This is an exceedingly dumb, beyond basic economics question, but it’s something I never understood: At any given time, if everyone’s doing the same amount of work, producing the same products and services that consumers and other businesses pay for, why does the economy go up and down seemingly at random?
(If the answer is “take Econ 100”, that’s perfectly acceptable… I know so little that I’m not sure how difficult a question this is to answer.)
Well, Econ 101 wouldn’t really deal directly with the problems.
Basically, economies tend to run a lot on people’s expectattions. This has a huge impact. Some events happened which thoroughly shook investor confidence. They pulled back from further investment, which caused other people to pull back from expansions, which hurt growth.
Just as good economies have avirtuous cycle, so bad ones have a vicious cycle. However, what generally happens in a free market is that the economy craches, stabilizies, and then grows again as soon as hings stabilize. In order to keep it nonpolitical, the Obama administration has been trying to “kickstart” the economy like a motor, and there is deep division about whether or not this can be done at all, whether the cost is worth it, and whether the plan would achieve it, and whether he’s trying to get control over things he should be touching (and thereby actually wrecking investor confidence).
However, there are a lot of problems. These have been building for years and years, and not at all just in the United States. Indeed, in a lot of ways, growth in the US was pulling the rest of the world along and masking problems all over the world, but eventually, we had a hiccup, and everyone went down together.
And many nations have never built a solid domestic economy (often crimping the possibility of imports), but just relied on selling things to America. And, too, eventually we just didn’t want anymore stuff. Their import restrictons have hurt American growth, because we weren’t able to sell our high-tech stuff overseas, and made them dependant o us. China is basically done gone down the spout right now.
The short answer is that the amount of goods and services that consumers demand changes over time. The long answer is less “Take econ 100” and more “Do a PhD in macroeconomics”.
You keep making the same goods, but you don’t spend your salary the same way. If you don’t spend your salary, you’re not buying someone else’s goods. You’re not buying his goods, then he doesn’t have a job. Pretty soon, you don’t either.
This is only part of the answer, since not everything rests on consumer spending. But that is the essence. Money must keep flowing in a circle. If it ever pools somewhere, the whole flow stops.
The biggest problem of economics is that we don’t really have any good mechanisms to pump the money when it starts pooling in a certain place. We have a couple, and they’re pretty crappy. Also, our economy isn’t nowhere near efficient, transparent, and ideal enough to keep the pooling from happening in the first place.
There were a lot of problems that caused the economy to tank even though everybody was doing the same job.
First of all, after 911, it was REALLY cheap to borrow money, this encouraged lots of people to try and lend more - with all the exotic and subprime mortagages. This caused two things to happen, first of all more people were buying houses, as demand for houses went up of course so did price.
Why did this matter?
First of all, people were getting mortgages that they could only afford in the short term (more on this later)
Secondly, people started realising that they had a $300,000 dollar house with only a $30,000 mortgage, this made them feel rich, so they started spending MORE than they were earning - hey, why not? Interest rates are cheap, I can just increase my my mortgage a little and have a great holiday, big screen TV, ritzy SUV.
OK, so coming back to the mortgages that people couldn’t afford, suddenly there were balloon payments to make, interest rates went up, mortagages weren’t being paid. This put a strain on the banks, funds and the like (more on this shortly). Everybody started wanting to sell their house, prices started going down. People could no longer finance their spending by borrowing on their house - in fact they had spend a LOT less - more money had to go to servicing the loan and such, so production was cut and people started losing their jobs.
Now, why did it matter that people were defaulting on their loans, after all the hosue was still there right? Well yes, but there is the “money multiplier effect”. When you deposit money in the bank, they don’t keep it all in a vault, they keep ponly 10% of it as a “reserve” against your withdrawals, and the rest they lend to someone. Then that “someone” deposits it to a bank, who then lends it to someone else. So your $1000 that you deposit suddenly becomes $10,000 floating around. Why does this matter? Well you see the money that the banks keep “in reserve” is also put into investments - like mortgages from other banks, the value of those investments go down, then the ratio of reserves to liabilities go down.
The banks can’t have this, so they start lending less (reducing the ratio by reducing liabilities), interest rates go up (as less people are willing to lend) and more people have trouble meeting their mortgage payments. More people sell etc etc.
What also compounded the problem (from what I have read) is that the way of valuing the sub-prime mortgages wasn’t very accurate. The way these mortgages worked was at a LOW interest rate, or interest only payments for the first X years, then the borrower had to suddenly pay more at some point. Well the lender only tested the borrowers ability to pay the LOW amount - not the true cost (and in some cases they didn’t test ability to pay at all). At the same time these fantastic new mortagages were valued on historical data of default.
For example, we know that between say 1990 and 1995 (to pull figures out of my arse) 5% of borrowers defaulted. But this was with “normal” mortgages that were given to much more rigourous standards.
This 5% default was used to “value” the new mortgages, but suddenly when the true cost of the mortgage had to be paid, default rates were MUCH higher (again to pull figures from my arse) say 20% so nobody wanted these “mortgage assets” on thier books…and remember that banks have to keep a reserve for you to take your money out - well because their “reserve” was going down, everything had to be tightened (less money lent).
Credit becomes more expensive, consumption goes down - you suddenly have massive problems.
Of course there were a lot of side issues as well, and my understanding is not good enough to go into them all - but this is it in a nutshell.
The OP is based on the false premise that everything is the same, which it isn’t. People lose confidence and they stop buying and other people get laid off which in turn makes then stop buying and other get laid off. Etc.
This makes no sense. It is self-contradictory and is based on several erroneous assumptions.
And “China is basically done gone down the spout right now”? Please! China’s growth rate has diminished a bit due to the global economy’s downturn but China retains a very healthy growth rate. A growth rate which America would kill for.
The notion that China “has never built a solid domestic economy” is palin BS. I can think of no country which has done a better job of pulling itself up by its own bootstraps. in the last 25 years they have managed to achieve something which is almost a miracle. They have built and grown their economy at incredible rates while retaining political and economic independence. I can think of no other country which has achieved anything on that scale.
The notion that China’s economy is based solely on exporting to America is just false (and silly). China’s exports to other countries, not only the USA, are a major source of income for them but internal demand is also a major driving force of the economy. China is building highways, railroads, dams and other infrastructure at a rate which the USA could only hope it could afford. In the field of telecommunications China is a major player. The biggest telecomm companies in the world are Chinese. The #1 market for mobile phones is China.
The notion that China has gone down the drain because the USA stopped buying is just not true and kind of silly. In fact, China is considered a major factor in getting the world economy going again because they are in a good position to do so.
Doesn’t seem like “down the drain” to me.
Can I get a cite for, well, pretty much any of that?
I’m not aware of a large number of banks that originate loans, subprime or otherwise, getting hurt all that terribly. I’m sure there are some, but I’d like evidence to see that it was subprime lending that brought them down. Hell, most of them didn’t own the loans for more than a month or two.
You sort of touched on the tranching problem, but you make it seem like it only made a big problem slightly worse. Many of us think that CDOs, CDSs and all of their relatives (they even have CDOs backed by CDOs which are backed by CDOs, etc.) were the problem, and that the rest of it is simply a smokescreen to redirect the blame to the borrower. That’s not to say there were no stupid borrowers, as there were, but I don’t see any evidence that they brought us down.
Er - exactly what would you call a cite for this? Are you saying that the valuation and trading of the “toxic mortgage instruments” is not a problem? What is the current default rate of mortgages against historical rates? For a long time America has been in a situation of negative, or near negative savings, which common sense tells you is NOT sustainable in any sort of long term economy.
I have greatly simplified matters sure, but the basic premise is still the same - people getting into mortgages that they could only afford in the short term, and then banks over-valuing those mortgages, and people using credit to supplement their income based on the premise that house prices are going to keep increasing is one of the major contirbutors to the crisis.
No, I’m agreeing that that is the problem. You made it sound like it was just compounding a bad problem that was already taking us down, which I disagree with, as I think that was the problem itself.
It’s bad. And? If the risks had been properly measured by the experts, this would have been a blip on the radar. It actually became profitable to not look too closely at the actual risk involved in various derivatives, for everyone, including the people who grade the risk, so greed won out.
And I’ve seen zero evidence that this is causing our current economic problems. Admittedly, if everyone had saved hundreds of thousands of dollars, we might be in somewhat better shape, but that’s not realistic, nor does it solve the problem that consumers just aren’t buying shit right now.
Again, that’s my problem with your thesis. There are always people who, for one reason or another, aren’t going to be able to afford their mortgages. Due to other factors, this number often rises and falls. That’s going to be true even with the most stringent lending standards in place. When you sell and resell packages of these, then sell other packages backed by these, then split up those packages and mix them with other packages of debt, then start doing credit default swaps, you’re going to have an ugly mess at some point. That ugly mess actually feeds on itself, as the resulting bust causes many people who were doing everything properly to suddenly wind up in the shitter. The goal of the greedy is to make their money before that happens, and screw the rest of us.
Again, many individual borrowers were stupid, but if there had simply been a loan between them and the bank that originated the loan, and had that bank (or other originator) known upfront that they were going to assume the risk, we’d be okay on the whole right now.
By the way, I’m pretty sure that this belongs in GD, unless we want to stick with “Take Econ 101 and then study macroeconomics and decide for yourself” as an answer.
DMC - sorry I wasn’t clear enough, I think the mortgages are the root of the problem, there are other issues that go with it sure, but it is the mortgages that is the killer. What I was trying to expound on a little is WHY bad mortgages causes the problem - which is what many
The problem with the mortgages going bad is that the cost of this was not properly figured into the price of all the credit swaps, and the risks were not properly evaluated.
To the idea that negative savings is not a problem, I would say the current crisis shows that it is. A national economy is far more complex than you family finances sure, but at the end of the day we know that you cannot continuously spend more than you earn (or “consume” more than you “produce”) or you are going to hit a wall - America has hit that wall now.
to go back to the OP - it is not a silly question. However demand is not steady. Do you buy a new car every year? Do you feel rich enough to but a new house? If enough people feel that way it can spark a increase in house builds or an expansion in car plants. That feeds onto an increase in building products, employ more people, more money floats around, more shops open. Of course it can go just as easily in reverse
In the past ten years the main factor making people feel rich seems to be the bubble in house prices and availability of easy credit.
The OP is right in that if everyone felt the same, produced the same then there would not be the same boom bust
This is my favorite typo this week!
:smack:
And I do proof-read my posts and then correct them if I see any further mistakes. Oh, well…
Think of it this way. Say I run a company and the staff Ive hired for 2009 is enough to take care of the business for all the things we are doing in 2009, that includes our expansion, moving into newer markets, and launching five new products. All these things are dependent on me getting the financing to pay for them. The banking emergency has made financing harder to get for everyone. So not only do I have to cancel or cut back on these projects, the people who would buy all my stuff do so with loans and they cant get any either. Suddenly, I have to cut all the people I hired for all these projects.
I didn’t say China was dead. I used a metaphoric expression to imply it was having huge difficulties. By any objective standard, the US economy also remains remarkably strong, too, but it doesn’t mean we’ve had no problems. China has laid off people by the millions - and that matters, even in a nation as large that.
Secondly, China’s growth is heavily dependant on global demand. The US isn’t their only customer, but we’re the biggest one, and what happens to us also affects demand for Chinese goods around the world. Finally, much of their growth is not quite what it appears because they are moving non-market farmers, who don’t impact certain statistics, to market systems.
The housing, or rather the overvalued housing market was the biggest problem.
It basically became a pyramid scheme. Here is a oversimplification of how it worked.
John Doe could afford $800/month for rent. That buys him a 1 bedroom flat. Then some reali estate agent says “What if I could put you in a 4 bedroom HOUSE for the same money.” He of course says “OK.”
Mr Real Estate says “For no money down and $800/month, you will pay that for five years. After five years your payments go up to $3,500/month.” Mr John Doe says “I can’t afford $3,500/month.” Mr Real Estate says “No problem 'cause your house will go up in value and you sell before five years.”
So you buy a house for $200,000 and make the $800/payment for five years. This of course goes soley to the interest. After four years you put the house on the market BUT the value is now $275,000. So you sell it, take the $75,000 you made off the sale and put a downpayment on a $400,000 house. This also has $800/month payments.
So you pay the $800/month and at the end of four years sell it but it’s now worth $550,000. You have made $150,000. Which you now put as a downpayment on a $700,000 house. This has $1,000/month payments, going toward interest only for five years.
So you live there five years, sell the house after four years and you sell it for $900,000. And you’ve made $200,000.
But what a minute!!!
Now 15 years have past your kids are grown and you no longer need a house. You can get by with a much smaller palce. You and your wife can get by with a one bedroom condo with a den, that happens to cost $200,000. So you pay cash outright for it. Now you have a condo and you own it outright in your retirement years.
If you had paid rent you would’ve had to pay at least TWICE as much and in the end you’d have no condo you own outright. PLUS you had the added advantage of tax breaks because you own.
OK this is an oversimplification, but as you can see it totally depends on the housing market, and prices of housing in general going up at a steady predictable rate.
When you oversimplify it it’s easy to see the faults in the logic, but when you complicated it with a lot of busy words and legalese and real estate-ese, you can see how applealing it looks.
Now you have many people stuck with house they bought that were over valued
You may have answered your own question here.
Suppose a large number of people are furiously building houses. The total number of houses exceeds what’s needed to actually house people, but for various reasons people keep buying, so naturally the builders keep building.
At some point, people wake up and say “Whoa - there are huge numbers of houses for sale, with lots more nearing completion. No one needs these. Easy money to buy them has dried up. Looks like the chance of selling them at a profit has disappeared.” If at this point those builders simply keep on doing what they’ve been doing, clearly things are going to get worse.
Circumstances change. The products and services that people produce must necessarily change with them.
As a non economist my take on it is this.
Many people were spending money that they didn’t actually have but would have in the future(Credit/mortgages on future earnings)
Other people were spending money that they didn’t have and would never in in the normal course of events ever have but were working on the expectations of getting a quick sale on the asset purchased(proprerty) at a profit and paying off their debt while keeping some money.
Because of this lenders were lending money to those they would not normally consider as they would not normally in the long term be able to pay them back and vice versa those who would never normally borrow money because their future earnings wouldn’t cover the debt went out and got themselves mortgages.
Because there was so much "not really real"money sloshing round the property markets prices rose beyond the true worth of the assets being traded back and forth not just slightly but heavily.
This would carry on until some institution lost its nerve and started calling the debts in,followed quickly by all the other institutions not wishing to be left holding bad debts.
And so the whole edifice came crashing down.
But as I say thats only my impression and I’m no economist.