So I recently read articles talking about the recession of 2008 and how severe it was, but because I have no knowledge on economics and finance, I can barely understand what happened during the recession. I only know that it has something to do with mortgages. Would anyone care to explain the 2008 recession with some sort of analogy? Like in terms of slices of cake or something easy to understand? Thanks.
In: Economics
In economics we have ‘demand’ which is how many of a thing people want to buy and ‘supply’ how much of a thing people are willing to sell.
When demand is higher than supply, one of two things happens: Supply increases or prices go up. Often both. The goal of this is to make demand and supply the same amount, and is how economies function best.
For a long time, demand for houses was higher than supply of houses, so house prices kept going up.
Usually, this would mean that people who couldn’t afford to buy houses at the new price would stop demanding houses, so demand would go down and be the same as supply and then prices would stop going up.
But a lot of people, including banks, were making a lot of profit from the prices always going up.
So they started giving mortgages to people who wouldn’t be able to afford them. This made demand go higher, so house prices went up, and when the people who bought the house couldn’t afford to pay back their mortgages, the bank got the house instead, which was now worth more than the mortgage was.
This happened for a long time, but it was always ‘fine’ for the economy because house prices were always going up. The banks never lost money in these situations. What they were doing was effectively gambling, and as long as house prices kept going up, as they had done for decades, they would keep making money.
So in 2008, house prices did in fact not go up, they went down. So all of the houses the banks got from people who couldn’t pay their mortgages were worth less than the mortgages were worth, so the banks lost a lot of money, some of them so much that they had to close. This made people not trust their money was safe in banks, so withdrew it and banks lost even more money.
Homeowners also lost a lot of money, as the value of their homes went down. You’re able to borrow money from the bank up to the value of your home pretty easily, so firstly, this amount went down, and secondly, banks became less willing to lend as they had less money.
Due to all of these people losing money, they stopped spending as much money, because they had less of it. All of the businesses that they stopped spending at lost money, and in turn ended up making redundancies in their staff. The people who lost their jobs and the companies with less income started spending less too, as they had less money, which basically went on and on, with everyone spending less and choosing to save instead which further reduced everyone’s income.
And that’s basically what happened.
Sorry that it’s so long, but hopefully it’s understandable?
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