What Causes an Economic Downturn Literature review

What Causes an Economic Downturn - Literature review Example Growth of the Housing Bubble: The year 2006 has seen a number of people refinancing their properties to be able to pay lower interest rates. The customers have also been noted to have taken out a second mortgage as well. These were steps taken by the house owners to extract as much money as possible. This however has lead to the increasing the housing bubble and leading the house prices to decrease. Once this hit the country, the borrowers were not able to pay for the interest rates and neither were they able to refinance the homes. This lead the borrowers to default and lead to foreclosures from the banks due to delinquency (Smith, 2009). Sub – Prime Lending: Subprime lending basically refers to lending to people with higher risks, i.e. with low credit ratings. Post the IT bubble burst in 2000 the fed had reduced the interest rates, and also agreed to provide loans to people with low credit ratings (even below 620). Post the borrowers receiving the loan amounts, and with the lowered interest rates, there was a sudden hike in the prices of the real estates of the company. This lead to the borrowers to be able to borrow even more. This extra borrowing became a burden for the subprime borrowers and the number of defaulters had grown to a great extent (Waring, 2007). Banking Sector Issues: Shadow Banking systems is referred to when non – bank financial institutes provide for loans to businesses to operate. With the increasing ‘Shadow Banking System’ in the country, the NY Federal Reserve Bank placed a freeze on the funds. This led to major companies needing to sell off the long-term assets at much lower prices to be able to meet up to the short-term loan payments. This left the system completely shaken up and also left a huge damage on the regular banking systems and the credit cycles. A combined effect of all the above factors together has led the country to move into complete recession. As far as even in 2008 various  articles, the writer had refused to use the term recession for the US economy (Khan, 2008).