The “Domino effect” theory has finally been proved. Not regarding to the influence of communism in a region or country, which was used by successive United States administrations during the Cold War to justify American intervention around the world. This time, “domino effect” has an inner meaning: ironically, the theory affects the capitalist system (or democracy, depending on the country you live in), that is, it affects us. Have you ever imagined that?
Many people are interested and willing to know how the American biggest credit crisis since the Great Depression could have reached Europe and other parts of the planet. How can an “internal” predicament shake the world’s economy? Well, let’s go straight to the facts!
In 2000 the Federal Reserve (Central Banking System of the USA) lowered interest rates due to the tech bubble recession of the late 1990’s. Demand for homes began to rise because the mortgage payments became cheaper, sending prices up. Moreover, millions of homeowners took the chance to refinance their existing mortgages. As the industry ramped up, the quality of the mortgages went down and the subprime credit came up.
The subprime credit is a “popular” credit and varies according to the Fed indexes. This kind of loan was very successful from 2000 to 2004 because Fed’s interest rate was very low (usually below 2%). In 2005 Fed’s indexes raised significantly in order to, on the one hand control inflation, but on the other hand, make home buyers disabled to afford their debts.
No payment means… houses for sale! Now imagine a big number of residences on sale (offering) and a low number of purchasers (demand)… this means houses are costing less. If houses are costing less and people cannot pay for their mortgages, banks and other investors confiscate the real estate and try to resell them to hedge against any risk.
These debts with lower value (houses costing less) create loss for the banks which must cover them. This way, the possibility of offering credit decreases, that is, a disbelieving wave starts and the channels of credit constricts.
Here comes the answer for the question:
Banks and investors, in order to find the liquidity (and it is becoming scarce), sell stocks in the market and the credit crisis spreads into the countries through the international stock markets.
The only solution for the credit crisis is “someone” financing the banks, that is, Central Banks are forced to bailout by concentrating the liquidity in themselves. Otherwise, countries become bankrupt and get into a chain reaction known as “domino effect”.
Fed has bailouted. European, Chinese and Japanese Central Bankings are bailouting too. We only hope the USA do not make the same mistake again. God save the world! (against stupidities)
The “domino effect” picture used to justify American intervention around the world durind the Cold War.
Ps: Now the World is intervening in the American economy!!!