Events That Can Worsen The Subprime Mortgage Crisis

What can worsen the current crisis?

(1) Further fall in consumer confidence. If US consumers totally lose confidence with the way government is handling the current subprime mortgage crisis, they will further cut their consumption into the economy. They are afraid to make credit commitments over the fear of job losses. Retail sales will further fall. House prices will also fall thus worsening the negative equity

(2) Increase in savings. Closely related to paradox of thrift, an economic theory propounded by J.M. Keynes. It states that if everyone thinks that by saving money during recession will do them good, then they are wrong. Fall in consumption will lead to fall in AD, therefore economic growth falls too. In the end, everyone is worse off

(3) People rushing to withdraw money. All due to imperfect information. News about giant insurer like AIG or even banks on the brink of collapse will cause everyone to rush to the bank to withdraw money, even from financial institutions that have healthy balance sheet. The further constrain in liquidity will cause the whole financial system to collapse

(4) Stringent lending. Remaining banks are now more stringent in lending. Interest rates had been increased to recoup previous written off debts. People & firms find it more difficult to get financing. Consumption & investment will further fall

(5) Further decline in business confidence. Economic uncertainties will discourage firms ranging from corner shops to large corporations from investment. There is fear of bankruptcy or they can’t recoup their capital. In such period, even with investment tax credits given government may prove futile. Major newspaper are not improving the situation, as news of companies filing for bankruptcy often serve as headlines

(6) Oil price increase. Again there is another talk recently to cut production of oil given that there is overproduction. By cutting the supply, oil price will increase once again & this will further hamper economic growth. Currently, oil price falls below US $100 & this is not a good news for major oil producing countries. As demand for oil is inelastic, fall in price means fall in total revenue.

(7) Bailout at the expense of taxpayers’ money. Bad news for working people. They will have lesser money to spend. AD will fall followed by economic growth. From supply side of argument, people will be discouraged from working hard knowing that the bulk of it goes to government. Output will fall

(8) Increase in interest rates. Nevertheless, inflation is creeping although at a smaller rate. This may trigger the Federal Reserve to raise interest rates. However one can argue that, for now US is concern of another Great Depression. Therefore the emphasis is on economic growth, not so much of combating inflation