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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?