The Role of Savings Rate in the Economic Crisis White Paper

Author: 
Dr. Amir Shoham, Temple University
Published Date: 
13 Jun 2012

Dr. Amir Shoham, Temple UniversityWhen considering the current economic crisis we can discern that variables of two different types contributed to its creation and magnitude. The first are the real variables that caused the initial imbalance in the economy. The second variables are the nominal ones, which are usually catalysts that accelerate situations. Metaphorically, the real variables can be compared to fire and the nominal ones to the fuel. Considering the way the crisis evolved, there is a clear view of the chief real variable that caused the crisis. This variable is the change in the savings rates, primarily in the US.

If we briefly review the history of the crisis, we see that the first signals of genuine economic instability began to appear in the first half of 2007, when a large wave of sub-prime mortgage lenders in the United States became insolvent. However, the seeds of the crisis were planted many years before. The United States created a deficit in its current account that grew steadily throughout the last decade. The deficit on one side of the ocean created surplus on the other side, especially in countries like China and Singapore. These countries then loaned the surplus back to the US so that it would be able to continue buying imports. Usually, a current account deficit is highly correlated with a government deficit, and the data from years before the crisis show that the US is no different. During this period, several bubbles were created in the American economy. The first bubble appeared in the lending market, led by the housing market where mortgages are granted to sub-prime borrowers and prime borrowers with low self-equity. These loans expanded beyond all reasonable proportions because of the financial system’s eagerness for short-term profits. This eagerness was ignited by short-term incentive contracts signed with managers of financial companies or what is known professionally as the “principal-agent problem.” Simultaneously, mortgages became securitized, which created an additional problem when rating companies granted these securities AAA ratings despite the high risk levels. The lack of supervision over the highly-influential rating companies working in an unregulated branch exacerbated the crisis.

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