intitiation to the economy and geopolitics

sub prime crisis

a financial crisis that severely affects the functioning of the financial system (banks)

housing bubble

• from the 1990s until february 2007 the prices of houses in the US increased by 130%

• a bubble is when the price does not correspond to its fundamental value

• the bubble eventually had to burst

what was the cause of the US housing bubble

• low interest rates; during the period from 2000 to 2003, interest rates in us were lowered from 6.5% to 1%

• it encouraged people to borrow money

• in the early 2000s the US enjoyed a period of low inflation, low interest rates and stable growth

• due to the stability of the economy, people were willing to take more risks

consequences of the US housing bubble

• led to a decline in mortgage requirements without taking sufficent account of repayment capacity

• financial institutions started to provide loans to sub prime borrowers

• real estate prices would always rise and if sub prime borrowers were unable to repay their loans, banks could seize the houses and recover the loan amount

consequences of the US bubble burst

• people had difficulties to refund their loans which had become very expensive due to rising interest rates

• the massive default to property foreclosures

• banks had to sell houses held as guarentee to recover loans

• as house prices were low, banks suffered losses as they could not recover the full amount of loans

• the increase in seizures has pushed fown further as the supply of homes on the market increased

• this bubble could have been restricted to the housing market in the US but it spread to the financial markets and it became a global financial crisis

why did the housing bubble spread to financial markets

• complex financial instruments allowed investors and financial institutions from all over the world to invest in the US real estate market

• banks repackaged and sold bad debt, including loans and morgages to investors in a form of bonds (asset securization)

• poor risk regulation by the financial system

• risk was spread throughout the system because of the complexity of the financial instruments

• the financial system was not aware of the risks taken and there was no safety in the system

• this led to a complete loss of confidence in the financial system

lack of adequate regulation

• regulators gave insufficient attention to the stability of the financial system

• the financial sector became increasingly unstable, it was a systematic crisis

• confidence in the entire financial system disappeared; nobody was willing to lend to eachother

• there was an extreme credit crunch in the economy and it affected other sectors of the economy which were heavily dependant on credit

credit crunch

corresponds to a restriction of credit offered by banks following a banking crisis

what has the FED put in place to contain the crisis

• government responded with fiscal stimulus and monetary policy expansion

• financial crisis led to a worldwide recession with huge unemployment and falling financial asset prices

• later contributed to the euro zone debt crisis

inflation to recession

inflation leads to a decline in purchasing power which negativley impacts household demand, the reaction of public policies to fight inflation (essentially by rising interest rates) affects economic activity

inflation becoming structural

• trade war; example of rising custom duties in the US

• rising demand for sustainable development will push up prices

• accelerating the reduction of greenhouse gas emissions represent a cost