Causes and Dynamics of the Current Financial Crisis

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A financial crisis has occurred regularly during the past century, as it was again in 2008. It will likely similarly happen in the future. Similar problems have occurred throughout history, and the only real difference is that modern concerns tend to be more acute, more frequent, and, thankfully, more quickly resolved.

THE NORMAL STATE OF THINGS BEFORE THE CRISIS

Typically, a crisis follows a sustained period of economic expansion, rising employment, and brisk activity. In most cases, businesses and individuals face the following:

After a lengthy period of prosperity, economic activity across the entire society is at a record high but is starting to fall.
– After a sustained increase of 300% or more, stock prices have hit an all-time high but are now beginning to fall.
– Real estate property values have risen sharply over the past few years—by as much as 300 percent—but are starting to level out.
– Aggressive investments made with borrowed money often lead to a company being too large for its good. Companies expect huge returns on their investments even though they have yet to bear fruit, assuming that overall expansion will continue unabated.
– The average person also has substantial debt after making significant investments in housing and luxuries. They’re having trouble making their initial debt payments but expect it to disappear when their revenue increases.

STAGES AT THE BEGINNING OF THE CRISIS

The crisis’s early appearance is typically subtle. Things can turn around in this window, and the economy can recover with minimal damage. The following sequence of events can be seen unfolding in this early stage:

More and more businesses are having trouble keeping up with their loan payments since they are finding that their significant investments are not generating the returns they had hoped for. They have stopped investing and started selling off assets suddenly.
More and more people are coming to terms with the fact that the size of their debt exceeds what their discretionary income can pay off. They’ve reduced spending and are unloading their extra possessions and real estate.
Reduced consumption and investment mean businesses are seeing a steady decline in orders, sales, and workload.
– Companies and people everywhere are seeing their earnings fall, and many are experiencing losses.
Stock prices are falling by 20-30% on average recently.
– There has been a drastic drop of 20-30% in the value of property rewards.

WHERE WE ARE IN THE CRISIS PROCESS NOW

At some point, things may take a turn for the worse, creating a full-blown crisis from which there is no simple exit. A tipping point is reached when a certain percentage of people and businesses, say 10%, recognize they can’t afford to pay their bills and that liquidating assets won’t erase their debt. These characteristics characterize a full-blown crisis:

Companies’ activity and profits are falling off a cliff.
– Numerous businesses suffer devastating losses every year.
– The percentage of businesses and households struggling with debt has recently increased.
– The rate of bankruptcies has increased dramatically.
– There has been a sudden increase in the jobless rate.
– Financial institutions are under extreme pressure when borrowers default on their loans and collateral loses value.
– To offset their losses, struggling financial institutions have significantly increased their interest rates. But this action worsens things for other financial institutions, people, and businesses, thereby speeding up the crisis.
– Many financial institutions collapse and go insolvent.
– As a result, there will be significant liquidations of equities and real estate. Individuals looking to shed some debt and financial institutions looking to stem losses on loan portfolios drive the sell-offs.
– The massive selling causes the stock market to drop by another 50%.
– Similar to the stock market, the real estate market might drop by half or more due to large-scale sales.

THE MARKERS OF THE FINAL CRISIS

The final phase of a crisis is unusual because governments usually intervene to restore some financial stability.

Production of products and services in society has dropped by 30 percent or more and is still declining due to the final crisis. No new money is being invested, and no construction is being done. Unemployment is sky-high, estimated at 30% or higher.

The economy has virtually wholly collapsed, and at this point, people can only pay for their basic needs, such as food and energy, on a day-to-day basis. The society’s industrial facilities and organizations have broken down by at least 30% due to a lack of upkeep, making a rapid recovery impossible.

FINALISING THE CRISIS

All debt-reduction sales must close before the situation can be resolved. Then, everyone in society must learn to live with defeat. Debts incurred by parties unable to make good on their obligations must be forgiven. The remnants of the defunct businesses must then be pieced back together into fully operational organizations. Once that happens, society can gradually regain its footing.

WHAT Brought on This Crisis

Companies and consumers’ unrealistic expectations during the preceding period of economic expansion are primarily to blame for the current catastrophe. People of this mindset tend to assume that the current phase of economic growth will never end. They also tend to think too highly of themselves, believing they will come out on top in each challenge.

Because of this optimism, which all humans share, all actors borrow enormous sums of money to purchase real estate, luxuries, and corporate growth. This trend toward expansion typically continues at a rapid clip until it finally hits a brick wall.

One reason is that bank executives are motivated by the prospect of substantial short-term financial gain at the bank’s and the borrowers’ expense if they lend as much money as possible to the latter.

HOW TO STAY OUT OF MONEY TROUBLE

Future crises can only be averted if banks are banned from lending money to people who don’t have a solid plan for paying it back. Only government laws establishing hard and fast requirements for any loan over a particular threshold will accomplish this.

Financial institutions mustn’t be permitted to offer CEO compensation tied to the number of mortgages they originate.

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