banking system. Some experts believe these institutions had become as important as commercial depository banks in providing credit to the US economy, but they were not subject to the same regulations. These institutions, as well as certain regulated banks, had also assumed significant debt burdens while providing the loans described above and did not have a financial cushion sufficient to absorb large loan defaults or MBS losses.
Concerns regarding the stability of key financial institutions drove central banks to provide funds to encourage lending and restore faith in the commercial paper markets, which are integral to funding business operations. Governments also bailed out key financial institutions and implemented economic stimulus programs, assuming significant additional financial commitments.
The s were the decade of subprime borrowers; no longer was this a segment left to fringe lenders. The relaxing of credit lending standards by investment banks and commercial banks drove this about-face.
Subprime did not become magically less risky; Wall Street just accepted this higher risk. However, as market power shifted from securitizers to originators and as intense competition from private securitizers undermined GSE power, mortgage standards declined and risky loans proliferated. As well as easy credit conditions, there is evidence that competitive pressures contributed to an increase in the amount of subprime lending during the years preceding the crisis.
Major US investment banks and GSEs such as Fannie Mae played an important role in the expansion of lending, with GSEs eventually relaxing their standards to try to catch up with the private banks.
A contrarian view is that Fannie Mae and Freddie Mac led the way to relaxed underwriting standards, starting inby advocating the use of easy-to-qualify automated underwriting and appraisal systems, by designing the no-downpayment products issued by lenders, by the promotion of thousands of small mortgage brokers, and by their close relationship to subprime loan aggregators such as Countrywide.
The majority report of the Financial Crisis Inquiry Commission, written by the six Democratic appointees, the minority report, written by three of the four Republican appointees, studies by Federal Reserve economists, and the work of several independent scholars generally contend that government affordable housing policy was not the primary cause of the financial crisis.
Wallison  stated his belief that the roots of the financial crisis can be traced directly and primarily to affordable housing policies initiated by the US Department of Housing and Urban Development HUD in the s and to massive risky loan purchases by government-sponsored entities Fannie Mae and Freddie Mac.
In the early and mids, the Bush administration called numerous times  for investigation into the safety and soundness of the GSEs and their swelling portfolio of subprime mortgages. On September 10,the House Financial Services Committee held a hearing at the urging of the administration to assess safety and soundness issues and to review a recent report by the Office of Federal Housing Enterprise Oversight OFHEO that had uncovered accounting discrepancies within the two entities.
The majority of these were prime loans. To other analysts the delay between CRA rule changes in and the explosion of subprime lending is not surprising, and does not exonerate the CRA. They contend that there were two, connected causes to the crisis: Both causes had to be in place before the crisis could take place. Others have pointed out that there were not enough of these loans made to cause a crisis of this magnitude.
In an article in Portfolio Magazine, Michael Lewis spoke with one trader who noted that "There weren't enough Americans with [bad] credit taking out [bad loans] to satisfy investors' appetite for the end product. Economist Paul Krugman argued in January that the simultaneous growth of the residential and commercial real estate pricing bubbles and the global nature of the crisis undermines the case made by those who argue that Fannie Mae, Freddie Mac, CRA, or predatory lending were primary causes of the crisis.
In other words, bubbles in both markets developed even though only the residential market was affected by these potential causes. Countering Krugman, Peter J. Krugman's contention that the growth of a commercial real estate bubble indicates that US housing policy was not the cause of the crisis is challenged by additional analysis. After researching the default of commercial loans during the financial crisis, Xudong An and Anthony B. Sanders reported in December Business journalist Kimberly Amadeo reports: Three years later, commercial real estate started feeling the effects.
Gierach, a real estate attorney and CPA, wrote:. In other words, the borrowers did not cause the loans to go bad, it was the economy. This ratio rose to 4. This pool of money had roughly doubled in size from toyet the supply of relatively safe, income generating investments had not grown as fast.
Investment banks on Wall Street answered this demand with products such as the mortgage-backed security and the collateralized debt obligation that were assigned safe ratings by the credit rating agencies.
In effect, Wall Street connected this pool of money to the mortgage market in the US, with enormous fees accruing to those throughout the mortgage supply chainfrom the mortgage broker selling the loans to small banks that funded the brokers and the large investment banks behind them.
What really causes economic downturns?
By approximatelythe supply of mortgages originated at traditional lending standards had been exhausted, and continued strong demand began to drive down lending standards. The collateralized debt obligation in particular enabled financial institutions to obtain investor funds to finance subprime and other lending, extending or increasing the housing bubble and generating large fees. This essentially places cash payments from multiple mortgages or other debt obligations into a single pool from which specific securities draw in a specific sequence of priority.
Those securities first in line received investment-grade ratings from rating agencies. Securities with lower priority had lower credit ratings but theoretically a higher rate of return on the amount invested. Duringlenders began foreclosure proceedings on nearly 1. Lower interest rates encouraged borrowing.
Causes of an Economic Downturn
From tothe Federal Reserve lowered the federal funds rate target from 6. Additional downward pressure on interest rates was created by the high and rising US current account deficit, which peaked along with the housing bubble in Federal Reserve chairman Ben Bernanke explained how trade deficits required the US to borrow money from abroad, in the process bidding up bond prices and lowering interest rates. Financing these deficits required the country to borrow large sums from abroad, much of it from countries running trade surpluses.
These were mainly the emerging economies in Asia and oil-exporting nations. The balance of payments identity requires that a country such as the US running a current account deficit also have a capital account investment surplus of the same amount. Hence large and growing amounts of foreign funds capital flowed into the US to finance its imports. All of this created demand for various types of financial assets, raising the prices of those assets while lowering interest rates.
Ben Bernanke has referred to this as a " saving glut ". A flood of funds capital or liquidity reached the US financial markets.
Foreign governments supplied funds by purchasing Treasury bonds and thus avoided much of the direct effect of the crisis. US households, on the other hand, used funds borrowed from foreigners to finance consumption or to bid up the prices of housing and financial assets. Financial institutions invested foreign funds in mortgage-backed securities. The Fed then raised the Fed funds rate significantly between July and July Subprime lending standards declined in the USA: Bymany lenders dropped the required FICO score tomaking it much easier to qualify for prime loans and making subprime lending a riskier business.
What causes a recession?
12 Nov Causes of an economic downturn could include: Global recession – downturn in
Proof of income and assets were de-emphasized. Loans moved from full documentation to low documentation to no documentation. One subprime mortgage product that gained wide acceptance was the no income, no job, no asset verification required NINJA mortgage.
Informally, these loans were aptly referred to as "liar loans" because they encouraged borrowers to be less than honest in the loan application process. Bowen III on events during his tenure as the Business Chief Underwriter for Correspondent Lending in the Consumer Lending Group for Citigroup where he was responsible for over professional underwriters suggests that by the final years of the US housing bubble —the collapse of mortgage underwriting standards was endemic. Moreover, during"defective mortgages from mortgage originators contractually bound to perform underwriting to Citi's standards increased There is strong evidence that the GSEs—due to their large size and market power—were far more effective at policing underwriting by originators and forcing underwriters to repurchase defective loans.
By contrast, private securitizers have been far less aggressive and less effective in recovering losses from originators on behalf of investors. Predatory lending refers to the practice of unscrupulous lenders, enticing borrowers to enter into "unsafe" or "unsound" secured loans for inappropriate purposes.
A classic bait-and-switch method was used by Countrywide Financialadvertising low interest rates for home refinancing. Such loans were covered by very detailed contracts, and swapped for more expensive loan products on the day of closing. Countrywide, sued by California Attorney General Jerry Brown for "unfair business practices" and "false advertising", was making high cost mortgages "to homeowners with weak credit, adjustable rate mortgages ARMs that allowed homeowners to make interest-only payments".
This caused Countrywide's financial condition to deteriorate, ultimately resulting in a decision by the Office of Thrift Supervision to seize the lender. Former employees from Ameriquestwhich was United States' leading wholesale lender,  described a system in which they were pushed to falsify mortgage documents and then sell the mortgages to Wall Street banks eager to make fast profits.
A OECD study  suggest that bank regulation based on the Basel accords encourage unconventional business practices and contributed to or even reinforced the financial crisis.
In other cases, laws were changed or enforcement weakened in parts of the financial system. Prior to the crisis, financial institutions became highly leveraged, increasing their appetite for risky investments and reducing their resilience in case of losses.
Much of this leverage was achieved using complex financial instruments such as off-balance sheet securitization and derivatives, which made it difficult for creditors and regulators to monitor and try to reduce financial institution risk levels. US households and financial institutions became increasingly indebted or overleveraged during the years preceding the crisis.
From tothe top five US investment banks each significantly increased their financial leverage see diagramwhich increased their vulnerability to a financial shock. Changes in capital requirements, intended to keep US banks competitive with their European counterparts, allowed lower risk weightings for AAA securities. The shift from first-loss tranches to AAA tranches was seen by regulators as a risk reduction that compensated the higher leverage.
Lehman Brothers went bankrupt and was liquidatedBear Stearns and Merrill Lynch were sold at fire-sale prices, and Goldman Sachs and Morgan Stanley became commercial banks, subjecting themselves to more stringent regulation.
With the exception of Lehman, these companies required or received government support. However, both Barclays and Bank of America ultimately declined to purchase the entire company. Behavior that may be optimal for an individual e. Too many consumers attempting to save or pay down debt simultaneously is called the paradox of thrift and can cause or deepen a recession.
Economist Hyman Minsky also described a "paradox of deleveraging" as financial institutions that have too much leverage debt relative to equity cannot all de-leverage simultaneously without significant declines in the value of their assets.
Once this massive credit crunch hit, it didn't take long before we were in a recession. The recession, in turn, deepened the credit crunch as demand and employment fell, and credit losses of financial institutions surged. Indeed, we have been in the grips of precisely this adverse feedback loop for more than a year.
A process of balance sheet deleveraging has spread to nearly every corner of the economy. Consumers are pulling back on purchases, especially on durable goods, to build their savings.
Businesses are cancelling planned investments and laying off workers to preserve cash.
6 Factors That Point to Global Recession in 2016
world trade leads to lower exports and lower domestic.
And, financial institutions are shrinking assets to bolster capital and improve their chances of weathering the current storm. Once again, Minsky understood this dynamic. He spoke of the paradox of deleveraging, in which precautions that may be smart for individuals and firms—and indeed essential to return the economy to a normal state—nevertheless magnify the distress of the economy as a whole. The term financial innovation refers to the ongoing development of financial products designed to achieve particular client objectives, such as offsetting a particular risk exposure such as the default of a borrower or to assist with obtaining financing.
Examples pertinent to this crisis included: The usage of these products expanded dramatically in the years leading up to the crisis. These products vary in complexity and the ease with which they can be valued on the books of financial institutions. This boom in innovative financial products went hand in hand with more complexity.
It multiplied the number of actors connected to a single mortgage including mortgage brokers, specialized originators, the securitizers and their due diligence firms, managing agents and trading desks, and finally investors, insurances and providers of repo funding. With increasing distance from the underlying asset these actors relied more and more on indirect information including FICO scores on creditworthiness, appraisals and due diligence checks by third party organizations, and most importantly the computer models of rating agencies and risk management desks.
Instead of spreading risk this provided the ground for fraudulent acts, misjudgments and finally market collapse. Martin Wolf further wrote in June that certain financial innovations enabled firms to circumvent regulations, such as off-balance sheet financing that affects the leverage or capital cushion reported by major banks, stating: The pricing of risk refers to the incremental compensation required by investors for taking on additional risk, which may be measured by interest rates or fees.
Several scholars have argued that a lack of transparency about banks' risk exposures prevented markets from correctly pricing risk before the crisis, enabled the mortgage market to grow larger than it otherwise would have, and made the financial crisis far more disruptive than it would have been if risk levels had been disclosed in a straightforward, readily understandable format. For a variety of reasons, market participants did not accurately measure the risk inherent with financial innovation such as MBS and CDOs or understand its effect on the overall stability of the financial system.
Another example relates to AIGwhich insured obligations of various financial institutions through the usage of credit default swaps. However, AIG did not have the financial strength to support its many CDS commitments as the crisis progressed and was taken over by the government in September It concluded in January The Commission concludes AIG failed and was rescued by the government primarily because its enormous sales of credit default swaps were made without putting up the initial collateral, setting aside capital reserves, or hedging its exposure — a profound failure in corporate governance, particularly its risk management practices.
AIG's failure was possible because of the sweeping deregulation of over-the-counter OTC derivatives, including credit default swaps, which effectively eliminated federal and state regulation of these products, including capital and margin requirements that would have lessened the likelihood of AIG's failure. The limitations of a widely used financial model also were not properly understood. Because it was highly tractable, it rapidly came to be used by a huge percentage of CDO and CDS investors, issuers, and rating agencies.
Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li's formula hadn't expected. The cracks became full-fledged canyons in —when ruptures in the financial system's foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril Li's Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees.
As financial assets became more complex and harder to value, investors were reassured by the fact that the international bond rating agencies and bank regulators accepted as valid some complex mathematical models that showed the risks were much smaller than they actually were.
Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility. More on the agenda. Macroeconomic tail risks A number of recent studies see Fagiolo et al. Input-output linkages, micro shocks, and macro risks In recent work Acemoglu et al.
More specifically, we argue that: The implications of our theoretical results can be summarised as follows: First, the frequency of large GDP contractions is highly sensitive to the nature of microeconomic shocks. Second, depending on the distribution of microeconomic shocks, the economy may exhibit significant macroeconomic tail risks even though aggregate fluctuations away from the tails can be well-approximated by a normal distribution.
Finally, there is a trade-off between the normality of micro-level shocks and imbalances in the input-output linkages. Conclusion Understanding the underlying causes of large economic downturns such as the Great Depression has been one of the central questions in macroeconomics. Brexit as an example of deglobalization and other top economic stories of the week Margareta Drzeniek-Hanouz 26 Sep
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