political econ: Ukraine & inflation

what is a financial crisis? + cause of subprime crisis

a crisis that several affects the functioning of the financial system (banks, investment banks etc)

subprime crisis (2007-2010)
the immediate cause was the burst of the housing bubble in the US

what is a housing bubble? + subprime crisis info

that’s when the price does not correspond to its fundamental value

from 90s to Feb 2007, prices of houses increased by 130% (more than double)
→ housing bubble, out of proportion prices
→ this bubble eventually had to burst

what was the cause of the housing bubble? why did the house prices increase so much?

economic context of early 2000s in US: low inflation, low interest rates, stable growth

low interest rates (stimulate economy)
2000-2003: 6,5% to 1% → people borrowed money

stable growth
→ people were willing to take risks

2003: start of war in Iraq, energy & oil prices rise

what were the consequences of the housing bubble?

mortgage requirements decreased

banks provided loans to sub prime borrowers (low credit solvability)
→ they thought real estate would always rise and if the sub prime borrowers couldn’t repay loans, the banks could sell their houses (worth a lot) and recover the money

SO:
housing prices were increasing
it was easy to borrow money (even for low income people)
→ people wanted to buy houses as investments

bankers increased interest rates for subprime borrowers as a guarantee
the borrowers are fine with it cause they think the prices of there houses will also go up

BUT real estate prices crashed
people had high loans and their houses weren’t worth enough to repay them

what happened when the housing bubble burst?

September 2007, real estate prices decreased by 25%

1. housing market was saturated
   the people who wanted one, had one; so decrease in demand

2. the Fed (US central bank) raised interest rates (2004-2006) to fight inflation
   home loans became expensive and less people wanted one

turning point for subprime crisis: the Fed’s decision to raise interest rates

what were the consequences of the burst of the housing bubble?

people couldn’t pay back their expensive loans (raised because of higher interest rates)

(property loans are flexible/adjustable)

this was a mass problem:
many houses were seized, banks had to sell houses to recover their loans

BUT house prices were low (bc demand was low and now even more houses were on the market) → so banks suffered losses bc they couldn’t recover their money

this was a sub-prime mortgage crisis

this could’ve been restricted to housing market in US
but eventually spread to financial markets AND whole world AND became a global financial crisis

why did it spread to financial markets?

complex financial instruments
global investments in US real estate
asset securitisation: banks repackaging and selling bad debts to make money quickly
risks of finical products wasn’t completely understood (or ignored)

poor risk regulation by financial system
financial instruments were complex (intricate structures and mix of different components)
financial system was unaware (or didn’t want to be aware) so there were no safety nets
liberal systems, little regulations
→ people completely lost confidence in financial system

lack of adequate regulation
regulators didn’t pay enough attention to stability of system
crisis started, people/banks were unwilling to lend to each other
extreme credit crunch in economy
→ affected other sectors dependent on credit

what is a credit crunch?

a restriction of credit offered by banks
follows a banking crisis/sudden shortage of funds

what did the Fed do to contain the crisis? what were the consequences?

fiscal stimulus and monetary policy expansion
(emergency loans, bail outs and lowered interest rates)

a worldwide recession, huge unemployment and falling financial asset prices

later contributed to euro zone debt crisis too

where does the current crisis come from?

the main problem is inflation.

inflation came from:

post covid demand rebound (reinforced by Biden stimulus)
→ excess demand, prices rise

war in Ukraine: supply deficits
→ can’t keep up with demand, prices rise
(less gas supply, less agricultural products like sunflower oil)

what is the American Rescue Plan Act of 2021?

helping US recover from devastating economic and health effects of the COVID pandemic

passed the House on Feb 27, 2021
passed Senate on March 6, 2021
signed into law by Biden on March 11, 2021

cost 1.9$ trillion, one of largest economic rescue plans in US

efforts to limit economic effects of pandemic + strategies to fight virus

can inflation turn into recession?

inflation leads to lower purchasing power
→ less household demand, a key driver of economic growth

public policies trying to fight inflation affects economic activity
(usually done by rising interest rates)

imported inflation is also important in this

→ inflation can negatively impact economy, leading to recession

how does inflation become structural? + current situation

slower globalization could cause higher prices
- causes: trade wars like rising custom duties in US, pandemic

more demand for sustainable development
→ pushes up prices, reducing emissions is costly

in France, people buy less food due to inflation prices
garment prices are increasing (but less than other sectors)
but decrease in relative price of garments (more production, fast fashion)