The Effects of the Current Financial Crisis.

1

• The Effects of the Current Financial Crisis.

2
House Prices and Mortgages

• As we saw, the price of housing was driven by
  anticipation of rising capital value, not the
  need or demand for houses.
• Thus there was no real demand for houses
  justifying the insane prices.
• Once this is realized, then prices dont just
  fall, they collapse.

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House Prices and Mortgages

• People take out mortgages based on the value of
  the property.
• If the value falls, the mortgage remains the
  same, so the buyer is paying more than the
  property is worth.
• This is called Negative Equity.
• This has a psychological factor.

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House Prices and Mortgages

• The buyers used the increased value of the
  home, as prices rise to take out Home Equity
  Loans, to buy, e. g. cars.
• All this vastly increased the amount of domestic
  debt.
• This debt grew out of irrational exuberance or
  false expectations of eternal growth.

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Debt Fright.

• As house prices were rising rapidly, banks loaned
  to people with inadequate income or prospects.
• Why? Because they could sell the house for more
  than they borrowed, and get out of debt.
• After all, There is no better investment than
  property.
• Wrong. False confidence.

6
Debt Fright

• As house-prices fell, people now realized that
  they had investments they could not afford, and
  could not sell for enough to cover their debts.
• Builders and Developers, who had been building
  millions of houses, suddenly found that they had
  houses they could not sell.

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Debt Fright.

• Even if the buyers, who had unsupportable debt,
  wanted to sell their house, they couldnt.
• Rental took over from purchase.
• The buyers could not afford to pay their
  mortgages, and so they defaulted, which panicked
  the banks, and they tried to cover their losses
  by seizing the houses. Foreclosure.

8
Foreclosure.

• The banks have a totally short-term cash-flow
  perspective, and so they moved to foreclose.
• But the banks are not in the business of selling
  houses, and so they tried to sell foreclosures as
  fast as possible at whatever price.
• This further depressed house prices, and worsened
  the situation.
• If a house is foreclosed, the houses around it
  lose their price. Spiral.

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Bank Debt
As a result, nobody knows what the banks are
worth, and so they lose their value, and share
collapse.

• The key factor in the developing crisis is the
  banks.
• They do not know how much bad debt they are
  holdinghow many more people will default?
• They are making this worse with foreclosure!
• Since they do not know how many bad debts they
  have, they dont lend anything to anyone.

10
Mortgage Banks

• In some countries there are banks that
  specifically lend to home owners.
• They collapsed like a house of cards, especially
  in Britain.
• Lines of people were seen trying to take all
  their money out of the Bank ( a run on the
  bank).
• The Banks did not have the money.

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Confidence

• People now start to panic, this causes the total
  market to collapse.
• People stop spending.
• The big items go firstcars, fridges etc.
• This reduces demands, and puts people out of
  work.
• Further reduces demand.

12
Growth

• Growth comes to a stop.
• Bank paralysis leads to economic paralysis.
• The Finance Companies who had loaned billions to
  banks to fuel the idiotic housing bubble, needed
  their money back now.
• That finally ruined the banks, and many of the
  financial inst.

13
External Factors Energy

• As the housing boom rose, there was an explosive
  growth in the price of energy.
• Oil went from 40 bbl to 150.
• This ruined sectors of the car industry (SUVs)
  and people panicked even more about the ability
  of their income to cover the cost of living.

14
Trade and Revenue.

• During the growth madness of the 1990s and early
  2000s, the economy was driven by Consumerism.
• The goods for this demand were made increasingly
  by the cheap labor of China.
• US ran HUGE trade imbalance with PRC. China used
  its HUGE income to buy Treasury Bonds.

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Trade and Revenue.
Credit CrunchParalysis

• In this model, if consumers stop buying, the
  whole thing stops, in the USA and China.
• US government cannot raise tax levels, and cannot
  raise money through Bonds.
• Plus, very low interest rates do not encourage
  private investors.
• Low interest rates also encourage scams (Ponzi
  schemes) Madoff.

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Remember

• Low interest rates to encourage borrowing,
  suppress deposits (saving) by the
  publiccontradiction.
• Banks still having a problem not knowing how much
  debt they have.
• Paralysis.
• Fear of unemployment further suppresses
  confidence/spending

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Falling Share Value

• As demand goes down, the value of companies goes
  down along with consumer confidence and profit
  margins.
• Many people have invested in shares, and so have
  their pension funds.
• So they see their savings evaporatefurther
  confidence loss.

Sell Everything!
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Currency Slides

• With the lack of confidence, the collapse of
  banks and the eroding value of shares, this has a
  serious effect on the trading value of the
  currency, especially the British pound.
• In a global crisis, of course, all currencies
  would slide, canceling out the effect. But some
  economies worse than others.

Pound Exchange Rate
?
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Currency

• Governments struggle to save their currencies by
  deflecting billions into supporting the currency,
  which is more taxpayer money, and deflecting
  money from investment.
• As currency devalues, it makes the exports of
  that country more attractive, and imports more
  expensive.

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Deflation

• In declining demand, there is a rush to sell at
  any price and so there is a rapid decline in
  price.
• This further depresses the profit margin of
  companies, and unless it results in increased
  demand, the company is likely to go out of
  business.
• This was key element in US Depression of the
  1930s.

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Downward Spiral

• Closure of retailers leads to unemployment.
• Rising unemployment leads to further depression
  of demand.
• Which leads to further closures of retailers (one
  per day in the UK over Christmas).
• Which leads to unemployment among manufacturers

22
Social and Political Effects

• As unemployment grows, there is pressure on the
  governments for Protectionism.
• This was demonstrated by the Buy America clause
  in the second Bail-Out proposal.
• This could start a Trade War, but it sets
  politics against economics.

23
A Quote

• Mr. Putin, an unlikely source
• do not react to the crisis with unrestrained
  economic selfishness.
• Another possible mistake is excessive
  intervention by the state in economic life.
• It shows the bankruptcy of the law of the
  jungle capitalism that no longer invests in
  companies and job creation, but instead makes
  money out of money in a totally uncontrolled way
  (Martin Schultz, Chairman of the Socialists in
  the EU Assembly.)

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Immigration

• As unemployment grows, then workers increasingly
  resent the presence of immigrant workers when
  there is competition for jobs.
• This can become violent and again puts serious
  pressure on the politicians.
• We can see this in the UK, France Poles,
  Bulgarians

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Effect of Developing World

• Many of the developing countries export raw
  materials, and the demand for these will fall, as
  manufacturing falls.
• AID and investment will also fall, and these
  countries cannot afford this loss.

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Conclusion

• Banks need to lend, but wont
• Confidence needs to be restored, but how?
• Mortgages need to be stabilized
• House prices need to relate to real demand
• Spending needed to get the economy moving again.

Its better you dont ask