Thursday, March 19, 2009

Recession.. how did it happen?

. Thursday, March 19, 2009

Everyone knows that global recession looms into our daily life. But what is recession? and how did it really occur?

From wikipedia, recession is:
"a significant decline in [the] economic activity spread across the country, lasting more than a few months, normally visible in real GDP growth, real personal income, employment (non-farm payrolls), industrial production, and wholesale-retail sales."

In a recession, people tend to buy less because of financial crisis, and hence this affects the businesses because sales drop down dramatically. This drop in sales lead to people losing their job, and thus aggravating the issue. i.e if you lose your job, your will tend to buy less to save money, and this continues in a downfall of the economy.

Normally, the world revolves around transactions. lets take a simple example to illustrate this:
I work in company xyz and receive salary of around $1,000. i can buy household stuffs (ration) for around $500 max and the rest i can spend on luxury. Note that the money moves. from my salary(company xyz made a profit to pay me) to the shopkeeper. the shopkeeper buys goods from another company(wholesaler) and that company buys from the manufacturing company. manufacturing company buys raw materials, etc.. and this keeps on revolving.

now comes the financial institutions. They take your money as fixed deposit (you earn interest) and loan out this money to needy people.

The origin of the recession came when people who didn't had enough finance took loans to buy houses. This policy was heavily backed by the bush administration to promote more people into buying houses. The financial institutions, mostly banks, didn't know what they were doing. They are always ignorant: They just care about their money, and they thought they can recover it by selling the houses that loaners bought. But the problem was that too many people bought houses. Also, in USA, the bank contract is such that the interest they pay depends on the actual interest rates( if actual interest goes down, their interest on the loan goes down) .

However, the opposite was the truth. the interest rates went up, and many people could not afford to pay for the interest and loans. Then, banks (thinking they are the wisest) seized the houses. now the problem comes into selling the house. The banks need liquid money and not asset in terms of land and house. The biggest problem they faced was finding people to buy the seized house! you are probably aware of the demand and supply law. The greater the supply, the lesser the price gets! The banks were not able to find buyers at the price that they had originally loaned on. Therefore they had to settle on lesser prices and the houses were sold cheaper, thus the banks making heavy loss in the process.

The losses of the banks triggered a panic. Naturally many people seeing their bank in poor situation would want to withdraw their money as soon as possible. But the bank did not have enough money in possession.
Therefore, you could see many people buying lesser and lesser to save what they already have. The sales dropped dramatically.

Now you are wondering how this affected the world? well, simple. America is a country that imports the majority of its goods. Since the buying trend dropped in the US, the demands dropped. The exporting country/company's product are not selling as it should. and this provoked the domino effect.

As you might have noticed, only part of the world have been affected badly, namely part of Europe, china and the likes. This is because these countries have big companies that exported their products to USA. The big companies sells in bulk, and were the first ones to be affected by the impact! In Mauritius, our companies are not THAT big to feel the impact, and the government had made reforms that helped decrease the severity of its impact on us.

Another thing to ponder is: where did the money actually go so that we are in recession?
My opinion is the banks/financial institutions swayed it!
Our famous example is the AIG - How can the institution pay out $165 million in bonuses when it has just received a stimulus package from the government to save the company. normally, you get bonus are a reward for making profits in the company..! These financial people are the reasons for the downfall of the world economy. The swooped all the money (and keeping it idle with them), hence stopping the normal movement of the money as i described above.

Another potential source is the Madoff case, where this guys takes new investors money to repay old investors, and in the middle swindle the money! Read Madoff investment Scandal.
I believe there are a few more of this kind wondering around and stealing people's money.. They are not creative people to make the country progress, and they are money minded businessman..

Do you think the people in the financial sector should receive so much importance in terms of bonuses? (you must be aware the the banks in Mauritius also pay big bonuses to their employees)!
Are their work so much outstanding for this benefit?

How can the recession end? 
And when the recession end, what will remain? (you can already see many companies closing, some trying to be saved by the stimulus package)


carrotmadman6 said...

Good thing you simplified it - economics is a subject that doesn't fascinate me at all. But I still got lost among the houses... will read it later more slowly. ;)

As for Madoff, hats off to the world's greatest conman! :D

Yudz said...

it doesnt really fascinate me too, but couldnt resist criticizing america.. lol.
this issue has been going on for quite some time, so why not blog about it :P

Kurt Avish said...

Even I was a bit lost in these economic terms lol. Nice post atleast I know where the money went now lol.

Anonymous said...


Anonymous said...

i appreciate your post here which is a more simpler version of the daunting economics terms..thank u..good luck and keep up the good work..

Anonymous said...

This was so far the best explanation on how recession actually happened!! I actually understood it for the firsst time!! Keep up the good work!!

Anonymous said...

Am I part of the reason or just a result of the product. My wife and I worked at the same company. We had a combined total income of $187,000 per year. We finally bought a house in 2007 for $545,000 per year. We really didn't have any savings so our mortgage payment was $4,000 per month. Now, for about 2 years we made every payment on time. We made our car payments, ect... We "had" great credit. Our kids got (not everything) new things. We went out to dinner alot. Again, everything was being paid and everything was going great. Then we got the bad news that the company was going out of business. My wife was pretty high up in the company and hadn't heard any news of us going out of business. The company made alot of money. The CEO is now part-owner of the San Diego Padres. The CFO, Treasurer and VP of Sales are all millionairs now. I only bring that up because I'm just saying that the company was doing great. Business may have slowed down but like I said, my wife and I didn't see it coming. So My question is, am I part of the reason or just a victim of the economy?

Yudz said...

Thank you all for the feedback, its encouraging. Will try to bring on more similar posts of the kind soon : )

The recession is a big scandal.. it didnt happen by itself, it was made to happen. i think you should sue the comapany (or owner or something) for compensation and prove they swindled all the money. the recession is a big excuse to close a business, declare bust and go rich! It will be difficult, but not impossible. research well before threading on it. good luck.

Parag said...

The Government keeps meddling in the things they are not supposed to be, and neglecting the things they are. Everything is going to get worse, but no the world will not come to an end.
Did the recession end

Anonymous said...

The reason for these problems is that the rich have the surplus money needed to correct the economic problems. Until people are not allowed to be rich the problems will continue.

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