The Recession. Why Businesses go Bust?

The Recession

The Recession. Why Businesses go Bust?

The Recession. Why Businesses go Bust?

Since the recession had such a great impact on a lot of people, it has become an important subject. The subject is important for not only business people, but also the general public. The general public includes students, teachers, farmers and even doctors. Everyone is affected in some way or another. My objective is to simplify this for the regular reader, and help that person understand what is going on around us in terms of the economy. This information will be useful to consider when making decisions. Decisions such as starting a business, selling your house or getting a loan. My goal is to help bring perspective for the reader to be able to make these kinds of decisions.

The credit crises rooted from the banks because of the loans that were given out.. Banks give out loans to business that can't pay for their inventory just yet. When the inventory is sold, the revenue is used to pay off loans. Loans are also given out from creditors, such as Fannie Mae and Freddie Mac, to help citizens pay for their home mortgages. Through out both of his terms as president, George W. Bush advocated affordable housing for all Americans. This meant banks were given the authority by the government to be lenient on loaning money out to citizens. Therefore, people with bad credit and people who would have problems paying their debt were given the opportunity to get a home on down payment. This leads to a higher percentage rate of unpaid mortgages. When people can't pay their mortgages they are forced to leave their homes, this leads to an increase in vacated houses. When there are vacated houses, we find low demand from consumers in the housing market. The weak demand causes a fall in the prices of homes. These were some of the earlier signs in the recession.

It was briefly mentioned in this article that banks also give out loans to small businesses. Which means that many small businesses rely on such institutions for profit. Credit is used to buy inventory from the supplier or manufacturer. As pointed out before, these lenders gave out bad loans. Not only were the banks not getting their money back, they were not getting the interest they collect as well. Eventually, credit agencies ended up in debt. This debt brought a sudden halt to loans for all businesses. Businesses need these loans to support circulation of their supply chain. When this is taken away, businesses stop functioning. Basically, businesses don't have access to inventory anymore because banks have denied their requests for loans.

When businesses start to fail, they are forced to downsize or shutdown. Surviving becomes the main objective during the rough stage. Since businesses have to downsize, they have to reduce workers and sell assets. The increase in unemployment makes it harder for many families to pay off their debts. This worsens the already problematic housing collapse. More people are unable to pay off their mortgages and are forced to be homeless. Since businesses are cutting costs, the economy will have a weak demand in labour. The weak demand in labour creates tougher conditions for people seeking jobs. New perceptions begin to arise that are influenced by negativity. People become angry and frustrated. A recession begins to fully emerge, and jobs are being cut on a global scale. Its not just the U.S. that becomes affected, its all the countries that have global business ties. Cost cutting initiatives slow down businesses that have plants based all over the world. Stock markets crash due to the lack of consumer confidence in businesses, investors everywhere lose lots of money. This was apparent in October 2008, when the stock markets took a beating.

Once the conditions of a recession occur, most middle class families are tied down with their spending. They are forced to save funds for bare necessities. There is less consumer confidence in many products, meaning people do not want to purchase goods anymore. Even cars become unattractive to consumers. Although other factors such as increase in oil prices caused cars to be less attractive to consumers, lack of credit also played a big role. Most customers buy cars through loans. When banks refuse to lend money, car sales drop rapidly. This dramatically affects the automotive industry. Many car companies such as GM, Ford, and Chrysler begin to see their market share pull away. Decisions of downsizing are tough because the automotive industry own many large assets. These assets include plants and machinery. The lack of cars sales and machinery make these assets useless, and labour that goes with the machinery isn't needed either. The companies are forced to sell off the assets and reduce jobs.

The problems of the automotive industry continues to usher, housing sales weaken demand, famous businesses collapse, and so do all the well known banks. Institutions rely on the government for bailouts. Companies that needed these bailouts range from Chrysler and GM, to Fannie Mae and Freddy Mac. The government bailouts are used to prevent these companies from going under. Losing an automotive company like GM could cause many more jobs lost all over the United States. It was determined that too many family incomes are dependent on the automotive industry. Not only that, the savings collected from pension plans would vanish. If credit agencies don't survive, no one is available to provide money to help businesses or have average citizens pay for their needs. Overall, the general conditions and low morale contribute to a low level of productivity. This means that businesses are creating less output and there is a decrease in demand for goods and services. People engage less in businesses which causes the gross domestic to contract (GDP). There is a direct correlation between the loss in jobs and GDP. When the number of jobs decrease, so does the GDP.

A recession requiring recovery needs quick action. This is because jobs will continue to be lost if businesses keep failing. Normal people will continue to lose money. In most cases, the government does need to decide what course of action to take. This is because people that are affected by the recession need relief, since they are hurt financially. There are several options the government can take. One course of action could be to spend on the industries that are hurting. As mentioned before, governments could send bail-outs to companies that have a large influence on the economy. This option can seem endless, and spending money on investments with losing returns is arguable. A lot of people with high political status feel that spending money to save failing companies will lose money for the government, which will increase the national debt. This worsens the recovery situation.

Another option that the government could consider is the 'laissez-faire' option. This would mean that literally, the government would do nothing. By doing nothing, they are letting the economy ride out the storm, and recover naturally. This does mean that many businesses will fall and new businesses will emerge afterwards. By not interfering, the government is allowing prices to continually deflate with decreasing jobs. Eventually, this causes businesses to collapse and file for bankruptcy. The market share ends up being released to new companies. This method can hurt the morale of everyday people, the act of not doing anything can be perceived as not caring. This leads to disagreements in many communities.

One might contemplate that the government does need to interfere, but invest appropriately. They'll have to consider spending the tax payers' money where there is opportunity. Spending money in investments with low value, can bring bad returns. Which is why it makes sense to invest where more money can be made. In this case, the government could consider investing where new jobs are created. Some of the classical Keynesian models involve direct spending in projects, and opportunities, to stimulate job creation. Furthermore, unemployment ends up being reduced. Not only does this create new infrastructure, people are also kept busy during stressful times. Also, the opportunity can create profits that would contribute towards the gross domestic product. Examples of this would be energy saving projects that could save money on household expenditures. More specifically, labour could be used to build wind power infrastructure. This can contribute directly towards lowering the electricity bills of everyday citizens. When the bills are lowered, further relief is provided. The productivity also contributes towards environmental sustainability. This process can help the economy proceed with a quicker recovery.

There is much to learn from this recession. As pointed out earlier, the problem roots from poor crediting decisions. The banks play an important role in future economic decisions, therefore proper actions should be taken to not allow history to repeat itself. One might say that loans should be carefully granted. If this is the case, should transparency exist in banks? Where there is no secrecy and information is made public. When there is transparency, outcomes can be predicted and mistakes can be forecasted. There are other benefits to having a completely transparent banking system. If there are unethical acts in the system, the public is involved in the judicial process. Transparency involves everyone. When everyone is involved, decisions are made carefully. When decisions are made carefully, we have a safer economy.

Written by Basim Mirza

Sources Used

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http://www.federalreserve.gov/releases/g19/current/g19.htm

Mortgage Loan. FHFA Reports Slight Decrease in Home Prices. [20th August 2009].

http://www.mortgageloan.com/fhfa-reports-slight-decrease-in-home-prices-3180

CNBC. Plans for Banks' Toxic Debt May be Unveiled Next Week. [20th August 2009].

http://www.cnbc.com/id/28879872/

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http://www.bls.gov/opub/ted/2009/feb/wk2/art02.htm

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Finfacts. US GDP contracted 5.7% in Q1 2009. [20th August 2009].

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The New York Times. House Questions Spending of Bailout Money. [20th August 2009].

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