Economics help blog – Page 261

Subprime Crisis and the Global Financial Markets

4 February 2008 by Tejvan Pettinger

Readers Question: To what extent can the subprime crisis affect the global financial market?

The subprime crisis refers to the rising number of defaults on US subprime mortgages. Basically, US mortgage companies sold a lot of inappropriate mortgages to people on low income and poor credit histories. Rising interest rates, and falling house prices are causing many of these mortgage owners to struggle with repayments. Therefore, many mortgage companies have lost significant amounts of money. Some of the leading US subprime mortgage firms have gone under and bankrupt. If it was just mortgage companies who went bankrupt, it wouldn’t be so much of a problem.

However, many of these mortgages were financed through securitization. Basically, the mortgage companies would lend the money to homeowners but would finance the mortgage loan by selling ‘mortgage bundles’ to other financial institutions. Basically, mortgage loans were financed by many different financial companies, not just the mortgage companies.

In the US, upto 70-80% of mortgage loans were financed by securitisation. In the UK, the rate is much lower about 21%. The only British bank to get into trouble was the Northern Rock. The Northern Rock, unsurprisingly had the highest rate of 61%.

The Most Profitable Company in the UK (2008) – Shell

14 January 20201 February 2008 by Tejvan Pettinger

But, do they deserve it?

Last year, Shell made profits of $27.6bn (£14bn). This equates to profits of about £1.5 million per hour – which by any stretch of the imagination is not a bad hourly earning.

The profits have been criticised by trades unions, environmentalists and motoring organisations.

Motoring organisations claim that petrol is too expensive and it is unfair companies make such profit at the expense of the motorist. Personally, I think petrol should be expensive (for environmental reasons). But, also, Shell make the majority of their profits in the production of upstream oil, not at the petrol pump. The profit margin on the retail price of petrol is quite low; most of the cost of petrol is tax to the government.

Environmentalists argue it is wrong to make the profit from a process which is contributing to environmental problems. It is argued a windfall tax should be levied on the profits of Shell; this money could be used to combat the effects of global warming.

Mortgage Equity Withdrawal and Economic Growth

3 December 202030 January 2008 by Tejvan Pettinger

Readers Question: Does mortgage equity withdrawal enhance economic growth? There is good evidence that mortgage equity withdrawal can lead to higher levels of consumer spending and economic growth Definition of Mortgage equity withdrawal – Mortgage equity withdrawal occurs when homeowners remortgage taking out bigger loans to take advantage of rising property values. Suppose you bought …

Why is Government Reluctant to Boost Demand?

29 January 2008 by Tejvan Pettinger

Readers Question. Explain how interest rates could be used to boost the economy. Why, then do the govenment frequently hesitate to take such steps.

Interesting Question.

Generally, lower interest rates help increase consumer spending, investment and economic growth. Lower interest rates help increase Aggregate Demand for various reasons.

Lower interest rates make borrowing cheaper encouraging investment and spending
Lower interest rates make mortgage payments cheaper, increasing disposable income of consumers.
Less incentive to save. Therefore increased incentive to spend
Lower exchange rate, making exports cheaper and boosting AD.

Most people in the economy like to see interest rates cut, especially homeowners and businessmen. Why then do Governments or Central Banks hesitate to cut rates?

Lower interest rates can cause inflation. If Aggregate Demand increases faster than aggregate Supply, the economy will experience inflation. Inflation is said to create instability and uncertainty in the economy.
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Effects of American Economic Decline on Vietnam

28 January 202027 January 2008 by Tejvan Pettinger

Readers Question: What are the effects of the economic decline in America to the country of Vietnam?

If the US economy entered into a recession the main effects on other countries would be:

1. A decline in exports. American consumers are a key component of world trade. If there was a decline in exports to America it would lead to lower growth in countries like Vietnam. In certain sectors, it could cause a rise in unemployment. There could also be a negative multiplier effect ‘knock-on effect’/ The initial fall in exports could cause a bigger fall in Aggregate Demand.

However, it depends on what % of exports are to America. For Vietnam, exports to the US are important, but not a huge %.This page shows that Vietnam exports to us totalled $7.6bn in 2005. link US – Vietnam trade

This is not a huge amount, it is about 20% of exports.

It depends on how the rest of the economy is affected. For example if domestic demand remains strong then this might offset any fall in exports

It depends on whether Vietnam is able to increase its exports to other Asian economies. For example, it may be that China’s economic growth takes the place of US exports. China is nearer.

Should Government Cut all Taxes?

27 January 2008 by Tejvan Pettinger

Readers Question: What the benefits and the negative effects of reducing all taxes? I wrote an Essay on the advantages and disadvantages of tax cuts The idea of cutting all taxes is key element of libertarian politics. Cutting taxes is often a mantra repeated by conservative parties, although in practice, they usually find it more …

Sorry, I lost £3.5bn on the Stock Market

25 January 2008 by Tejvan Pettinger

Yesterday, I mentioned future contracts could be used as a way to insure against risky commodity prices. This is one way that future contracts can be used. Unfortunately, future contracts and options can also be used to speculate on the stock market. Stock market options enable investors to take a position on the stock market rising or falling. If you expect the stock market to buy you can take out a contract to buy at a certain price. If the stock market rises you can then buy at the fixed price and immediately sell for the higher price. Options enable an investor to magnify his gains, but also can magnify his losses.

Economics of the Fire Service

24 January 2008 by Tejvan Pettinger

Readers Question: Why the fire service is a public domain and how is the fire service a merit good

I think you mean why is the Fire Service a public good?

A public good has 2 aspects.

Non rivalry – Once consumed doesn’t reduce the amount available to others
Non excludability – Once it is provided you can’t stop anybody using from it.

In a free market public goods are often not provided because there is difficulty getting everyone to pay for it due to the free rider problem

The fire service shares some aspects of a public good. If the fire brigade put out a fire, they can still go to another fire. Once you have instituted a fire service, they are prepared to put out anybody’s fire. When you dial 999 and ask for Fire, you don’t get asked “but, have you paid your annual fire payment”. They just come and are financed out of government taxation.