Bail Outs, Stimulus Packages, Recession, Oh My!

Making Sense of The Economic Crisis

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There is enough talk of the economic crisis out there to make a girl’s head spin!  Whether you’re gainfully employed, just lost your job, rich or poor, we are all affected by the fact that the USA is in a recession. But really, how many of us actually understand what is going on with economy?

Fab & Fru wanted to learn more, so we turned to our old friend Ben Carliner, who just so happens to be the Director of Research at the Economic Strategy Institute in Washington DC.  We asked Ben to give us a brief overview of this mind-boggling situation…

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money icon.jpgTHE DEBT SET

Ben says the easiest way to understand what is happening to the economy is to draw an analogy to your own personal finances.  If you have been living beyond your means for years, chances are you have racked up too much debt and you are struggling to pay it off.   Well, America, like many individuals, is in some serious debt. We have borrowed too much money, and we consume more than we produce.  When you hear economists use terms like “current account deficit”, this is what they are talking about: the difference in what we spend abroad and earn abroad in a year (what we import vs. what we export).

money icon.jpgHOUSE OF CARDS

The housing crisis is one of the biggest contributors to the recession, and it’s the reason that we have seen so many banks go under. As the real estate market across the country sky-rocketed, banks gambled that housing prices would continue to rise, and many of them relaxed their lending policies by approving high mortgages often to people who were buying out of their price range.  The security for the bank was, that even if the buyer defaulted on their loan payments, the bank could seize the property in foreclosure and, in theory, get their money back by selling it.

Over the years, it has become common practice for banks to create, bundle together, and sell their Mortgage-Backed Securities (MBS).  MBS are asset-backed securities whose cash flows are backed by the principal and interest payments of a set of mortgage loans. Payments are typically made monthly over the lifetime of the underlying loans.

Banks often sell their MBS to secondary markets (like investment firms on Wall Street) in a similar way that bonds are sold.  The collective revenue stream from the mortgages is then used to pay the investors in these securities.  So, when times are good, MBS can be an attractive place to invest your money.   However, when the real estate bubble finally burst and housing prices went down, banks and private investment firms found themselves sitting on a bunch of bad loans for properties that no longer were worth what they once were.


In the long run, just like when it comes to our personal finances, the stock market just can’t ignore reality.  Many people lost a lot of their savings in the stock market (although over time they may recover their money), their homes are now worth less, their jobs are in jeopardy, and they still must find a way to pay their monthly expenses.  So, what do people do when money gets tight?  They try desperately to cut their costs.   This means people are buying less and therefore less money is fueling the market place and as a result the economy is shrinking.

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