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The Effects of the Current Financial Crisis.

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The Effects of the Current Financial Crisis. House Prices and Mortgages As we saw, the price of housing was driven by anticipation of rising capital value, not the ... – PowerPoint PPT presentation

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Title: 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.

3
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.

4
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.

5
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.

7
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.

9
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.

11
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.

15
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.

16
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

17
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!
18
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
?
19
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.

20
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.

21
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.)

24
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

25
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.

26
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
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