Pretty much title. I’ve seen this talked about a lot but I only very vaguely know what all this means, could someone elaborate on what happened, why it happened and what the consequences of it are?

  • betelgeuse [comrade/them]@hexbear.netEnglish
    13·
    8 months ago

    Whenever you borrow money from a lender, you must pay it back with interest. The percentage of the borrowed amount that must be paid back with the negotiated time period is the interest rate. Banks lend money to people and companies. Banks also lend money to one another. The rate of interest that banks can charge one another is set by the a committee that’s part of the federal reserve. They meet eight times a year to set a target interest rate on the biggest lenders. This is to adjust how fast the economy is growing. Low rates means these banks exchange more money more often because it costs them less interest to do so. Higher interest means they’re more picky about lending.

    The way the biggest lenders exchange with one another has an effect on the smaller banks and lenders. Ultimately, the money comes from the top, where money is exchanged and managed with the federal reserve system.

    When those interest rates are very low, money moves easily and faster. Any borrower is more likely to take advantage of a lower interest rate, the money they are borrowing is cheaper in terms of debt service cost. When interest rates are very high, the opposite happens. Borrowers can’t afford to borrow and lenders don’t have as much capital to lend.

    For a little bit of time in recent history, interest rates were historically low. Large companies and banks could borrow money for very little interest. This is why there was a startup boom in silicone valley. A venture capitalist firm could easily borrow money to fund any project they thought could work. It also helps with borrowing money for things like construction. You get increased real estate construction with low interest rates.

    When the federal reserve started targeting higher rates, due to inflation, the banks were spoiled on low rates. It was a shock to people because many had spent most of their career having easily accessible capital. Now it suddenly became an issue because you interest payments on $100M became a lot more expensive. Even though rates are still reasonable compared to historical rates, people still freaked out.

    • Yllych [any]@hexbear.netEnglish
      7·
      8 months ago

      Also important to note: 30 percent of US firms are zombie firms

      A zombie firm is one that only makes enough money to service their debt but not to pay it down, and so are stuck staggering onward in an undead fashion. During the period in which there was ‘free money’ (low interest rates), these companies could go on as their debt repayments were not too harsh, and some could even continue borrowing more credit to use for servicing previous debt.

      If this sounds insane that’s because it is. Estimates are that a third of US firms rely on essentially a quicksand base of debt, and their profitability is not growing enough to cover their debts. The federal reserve, as the guardians of American capital and firm believers in the Philips curve, recognise the interest rate as the only tool available to guide the economy.

      Meaning they are caught between keeping rates too low to properly deal with the debt bubble, or to raise them high enough to cause a shock that will wipe out much of the debt and much of the economy with it. For now it seems that a total crash is being avoided, but for how long who knows