Economics is not always an intuitive subject. If times are hard, and we are worried about our job, then most of us react to this by cutting back. We start saving more. It is common sense. The snag is that during a recession most of us tend to do that, and if we all start saving more, the economy is starved of demand and the recession gets deeper.
It is what the economist Keynes called the paradox of thrift.
We all know the government is in debt, and that somehow it has got to pay its creditors. But this is not always the disaster we think it is.
Sometimes a government gets into debt because the economy is in recession, and sometimes a recession gets deeper because people stop spending and save more. When the economic news is bad we all start to tighten our braces. And what do banks do with this money we are saving? Why, in a recession they lend it to the safest place possible, the government. Sometimes the very fact that banks are pumping their money into the government, and lending it money, is the very factor that means the government needs to borrow.
Now consider mortgages, and see them from a banks' point of view.
A bank may have learnt through experience that there comes a time when the best thing it can do in terms of maximising its profits, and minimising its losses, is to foreclose on a mortgage and take possession of a home. For the home-owner concerned it is tragic; for the bank there is cruel logic behind its action.
But in a recession, the banks' logic goes up in a puff of smoke.
In a recession it becomes more common for people to get behind with their mortgage. If the banks apply their normal criteria for repossession, the result will be a huge jump in the number of repossessed properties. This will mean a big jump in the supply of properties for sale, and house prices will fall. Banks may find that once they have sold the property they took into possession, the price they get is less than the value of the mortgage. So the banks are still nursing heavy losses.
In a recession, the rules have to change. If they don't change, banks find the value of properties that are used as security against the mortgages they have provided start falling, and eventually they find properties have insufficient value. In turn, the banks then start making losses.
Banks failed to appreciate this during the early 1990s, and as a result the housing market saw a dreadful crash in prices.
This time around it seems that, to an extent, the lesson has been learnt. Repossession levels are alarmingly high, but not as high as in the early 1990s. Given the depth of the recession, you would have expected repossessions to have been much, much higher.