For subscribers
Shadow of the 2008 economic crisis still hangs over the US and China
Princeton economist Atif Mian says that debts have continued to rise because their root causes have yet to be addressed.
Sign up now: Get ST's newsletters delivered to your inbox
Although central banks responded by lowering interest rates to almost zero after 2008, the previous borrowers no longer had the capacity to borrow much more.
PHOTO: REUTERS
Follow topic:
Suppose you buy a house for $1 million, putting 20 per cent down and borrowing 80 per cent from a bank. If the price goes down by 20 per cent, you lose all your equity, but the bank loses nothing. It can simply take the house and sell it to get its $800,000 back.
But two things then happen that will have economy-wide repercussions. First, you and maybe millions of others who have also lost their equity cut back on spending. Demand goes down in the economy, there are widespread layoffs and a recession follows. As a result, even those who still have positive equity in their homes cut back on their spending as well. Second, foreclosures increase, which sends house prices down further, intensifying the recession and creating problems for banks, many of which become insolvent.
