Transcript The Great Recession - ucsc.edu) and Media Services

The Great Recession
Causes & Prospects
What is the “Great Recession?”
• Decline of speculative
markets in 2007
• Bursting of the real estate
bubble
• Decline in credit, even with
cheap money
• Decline in circulating money
• Drop in production & job
losses
• High unemployment
• Low growth & growing
government debts
• As Morris argues, the stage
was set long ago
Let’s go back to the beginning
• Consumption in the U.S. has
been subsidized by low-cost
imports from China
• Wages had more buying
power & hardly grew
• After dot.com crash in
2000, Fed lowered interest
rates
• This made money cheap
• Cheap money seeks to earn
high returns
• Real estate looked good
So, where did this cheap money come
from?
• Equity pulled out of houses
financed consumption
• Consumers bought low-cost
goods from China
• Dollars flowing to China used
to buy Treasury bonds
• This is a “loan” to the U.S. at
low interest rates
• Allowed U.S. to continue to
consume Chinese goods
• Also permitted tax cuts & high
military spending
• China grew, as did it dollar
holdings
This shows how the money circulates in “Chimerica”
Economy grows via increases in
consumption of goods & services
• Stagnant wages posed a
problem for growth
• Real estate became focus of
investment & cheap money
• Low interest rates & high
growth in housing prices
• Homeowners could take out
cheap equity loans to consume
• Speculators could realize high
returns from flipping houses
• Both real & speculative
economies were juiced
Mortgages used to be held by lenders
• Home buyer went to
bank to borrow funds
• Bank held a lien on the
house to secure loan
• Mortgage owned by bank
• But bank can only loan
out 10x its deposits
• If it can sell mortgage, it
gets new money to loan
• And it can further
leverage its assets
When money is cheap, highly-secure
mortgages don’t return much (4-5%)
• But they can return more
if they are high-risk
• Sub-prime mortgages
• Lenders can borrow low
and sell high (8-10%)
• To mitigate risk, they
bundle them with lowrisk mortgages
• These packages are sold
to investors as CDOs
• “Collateralized Debt
Obligations”
This is how a CDO works…
So investors, speculators, pension funds,
hedge funds, banks, etc. bought CDOs
• The market in CDOs took off and their
prices rose
• Value is linked both to interest paid
and price of CDO
• Each CDO is made of layers of low- &
high risk mortgages
• Combined return can be high
• But what happens if the high risk
mortgages go bad?
• No one wants to buy them—so their
“real” value is uncertain
• If there is no market, there is no
price
• As assets, CDOs suddenly become
worthless
• Banks don’t know how much money
they have
The Great Recession is the result of a
sudden collapse in the global money supply
• The “real” economy was
supported by cheap money
• Speculative economy took
up excess money supply
• Inflation & interest rates
were low
• When securities markets
froze up, paper had no
clear value
• This made financial actors
insolvent
• Money stopped moving
What happens next?
• Speculators continue to look
for places to invest
• Investment in such markets
does not create jobs
• Governments (UK) seek ways
to reduce budget deficits
• They lay off large numbers of
employees
• Consumption & wages are
stagnant, so little growth
• Prices could begin to decline:
deflation
• Even less consumer spending
• What is to be done?