Lecture 2: Timeline of the Crisis & Basic Definitions

[Lecture 2: Timeline of the crisis and basic definitions] A few definitions: *Federal Reserve*- The US Central Bank - Regulates banks and changes interest rates. Does not issue loans. The equivalent of the bank\* *"Subprime" mortgages*- mortgages lent to people (usually in the US but incre...

[Lecture 2: Timeline of the crisis and basic definitions] A few definitions: *Federal Reserve*- The US Central Bank - Regulates banks and changes interest rates. Does not issue loans. The equivalent of the bank\* *"Subprime" mortgages*- mortgages lent to people (usually in the US but increasingly up to 2007 in the UK and Europe as well) who are seen as a bad credit risk because they have irregular work/ low wages or have been in debt before. - The financial crisis started due to mortgages. High possibility that people could not pay their loans. - Why would there be lent mortgages to people who were unlikely to pay it back? *Fannie Mae/ Freddie Mac*- US "Government backed" mortgage lenders *Dow Jones*- stock market index of US shares - Shows if firm markets are going up or down *Interbank lending market*- A market where banks lend to other banks. - Why should banks lend money to each other? *Libor-* London InterBank Offered Rate- the interest rate charged on the interbank lending market. - *Mortgage- backed securities*- financial assets deriving their value from mortgages (in the same way that shares- another financial asset- derive their value from company profits). These can be bought and sold on financial markets. *Auction rate securities*- Financial assets where large institutions raise funds by selling these bonds. Anyone wishing to withdraw their investment can exit via regular auctions to other people. After this the financial crisis turned into a world- wide recession. How did this happen? Briefly: a\) The collapse of so many banks and the "credit crunch" resulted in a lack of credit for businesses and consumers. In particular, lending terms became more difficult thus restricting the numbers who had access to credit. b\) This led to "credit rationing". Many businesses and consumers did not have access to credit, so this meant that they had less to spend on investment and consumption. c\) The lowering of spending on investment and consumption lowered overall spending in the economy. d\) As less was being spent, so fewer goods and services were being sold. As fewer goods and services were sold , so fewer were produced, leading to layoffs of workers and underutilisation of machinery. e\) This resulted in a downturn in GDP and employment, causing the recession. However, this is only an outline of what actually happened. The next lecture looks at *why* economies can go into recession and possible policies for bringing them out of recession.