Chapter 10 - 10.1 Introduction In this chapter we learn...

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1 Chapter 10 The Great Recession: A First Look Charles I. Jones 10.1 Introduction In this chapter, we learn: – The causes of the financial crisis that began in the summer of 2007 and where the economy currently stands. – How the current financial crisis compares to previous recessions and to previous financial crises in the United States and around the world. – The financial crisis that started in the summer of 2007 and intensified in September 2008 marked the end of an era for U.S. investment banking. – Several important concepts in finance, including balance sheet and leverage . – The National Bureau of Economic Research determined that a recession began in December 2007 and was the worst recession since the Great Depression of the 1930s. 10.2 Recent Shocks to the Macroeconomy What shocks to the macroeconomy have caused the global financial crisis? – Housing prices Housing prices – Global saving glut – Subprime lending and rise in interest rates – Previous financial turmoil – Oil prices Housing Prices Housing prices tripled between 1996 and 2006. – “Housing bubble” Between mid 2006 and February 2009 Between mid-2006 and February 2009, housing prices plummeted by 31.6 percent. – The bubble “burst”
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2 The Global Saving Glut The current financial turmoil was caused partly by prior financial crises. – Ben Bernanke March 2005: “global saving glut” – Glut = “excess” The United States had an excess of savings with desire to invest. Higher investment demand contributed to rising asset prices in the housing market. Subprime Lending and the Rise in Interest Rates The savings glut led to low interest rates, and many borrowers took out mortgages to buy homes between 2000 and 2006. • Many of these borrowers were “subprime” Many of these borrowers were subprime – poor credit records – high debt-to-income ratios.
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