ECONOMIC CRISIS EXAMPLE

A simple example of systems thinking applied to the 2008-2009 economic crisis involves the unprecedented growth of housing demand that was initially fed by favorable interest rates and policies that promoted home ownership. This example is derived from the more comprehensive discussion in Financial Whirlpools.

Using causal loop diagrams, the slideshow on this page traces the progression of events and interactions that describe growth and decay in the housing and financial markets during the crisis. Slides 1 through 3 show the growth cycle. In these slides, favorable interest rates and home ownership policies stimulated housing demand. High demand drove housing prices up and fueled the expectation of a continuing rise in prices which further amplified demand. Demand for houses and favorable policies promoted high risk home loans which in turn encouraged sales of high risk securities that were built from these loans. These conditions expanded home ownership, allowed home owners to amass wealth, increased profit for investors, and created a spike in U.S. GDP. In this depiction, three reinforcing loops generated unbounded growth.

However, because growth cannot continue forever, because policies changed, and because many borrowers were overextended, these same loops just as rapidly generated devastating decay. Slides 4 through 6 illustrate the decay cycle in which higher interest rates and tight lending policies eventually exacerbated defaults on high risk loans and ended with foreclosures, securities failures, corporate bankruptcies and national bailouts.

Demand for

housesR

s s

s

Housing prices

Expectation that prices will rise

• Favorable interest rates• Policies promoting home ownership

GROWTH LOOPEverything increases

© 2013 Karen L. Higgins, Ph.D. 2

Demand for

houses

s

s

High risk

loans

s

s

sHousing prices

Expectation that prices will rise

• Favorable interest rates• Policies promoting home ownership

GROWTH LOOPSEverything increases

R R

© 2013 Karen L. Higgins, Ph.D. 3

Demand for

houses

High risk securities

s s

s

High risk

loans

s

s

s

sHousing prices

Expectation that prices will rise

Deregulation• Favorable interest rates

• Policies promoting home ownership

GROWTH LOOPSEverything increases

R R R

© 2013 Karen L. Higgins, Ph.D. 4

Demand for

houses

High risk securities

s s

s

High risk

loans

s

s

s

sHousing prices

Expectation that prices will rise

• Home ownership/ nest eggs• Speculator profit

• Financial organization profit• GDP growth

Deregulation• Favorable interest rates• Policies promoting home ownership

POSITIVE OUTCOMES

R R R

© 2013 Karen L. Higgins, Ph.D. 5

Demand for

houses

High risk securities

s s

s

High risk

loans

s

s

s

sHousing prices

Expectation that prices will fall

Deregulation• Rising interest rates [ARM reset]

• Tight lending policies

ENVIRONMENT CHANGED

DECAY LOOPSEverything decreases

R R R

© 2013 Karen L. Higgins, Ph.D. 6

Demand for

houses

High risk securities

s s

s

High risk

loans

s

s

s

sHousing prices

Expectation that prices will fall

• Loan defaults/ foreclosures• Securities failures

• Corporate bankruptcies• National bailouts

Deregulation• Rising interest rates [ARM reset]• Tight lending policies

NEGATIVE OUTCOMES

R R R

7