We are now living in one of the worst global financial crisis. This is proven by the fact that a lot of economies are going into recession and trillions of stock values were wiped out. Aside from these, a lot of companies have reduced their earnings with a lot of plant closures and job lay offs.
We often hear the word recession. We’ve watched news that Singapore, Germany, Japan, and New Zealand officially declared recession in their economies. But what is recession? And what caused it?
Recession, in economics, is defined as the contraction of an economy’s Gross Domestic Product for at least two consecutive quarters. That means the economy shrank.
We all know that the world’s largest economy is that of the United States. A lot of countries depend on them most especially countries which depend on export products. There’s this popular saying that “when United States sneezes, everybody catches a cold”. This is so true nowadays which is evident in the domino effect of the global financial crisis with a lot of economies caught colds.
What caused the recession? The problem started in the United States with the so-called Subprime Mortgage Crisis. The crisis was triggered by the rise in mortgage delinquencies leading to foreclosure of houses and ultimately a credit crunch leading to a freeze in liquidity.
Subprime Mortgage are mortgages given to high default risk credit borrowers. A lot of mortgages issued in US are called subprime which means that little or no downpayment was made by the borrowers to buy houses, cars, etc. Some credit were even given to low income families or with bad credit history. Because of the nature of these mortgages, a lot of borrowers defaulted on their loans which led to banks foreclosing securities of these loans including houses, cars, etc.
All these accumulated and led to the “credit squeeze”. There were no more cash available to other borrowers as all these cash were frozen to foreclosed houses with no willing buyers. The tightening of credit led to a slow down of the economy as there were no more loans available to other borrowers which they can probably use as capital in their businesses. Now, this led to a series of events:
Low Demand. Because of the tightening of credit, there was a slow demand of products of these businesses.
Decrease of Profits. Because of low demand, then there was a decrease in profits for these businesses.
Plant Closures. Because of decrease of profits, then companies need to shut down some of their plants to reduce costs. There was also a notable increase in bankruptcy filings.
Job Lay Offs. Because of plant closures and bankruptcy filings, then companies laid off a lot of their employees and unemployment rate rose.
Stock Market Decline. All these series of events led to the rampant fear of stock investors dumping their stocks which led to tremendous wipe outs of stock values.
The United States and other countries are all doing their best to combat this financial crisis by using different strategies including the recent US$700 Billion bail out plan to increase liquidity in the economy. US Treasury is providing millions and billions of loans to ailing companies to sustain this financial crisis and prevent further recessionof other economies.
The current recession have caused some companies to succumb and declare bankruptcy. Two of these companies include Six Flags, the world’s largest theme park and CIT Group, the American commercial and finance company.
What about a more severe type of recession called depression? I did some study specifically on what caused “The Great Depression” in the 1930s.