Recently, I have been wondering if my understanding of the current economic downturn is correct. So I've researched some of the major contributors to the problem. I'm sure you probably already know this info, but it might be worth a refresher. Feel free to flame me if you disagree.
1) HOUSING SLUMP - When the rate of housing purchases slows, people are spending less money and saving more money away in the bank. This means that banks are excepting more deposit then they are giving out in withdraws. This results in the banks having a larger pool of funds from which to lend, but less customers to lend to (since everyone is saving money). With more money available for lending and less demand to withdraw money, the rates will inevitably lower over time, since banks are eager to get people to take out loans. The lower interest rates should result in consumers purchasing homes again because the cost of borrowing is down. So over time, the “housing slump” should correct itself.
2) CREDIT CRISIS - A reflection of consumers who purchased houses they could not afford at the time, but with “creative” mortgages were able to meet initial payments. When the interest rates went up (as expected) the consumers ability to make the monthly payments went bye-bye. People decided to go bankrupt and foreclose on their mortgages, thus transferring the property back to the bank that held the mortgage. This situation is very dangerous for banks, since they are now flush with property that they can't make any money on because the properties they just absorbed are worth much less then when they originally purchased them. On top of that, the banks can't make as much money on the loans as they used to since they have had to lower the interest they charge on loans (because of the housing slump). This situation results in a vicious circle since banks now have to raise interest rates on loans (so they will bring in more money) and lower interest rates on savings accounts (so they are not losing as much money). So the solution to the credit crisis is in direct conflict with the solution to the housing slump.
3) INFLATION - One of the most prominent factors of inflation is the printing of money. Every year the Federal Reserve prints new money proportionally to the increase in GDP for that year. GDP (Gross Domestic Product)is the total value of all goods and services in the country. Inflation occurs when the Fed prints more money then the annual increase in GDP. So right now there is more new money is in circulation relative to the total GDP. So we have too much money chasing a too few goods. This is why the price of everything goes up during inflation. A dollar now purchases less product than it used to. From an international standpoint, this is good and bad. It's good because it becomes cheaper for foreign countries purchase our good (since their money is worth more).So we produce and sell more goods (Which is good for business). It's bad because we are now paying more money for foreign products to be imported to us. Altogether, it is a net loss for us since we import more then we export.
1) HOUSING SLUMP - When the rate of housing purchases slows, people are spending less money and saving more money away in the bank. This means that banks are excepting more deposit then they are giving out in withdraws. This results in the banks having a larger pool of funds from which to lend, but less customers to lend to (since everyone is saving money). With more money available for lending and less demand to withdraw money, the rates will inevitably lower over time, since banks are eager to get people to take out loans. The lower interest rates should result in consumers purchasing homes again because the cost of borrowing is down. So over time, the “housing slump” should correct itself.
2) CREDIT CRISIS - A reflection of consumers who purchased houses they could not afford at the time, but with “creative” mortgages were able to meet initial payments. When the interest rates went up (as expected) the consumers ability to make the monthly payments went bye-bye. People decided to go bankrupt and foreclose on their mortgages, thus transferring the property back to the bank that held the mortgage. This situation is very dangerous for banks, since they are now flush with property that they can't make any money on because the properties they just absorbed are worth much less then when they originally purchased them. On top of that, the banks can't make as much money on the loans as they used to since they have had to lower the interest they charge on loans (because of the housing slump). This situation results in a vicious circle since banks now have to raise interest rates on loans (so they will bring in more money) and lower interest rates on savings accounts (so they are not losing as much money). So the solution to the credit crisis is in direct conflict with the solution to the housing slump.
3) INFLATION - One of the most prominent factors of inflation is the printing of money. Every year the Federal Reserve prints new money proportionally to the increase in GDP for that year. GDP (Gross Domestic Product)is the total value of all goods and services in the country. Inflation occurs when the Fed prints more money then the annual increase in GDP. So right now there is more new money is in circulation relative to the total GDP. So we have too much money chasing a too few goods. This is why the price of everything goes up during inflation. A dollar now purchases less product than it used to. From an international standpoint, this is good and bad. It's good because it becomes cheaper for foreign countries purchase our good (since their money is worth more).So we produce and sell more goods (Which is good for business). It's bad because we are now paying more money for foreign products to be imported to us. Altogether, it is a net loss for us since we import more then we export.
1 comments:
Here's an interesting read on how we got here and where we might be heading:
http://online.wsj.com/article/SB123509667125829243.html
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