A Simple Mathematical Model Of The Underlying Economics

1514 Words Jan 6th, 2016 7 Pages
The current crisis is catalyzing an array of responses, including searching for causes, reworking regulations, scapegoating and a massive capital injection. Without a clear understanding of the cause, the remedies may do more harm than good, innocents may be scapegoated, and valuable progress in financial tools may be lost. Worse, it will happen again. From a simple mathematical model of the underlying economics, I first predicted this crisis in July of 2004. Economic dynamic relating very low interest rates to the structure of the demand curve in the housing market made this outcome foreseeable, indeed inevitable. The current crisis had a mathematical cause. There isn’t space here for full explanations; see mattersofinterestmatters.blogspot.com. This much is clear to everyone—the crisis results from an epidemic level of mortgage defaults, in turn caused by ballooning monthly payments from variable rate mortgages, caused by a rise in interest rates from historically low levels. This made the monthly payment change quite large, because while the rise was small in absolute terms, it was huge in relative terms. The simultaneous plummet in property values made default the only option. This is the effect which we must understand—why do low interest rates cause a bubble in real estate value, and why do rising interest rates burst that bubble? Like all equilibrium pricing, there is a supply curve and a demand curve for housing. Over the short term, the housing supply can’t change,…
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