The current macroeconomic situation and the global recession: the cause of the current world financial crisis.

Last time I discussed some introductory economics. This post, while somewhat of a tangent, is a product of the fact that I am sick and tired of hearing and seeing completely untruthful information about the current macroeconomic situation in the US and the global recession in regards to the cause of the current world financial crisis. Thus I felt this post was immediately necessary.

For the past few years many people (noneconomists) have thrown around all sorts of phrases and economic and financial jargon like supply and demand, inflation, money supply, GDP, etc. that they heard a reporter rattle off on the nightly news (as if those things actually mean something) as causes of the current world financial crisis and the current economic situation in the United States (as well as the global recession). Yes, those terms are important, but only in other contexts! They are not causes of the financial crisis at all. Keep reading and you will see why.

In short, the primary root cause of the current recession and economic crisis was the huge increase in the issuance of subprime adjustable-rate mortgages and the CDO's (collateralized debt obligations) that they made up. The amount of subprime mortgages issued in 2005 and 2006 increased drastically, while the issuance of prime mortgages actually decreased. Basically, banks loaned money (more than ever before) to people who would obviously default on those loans. People bought houses with these loans expecting housing prices to increase, but that didn't happen. 

Mortgages are securitized by the American government; they are pooled together and sold off in sections, which obviously spreads the risk and uncertainty to those who take part in purchasing them. This created a large, widespread web of risk, if you will, in that the securities are dependent upon their underlying subprime mortgage values. The value of the CDO's and their securities decreased and were miscalculated to begin with. Ratings agencies could not accurately determine their value, thus more uncertainty existed. This is why so many Americans lost their retirement, which was largely based on these mortgage-backed securities.

 

Worst of all, the federal government encouraged the purchasing of these securities without knowing the underlying risk involved. The web of risk was not limited to the US; it was worldwide (and still is). Major corporations like AIG, Citi, Chase, Bear Sterns, etc. held many of these risky CDO's and when they failed, everything that depended on them failed (many aspects of society).

 If all this helps at least 1 person, then this post will have been worth writing. I have a feeling that it will clear up some things for many of you. I hope it gives you a better understanding of the current macroeconomic situation in the US and the global recession in terms of the cause of the current world financial crisis. Feel free to comment or email with any questions.

Best,
Tyler