Recession
Definition
A periodof generaleconomic decline; specifically, a decline in
GDPfor two or more consecutivequarters.
In economics, a
recession
is a general slowdown in economic activity over a sustained period of time, or a business cyclecontraction.
During recessions, manymacroeconomicindicatorsvary in a similar way. Production as measured byGross Domestic Product(GDP), employment,investment spending,capacity utilization, household incomes and business profits all fall duringrecessions.
. A recession is a decline in a country's gross domestic product (GDP) growth for twoor more consecutive quarters of a year. A recession is also preceded by severalquarters of slowing down
US Sub-Prime Mortgage Crisis: 'AnUnknown Unknown
Introduction
Sub-prime stories continue to pour in. There is gloomy forecast that the US sub-primemortgage crisis might convert into recession that could be as great as the Great Depressionof 1930's that lasted over a decade. The sub-prime crisis that started in 2004 and 2005 isextended to the current economic cycle world over.In US, homeowners select a mortgage lender who gives the loan after inquiring theborrower's creditworthiness and the property that serves as collateral. The lenders resellthese loans to investors or Wall Street firms, who in turn bundle thousands of mortgageloans from different lenders into mortgage backed securities. These securities are oftensliced and diced into different structures like Collateralized Debt Obligations (CDO), rated byrating agencies like Moody's, S&P, Fitch etc. and are finally sold to institutional investorsworldwide- mutual funds, banks, hedge funds, central banks and pension funds.The US mortgage-backed securities market is the largest fixed income market in the world,with over $8 trillion outstanding followed by US treasury market with around $5 trillionoutstanding.
These mortgages do not create any problem for lenders until the mortgagers fulfill theircommitments in time. But with rising payment obligations, sub-prime mortgagers ran forforeclosures. Sub-prime mortgage refers to the lending by the banks and other financialinstitutions to borrowers with poor or no credit history or variable income flows. Borrowerswith the higher-than-average risk profile because of low creditworthiness are charged ahigher interest rate for loans. These loans are considered sub-prime.Source: Office of Federal Housing Enterprise Oversight
Causes of Bubble in the housing market:
•
The demand for housing like any other commodity is dependent on demand andsupply. So, the increase in disposable income and decline in interest rates onmortgages encouraged home ownership among US consumers.
•
The bubble burst when the demand decreases while the supply increases.
•
The increase in interest rates in US makes homeownership costlier for some buyersleading to defaults and foreclosures adding to supply in the market.
•
Similarly a decline in the general level of economic activity in US lead to lessdisposable income in the hands of consumer leading to decline in demand.According to Bryson, US sub-prime market accounts for about 20% of the total USmortgage market. The heat of sub-prime crisis is not limited to US but is faced world-over.Though, China holds more than $250 billion and Japan holds close to $200 billion of mortgage backed securities, but the worst affected nation is UK because China and Japanhave very low exposure to corporate mortgage-backed-securities where sub-primemortgage sits. UK held $44 billion in corporate MBS accounting for the bulk of its exposureto US mortgages making it most susceptible to risk after the shocks. So far, losses havebeen reported from France, Germany, China, Australia, Japan and U.K. in addition to US.But this is just the tip of iceberg. There are likely to be many more casualties over the nexttwo years.
Origin: Cause of Sub-Prime Crisis
In the recent times, many sub-prime mortgages are offered at below the market rate of interest-that marks the beginning of crisis. But the seeds of the crisis were sown long backby Alan Greenspan, ex-chairman of Federal Reserve Bank. The inflationary policies of Greenspan are largely responsible for the defaults in the US housing market. His plan topump billions of dollars in the economy via lower interest rates paved the path for theeconomic slowdown.Source: Federal Reserve, Bureau of Economic AnalysisThe interest rates have declined from the high of 6.5% in 2000-01 to a low of just above1% in 2003-04 before it started moving north. US middle income class saw it as goldenopportunity to expand its stagnated income. Consumers took these mortgages with thehope to re-finance them after a few years at an affordable rate of interest. These mortgagesare in-turn packaged into pools and sold as high-yielding securities to the investors.Investors even started borrowing money from the market to invest in high-yieldingsecurities. This massive borrowing spree and uncalculated investment created a bubble inthe market. By the time this bubble burst, it left millions of people in hell.Greenspan's moves were aimed at masking the economy from the piling current accountdeficit. According to the Bureau of Economic Analysis (BEA), current account deficit (thebroadest measure of the U.S. balance of trade in goods, services, and payments to the restof the world) stood at $835 billion in the first quarter of 2006. This burgeoning US currentaccount is financed by capital account inflows. It means that US must attract a net capitalinflow of $70 billion per month to finance the current account deficit!!!!!But how long can US depend on China and Japan to finance its trade deficit? The trade
of 00
Recession
1,362 Reads
Info and Rating
| Category: | |
| Rating: | (1 Rating) |
| Upload Date: | 06/22/2009 |
| Copyright: | Attribution Non-commercial |
| Tags: |
Leave a Comment