<< Chapter < Page Chapter >> Page >

Building home equity

This image is photograph of a woman holding a “sold” sign.
Many people choose to purchase their home rather than rent. This chapter explores how the global financial crisis has influenced home ownership. (Credit: modification of work by Diana Parkhouse/Flickr Creative Commones)

The housing bubble and the financial crisis of 2007

In 2006, housing equity in the United States peaked at $13 trillion. That means that the market prices of homes, less what was still owed on the loans used to buy these houses, equaled $13 trillion. This was a very good number, since the equity represented the value of the financial asset most U.S. citizens owned.

However, by 2008 this number had gone down to $8.8 trillion, and it declined further still in 2009. Combined with the decline in value of other financial assets held by U.S. citizens, by 2010, U.S. homeowners’ wealth had declined by $14 trillion! This is a staggering result, and it affected millions of lives: people had to alter their retirement decisions, housing decisions, and other important consumption decisions. Just about every other large economy in the world suffered a decline in the market value of financial assets, as a result of the global financial crisis of 2008–2009.

This chapter will explain why people buy houses (other than as a place to live), why they buy other types of financial assets, and why businesses sell those financial assets in the first place. The chapter will also give us insight into why financial markets and assets go through boom and bust cycles like the one described here.

Introduction to financial markets

In this chapter, you will learn about:

  • How Businesses Raise Financial Capital
  • How Households Supply Financial Capital
  • How to Accumulate Personal Wealth

When a firm needs to buy new equipment or build a new facility, it often must go to the financial market to raise funds. Usually firms will add capacity during an economic expansion when profits are on the rise and consumer demand is high. Business investment is one of the critical ingredients needed to sustain economic growth. Even in the sluggish economy of 2009, U.S. firms invested $1.4 trillion in new equipment and structures, in the hope that these investments would generate profits in the years ahead.

Between the end of the recession in 2009 through the second quarter 2013, profits for the S&P 500 companies grew to 9.7 % despite the weak economy, with much of that amount driven by cost cutting and reductions in input costs, according to the Wall Street Journal . [link] shows corporate profits after taxes (adjusted for inventory and capital consumption). Despite the steep decline in quarterly net profit in 2008, profits have recovered and surpassed pre-Recession levels.

Corporate profits after tax (adjusted for inventory and capital consumption)

Corporate profits after tax were around $500 billion in 2000 and climbed as high as $1,400 billion around 2007 before plummeting down around $600 billion in 2009. 2013 reports showed corporate profits after tax were around $1,800 billion.
Until 2008, corporate profits after tax have generally continued to increase each year. There was a significant drop in profits during 2008 and into 2009. The profit trend has since continued to increase each year, though at a less steady or consistent rate. (Source: Federal Reserve Economic Data (FRED) https://research.stlouisfed.org/fred2/series/CPATAX)

Many firms, from huge companies like General Motors to startup firms writing computer software, do not have the financial resources within the firm to make all the desired investments. These firms need financial capital from outside investors, and they are willing to pay interest for the opportunity to get a rate of return on the investment for that financial capital.

On the other side of the financial capital market, suppliers of financial capital, like households, wish to use their savings in a way that will provide a return. Individuals cannot, however, take the few thousand dollars that they save in any given year, write a letter to General Motors or some other firm, and negotiate to invest their money with that firm. Financial capital markets bridge this gap: that is, they find ways to take the inflow of funds from many separate suppliers of financial capital and transform it into the funds desired by demanders of financial capital. Such financial markets include stocks, bonds, bank loans, and other financial investments.

Visit this website to read more about financial markets.

Our perspective then shifts to consider how these financial investments appear to suppliers of capital such as the households that are saving funds. Households have a range of investment options: bank accounts, certificates of deposit, money market mutual funds, bonds, stocks, stock and bond mutual funds, housing, and even tangible assets like gold. Finally, the chapter investigates two methods for becoming rich: a quick and easy method that does not work very well at all, and a slow, reliable method that can work very well indeed over a lifetime.

Questions & Answers

Compare and contrast between Natural and Artificial Resources and their ultimate impacts in an economy. Give one example to support your discussion.
Angela Reply
Exemple: Diamant or uranium, fer, calcaire
how does interest rate affect aggregate output
kelvin Reply
what is Keynesian theory
need a curves for typical isoquost and isoquant
what is isoquant
isoquat is a curve shows differnt combinations of two inputs which can produce same level of output
examples of giffen goods
then what isoquost
, if the price of an essential food staple, such as rice, rises it may mean that consumers have less money to buy more expensive foods, so they will actually be forced to buy more rice.
that's an example
majid Khan that's the wrong definition of isoquant
you are defining isocost
isocost curve is a locus of points that shows the different combinations of commodities purchased by a consumer with a fixed budget
The change in fiscal policy leads to an increased level of output and interest rates is because an increase in government expenses directly affects aggregate demand. A decline in taxes result in more disposable income, consequently leading to a rise in consumption expenditure.
dats for kelvin
dats d answer for the audio how does interest rate affect aggregate output
question not audio
u are right joker
what is journal entry?
explain the nature of economics
Matilda Reply
interpret micro economic issues
ito ang dami ng producto na nais handa at kanyang ibenta ng isang prodyuser
Jomar Reply
i dont understand
even I also don't understand ..this language.. vn I converse everybody say farzana ur language is not understood by all user? now no one there is question about it?
he is saying that "this is the amount of product it wants to be ready and sells by a producer"
I Merr has knowledge,which is the economiccircuit role in a society
What is diminishing returns?
Shadrach Reply
explain competitive demand
the demand that are compiting for sale. the buyer can substitute one for another good
the demand where commodities fight for the market. in this type of demand, commodities can be substituted for the most suitable one subject to ( price, consumers choice, consumers income etc)
Demand is said to be competitive when a commodity that is needed to satisfy wants in place of another similar goods. increase in price of a commodity X will result in increase in demand of the substitute (commmodity Y).
examples of giffen goods are garri (cassava), maize
yusuf Reply
what is Public Finance?
kweku Reply
it's basically the field of economics that deals with the government's involvement in the economy; from spending to maybe interest rate manipulation, etc.
examples of giffen goods
i want to get the solutions of problems how i get kindly give guidance
Syeda Reply
please give some suggestions about getting solutions of all chapters...
hard work
and the grace of God
knowledge skills
Syeda Economics is difficult. No all fields are difficult
what is Keynesian
Keynesian economics is the theory proposed by Keynes( an economist). He proposed to manipulate demand side factors to bring economy out of depression in 1930s.
whose totaly oppossid the government intervention and give importance to agreegad demand
Good afternoon my fellow forum brothers and sisters
Abdullahi Reply
no just want to know true God
Good afternoon!!
hey is there somebody single n young like me bcoz I'm looking for
what is facing trade offs
Nancy Reply
It is giving up a commodity to purchase another commodity
for example, when we have two commodities like chicken and turkey you can trade off of give up chicken to purchase turkey
that can also be called foregone goods
it like opportunity cost
it's like trade by batter
Do you transform into thesecourses, in french people?
I can just speak french andI can just speak french and no english
what is elastic
Tida Reply
elastic is the change in to price and change in demand
Is the percentage change in quantity demand and quantity supply.
Or percentage change in price of demand and supply
Robert Mensah you are explaining elasticity of demand
robert i think he talk about elastic releated to elasticity of price a proportionate change in price over qd
can anyone explain what happrn her i don't understand anything
is the percentage change in demand as price change
sometimes price is elastic,inelastic
price elasticity is different from price being elastic
elasticity is not always the percentage change in demand as a result of changes in price. there's income elasticity and cross elasticity so it's not necessarily always price
elastic is when a change in price of a commodity results in a relatively a larger proportion change in the quantity demand of the commodity
what is inelastic
Tida Reply
price is said to be inelastic when it is less than 1
what is national income accounting
Aisha Reply
National income is the income earned by all factors of production..
So this benefits the workers or the businesses?
Like whose income are we talking about here
what is multiplier
Good & services manufactured in a country with in one year is calld national income
incom earned by using of sources of production is national income while i dont know the accounting insuch
neil and aisha can u explain the turm accounting in such question
I think when we include accounting national income accounting is the measurement of total goods and services produced in an economy in a given period of time
what is mutual funds
Khalid Reply
it is a combination of financial securities such as treasury bills , bonds etc in one managed by an institution that individuals and firms invest in for profit. it is usually a long term investment and is seen as a low risk investment because the financial instruments invested in, are diversified.
A mutual fund is a professional managed investment that pools money from many investors to invest.

Get the best Principles of economics course in your pocket!

Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Principles of economics' conversation and receive update notifications?