THE CAUSES AND EFFECTS OF RECESSION

  • SumoMe

Dating back to 1997-98, the economies of various countries of Asia such as Thailand, Malaysia and Indonesia suffered major economic crisis due to huge investment in real estate. The money for investment came from not very renowned foreign sources and thus it led to crisis due to poor banking practices. Meanwhile Crony Capitalism (where a borrower is backed by the government. For example, a president’s son could open up a bank easily and attract borrowers to involve their money as it would be in safe hands due to official connections behind) came into being. With these crisis in existence, the Asian countries soon realized that there requires a need for Foreign Exchange Reserve also called Forex Reserve. Forex reserve deals with conversion of currencies between the countries and thus allows easy money flow. As a result, Asian countries started to buy a lot of reserves and the U.S. securities to build a good foreign exchange reserve from international banks. Thus, the countries made a tendency of saving as much money as possible and expenditure became much lesser. The global demand crumpled and led to an imbalance in the global economics. According to many illustrious economists, today high Forex has become one of the very important reasons for the current recession. If today recession has taken place, the Asians share the blame too. Let me explain it to you.

After 1997-98 crisis, the Asian economies started to buy the U.S. securities as mentioned above. This led to dispense of dollars into the U.S. The American economy got so flooded with dollars that it needed an outlet. The outlet came in form of a borrowing and spending splurge. The U.S. financial system works that what ever loans or schemes they offer, hides the flaws and risks with such erudition that a borrower is lured to buy them.

The two main reasons that attracted the borrowers were low interests and huge funds that helped easy loans for people. With such attractive promises, people took more and more loans to build houses and invest money. Since there was surplus amount of money in the banks, all the terms were relaxed and the demarcation between the prime and sub prime loans came at par. Banks merely looked for borrowers irrespective of their background, returning capacity and poor credit history. Borrowers were lured with incentives and bonus offers. The interest rates were also kept low initially and were meant to increase after the initial period. Despite of this borrowers continued to buy even those with a poor credit history called NINJA (No Income No Job No Assets). The house prices started to soar due to huge investments. The splurge proved a good time for all. The lenders and borrowers believed that the interest rates that would increase gradually or the soaring house prices will help in recovering of the loans. In case the borrower is unable to pay the interest, the houses could be sold off until the prices are soaring.

Now begun the complication when the overbuilding of houses caused a decline in the prices thereby grasping the returning capacity of the borrowers. The borrowers had no money to repay the loans and meanwhile the interest rates continued to soar. The situation became worst when the loan amounts exceeded the total cost of the house and gave way to the current recession. Recession in economics means a general slowdown in economic activity in a country over a sustained period of time, or a business cycle contraction. During recessions, many macroeconomic indicators vary in a similar way. Production as measured by Gross Domestic Product (GDP), employment, investment spending, capacity utilization household incomes and business profits all fall during recessions.

During recession sub prime loans came under immense limelight and turned out to be an excellent option for the banks. Many big investors bought such loans from the original lenders thus helping lenders with fresh funds to raise again. These investors were not only from America but also from the other parts and as a result the phenomenon remained no more confined to the U.S. The limelight of the loans remained until the prices soared. But as soon as there saw a decline, loans became unbeneficial and dicey.

Investors from all over the world who took loans faced major losses. These losses trickled down to other banks that were in chain with the international banks of America who formed the backbone of many banks. As the banks were left with no money, the major industries and companies worldwide that depended on loans from these banks for their activities faced closure. The recession became hazardous for the world market soon.

The effects it had on India were:

1) share markets were falling: If our share markets ever touched new heights, it was due to investments from international banks. Now that- due to recession banks- faced shortage of liquidity; they started to withdraw their investments from India.

2) The Indian currency got weakened against dollar: Before recession, banks continued to buy stock from India but now they are selling. The same stock thus converting Rupee into Dollars and weakening our currency.

3) Banks faced huge shortage of funds and soon collapsed: As banks kept giving loans and funds at reasonable terms. At the end of the day, they were left with nothing.

Comparatively, India faced much lesser effects of this hazard. On the other hand, Iceland has become completely bankrupt and a country such as America is under a dreadful shock. World’s greatest banks suffered losses and thousands of people lost their jobs. Statistics say 4000 jobs cut at Motorola, 100 at Google, Louis Vuitton cancelled the idea of setting up a mega store in Tokyo, Chanel have put down 200 staff in Paris and many other huge companies have done the same. Banks are short of money and capacity to run huge stuff has become impossible.

Recession is not something to deal with easily. Major economies and renowned economists are looking forward to solutions.

Nobel Prize winner Paul Krugman said up to $5 trillion money can expedite recovery from recession and projects such as Freight rail could bring fast money. Many more solutions have been talked about but things will not recover soon. In case all turns out to be in vain, time is the greatest healer. Let’s wish time moves faster than ever expected and the wound gets healed soon. At the end I would like to share a phrase I read somewhere on net that says Recession is ‘Greed of some, woes of Billions’.

Shelly Mahajan

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[Image source:http://www.flickr.com/photos/anders-vindegg/3388597525/sizes/m/]

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