If centeral banks didn't interviene in the markets?

Question

If the central balks didn't intervine in the markets, what would happen?

I have heard something about 'sub prime' loans going bad in the US. If the markets hadn't stepped in to help, what would have happened?

Answer 1

I'll try to put it simply.

When you buy a house you don't actually own it. The bank does and it provides you with a loan to pay them back, ie a mortgage. You put down a 10% deposit and make repayments so that eventually you pay the loan back and own the house.

Companies trade shares like this. They borrow money to buy them. If they broow 90% of the value of the shares and they double in price they do very well.

EG.

to buy 100,000 pounds of shares they pay 10,000. If the shares double to 200,000, they pay back the 90,000 loan and are left with 110,000. The initial 10,000 they had and a further 100,000 in profit (less a bit of interest they had to pay on the loan).

The problem is that when the shares were worth 150,000, they would have been able to take out the 50,000 profit and do the 10 K deal again 5 times over. It is like using the equity in your house for a deposit on another.

If the value then goes down, which has happened with "sub prime shares" you have lost the 10 K steak for the other deals and have to sell something to get the money. This drives prices down further. Whe people are forced to sell because no-one will give them a loan they have to sell the good stuff at very cheap prices, (no-one will buy the bad stuff). This means that the valuations of what everybody else has goes down and puts even more people in the situation of having to sell. Eventually we would get to the point where there were no buyers. (yes - Let's just wait for Buffet's stash)

The banks intervened to stop this downward spiral getting out of control. The probelm is that the central banks have a bit of a balancing act to do. If they don't give enough, they don't break the cycle. If they give too much, everybody panics as they think there are even more problems out there than they know about.

The Central banks need to get right both the amount ogf money and the timing so that their actions make the situation better rather than worse.

Answer 2

The free market has never failed. It actually has never been tried. Restrictions and pressures placed on the market, placed by the US government, have caused it go in a direction that it would not have, if left alone and to its own corrections. Example: The government has made sooooo much money available (through Fanny mae and Freddy mac) that the Buyer end of the buyer/seller dynamic has become artificially inflated. This is how 150,000 dollar 3 bedroom homes somehow became worth 900,000 dollars in California. There was too much money compared to how the free market would have been without the artificial influx of money on the Buyer end. 2nd example: The government has placed soooo much in college loans and grants that now colleges can charge 100,000 for 4 years of college. I'm not talking about Ivy league either, I'm talking about some good state level colleges. Why have college costs gone up so fast and why are the prices so high ???? because the money is there, the government made it available. Why do colleges charge so much ?? Because they can. Hold on to your belt loops because the same thing is going to happen to health care in the near future.

Answer 3

It likely would have been a disastrous day on Wall Street on Friday, but beyond that I'm not sure. The Fed is the "lender of last resort." They pumped liquidity into the market but it was a very short term solution to protect the markets for a few days at best.

Answer 4

what i want to know is where the hell did the eu bank get 65 billion of OUR money to invest in this market , i could care less if the market goes through the floor.