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The World Recession
Sheet Number: 20114459
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All over the world people buy and sell things everyday. Companies sell their products and the general public buy these products. This whole activity is known as the world economy. When the economy starts to slow down and people are not buying as much while companies are not selling as much, this is known as an “Economic Recession”. We all have heard of it, so lets explain how this present economic recession happened in the first place.
Repaying capacity of their new 5 customers. So now we have a situation were people with low incomes and bad credit history were given loans. Loans of this nature that were given out to people with a bad credit history were known as “SubPrime” loans. As demands for homes increased, so also did the value of property, with many people taking out further loans at attractive lower interest rates. These lower rates were offered for an initial period of time and were known as “Adjustable Rate Mortgage” (ARM).
Effects on the World
So, How does this American housing problem cause a worldwide recession? The “Sub-prime” loans offered by the lending agencies were seen as an excellent investment and a very lucrative addition to their investment portfolio. They figured that the higher interest rates given on the Sub prime loans would yield a higher return from the borrower. If the borrower could not repay the loan, the agency could exercise its power and have the house repossessed and sold at a
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The current financial crisis that the world is experiencing at the moment can be traced back to the activities of the housing market in America for the last number of years.
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When an economy moves very fast, people buy and sell things very quickly. Banks enable this to happen by lending money to individuals and companies for the purposes of spending.
As more and more home loans were being granted, the demand for property went through the roof and drove house prices up even further. With large amounts of money to lend, the loan agencies decided to relax
So, the housing market is at an all 6 time high and the overbuilding of houses has now led to an over supply of new homes. This overbuilding of homes has now led to property prices to decrease. Once the prices of houses started to fall, refinancing would become more difficult. Homeowners expecting to get refinanced due to increased property prices were now unable to avail of further loans and began to default on their existing loans partly because of
high market price to recover their loan. So, whatever happened, the sub-prime loans were looked upon as very good investments. As the economy was booming, big fund investors such as hedge funds looked upon the subprime loans as a fantastic investment opportunity. They started to buy these sub-prime loans from the original lending agencies to add to their own investment portfolios. The original lenders were quite happy to sell as it gave them fresh funds to
The Lending companies were also in trouble too. They had repossessed all these properties and could not sell them due to the falling house prices.
13 The large American and European
The original loan which they had issued was now worth more than the house, so they had no option but to write off losses on these loans.
As the banks investment portfolios were wounded and the losses increased, the entire banks capital would be destroyed.
investment banks that had invested in these “Mortgaged Backed Securities” were now in trouble as the loans had now lost their value.
Back in the late 1990’s, a major 3 boom in the housing market in America was driving the economy to a new high. The low interest rates together with large injections of foreign funding created easy credit conditions for people to obtain home loans.
the resetting of their interest rates by the lending companies.
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It would take some time to figure out how big the losses would be and which banks had been hit the hardest.
18 As the money market is important to 17 A recession is part of an economic any bank for the release of funds to cycle. It has happened before and will the economy, this breakdown of trust probably happen again. between the banks has hurt cash flow to the public. The main thing to remember is that the world will continue to go around When borrowing becomes a problem and although recessions can be a very for companies and individuals, the worrying time for people, they do end tendency to be careful and not and the cycle of prosperity returns overspend on things that are not bringing with it new and exciting necessary becomes part of peoples possibilities. way of living. When this occurs, it can be said that we are in an economic recession.
at reduced prices.
11 So, these original loans that were
All of a sudden the sub-prime loan market became a very attractive investment opportunity for large American and European investment banks. They bought heavily into these loans which were now known as Mortgaged Backed Securities (MBS).
14 As it turned out, the losses were
As the greed factor kicked in, many of the lending agencies didn’t take too much notice of even checking the
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This led to an increase in the surplus of homes available. This in turn drove the prices even further down increasing the risk of repossession to peoples homes due to default payments.
Already by 2008, over 10% of American home owners had zero or negative equity meaning that their homes are worth less than their mortgages. Because of this, it was easier for people to walk away from their loan then to try and pay their mortgages. Because of default payments, more and more homes were being repossessed. As well as this, people were unwilling to sell their homes
10 Offer as loans once again.
their loan conditions to enable 4 even more people to start borrowing. With bonus incentives, loan agents were now very eager to find as many potential home buyers as possible. Because the property prices were getting higher and higher, the main aim for lending institutions was to grant loans to as many potential customers as possible.
However, when the house prices started to fall, the sub-prime loans were now looked upon as too risky. As the interest on the loans increased and house prices decreased, many homeowners decide to default on their mortgages and vacated their properties.
15 Money Markets have also been
monumental. Global banks and brokers have had to write off over 500 billion dollars in sub-prime losses to date. This ongoing panic within the banks has now swept across the world. When a bank incurs a loss to its net capital, its ability to give loans out effects a lot of different areas.
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confined to the USA , were now part of the world financial markets. These MBS investments would have been fine as long as the house prices in America continued to rise.
affected by these huge losses by banks.
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The money market is actually an interbank market were banks borrow and lend money to each other for short term funds. As a result of the heavy losses incurred by banks, their own money market has now shrank as each bank becomes paranoid of each others ability to honour commitments.
Companies big and small depend on the banks capital to run their businesses.
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Santiago 2012
What is a world economic recession?