The Credit Crunch: Is There Hope For The Future?
Posted by Allison on 4 April 2009, 10:13
The global credit crunch started in 2006, when the US housing market suddenly went into meltdown as a result of sub prime borrowing, when lenders who had issued loans at above the higher prime rate of interest, suddenly found that they could not get their money back.
The credit crunch didn't happen overnight, but rather came about as the culmination of several issues that were taking place, first in the United States and then throughout the globe. So to make any real predictions about whether or not we can hope that the future might be brighter we need to look at how we got to the place we are in now and then see what is the most likely outcome for the future.
Credit Crunch History
After the credit crunch first hit, bitter arguments and recriminations followed. Lenders were accused of having targeted people who could not afford to pay the higher interest rates in the first place. Lenders argued that they had given out the loans because they wanted to target people who had poor credit ratings, or who were self employed and therefore higher risk. A central theme to their argument was that they had to do this to ensure that those individuals could get access to housing. By doing this, the housing market is kept buoyant and when the housing market is doing ok, we can usually all guess that everything is going reasonably well in terms of the economy.
But the casualties in the sub prime crisis were basically unconcerned as to these arguments. They had lost their homes, credit ratings were blown away and whilst many wanted answers as to why this had happened in the first place, others simply were too busy trying to rebuild their lives. Hitting those who had a poor credit rating first, the crunch didn't impact on the wider community. Some media attention followed developments, but generally everyone just went about their business. Life just ticked on as usual. Then 2007 came. Now things started to look very different, particularly in the US.
In the United States, foreclosure, where people are either threatened with repossession, or 'debt recovery' proceedings are instituted, rose by a staggering 79% in 2007. So, people who had been struggling to pay their mortgages, but were doing so, albeit with difficulty, suddenly began to feel the squeeze from their lenders.
But more casualties were to follow. Suddenly the middle classes and Middle America were hit: house prices started to fall dramatically and suddenly the middle classes started to ask why this was happening.
The answer was soon to become chillingly obvious: the housing crisis had been triggered not just by lending at higher rates of interest, but the lenders had done deals with 3rd parties, entitling them to the money raised from mortgage payments, as well as the credit risks and the default risks.
As these 3rd parties slowly began to crumble under the strain of the pressure, the stock market was affected. However, as so often happens when the United States catches a cold, the rest of the world starts sneezing and globally, financial markets started to feel the pressure, in particular stock markets. Gradually, the effect of what had started off as a purely American problem was being felt around the world and the effects have still to wear off. Even the poorest, most undeveloped nations have felt the effect of the American crisis, in some way or another, even if it is only how the aid they receive has altered as a result of the weak dollar.
Subprime and the credit crunch
The sub prime crisis then triggered the credit crunch, with a pretty straightforward cause and effect motion. Lenders lending money out to high-risk people, at higher than standard rates had become standard practice in the US. They didn't get much of their money back. Some went bust; others were teetering on the edge of financial meltdown. So what is the answer? Well, even to non-financial gurus, it's pretty obvious. Stop lending. If the lenders don't lend, then the borrowers can't default and so everyone will be ok.
Except, it doesn't work like that. The lenders stopped lending and borrowers, particularly higher risk borrowers, couldn't borrow. So everyone was stuck in a kind of financial limbo. As America languished in this limbo, the rest of the world was still nervous. They could see how their stock markets were being affected and were concerned that the same would happen to their economies and indeed, most markets on a global basis, started to feel the pinch.
Moreover, borrowers, not just in the US, but also throughout Europe, Japan and other countries all over the world, were finding that even if they could find someone who would lend them money, it was at a much higher rate. So people who were borrowing had to plough more of their hard earned cash into meeting repayment schedules. So what was the result? They had less money to spend on consumer goods, less to spend on going out and having a good time. This meant less cash circulating in the economy and as a result, the economy in the US started to stagnate, then the rest of the world followed suit.
The housing crisis continued in the US and parts of Europe. As more homes were re-possessed, more were flooding onto the market, at a cheap rate, to at least get some dollars back for the lenders. House prices were low. Some people who had recently taken out a mortgage were starting to find that their homes were worth less than the mortgage. Whilst that alone could be a short-term blip and they could live with it, they then were paying high interest rates and they had less money for essentials.
Add to that the global increases in gas and food and more and more people start to feel the pinch.
As less money circulates in the economy, businesses start to suffer. They go bust or have to put their prices up, or in some cases, they put their prices up and then go bust. Importantly, this leads to a slow economy and one that does not grow and as a result, people start to lose faith in the government, financial experts and in taking any financial risks. So those people who had been contemplating moving house, stay put. This creates stagnation in the housing market, the first time buyers are also staying put and less houses are required. Houses aren't built, so builders lose work and profits and the whole circle of housing, boom and bust happens over and over again.
The dollar remains weak, with the pound strong and the euro fairly consistently strong. The Japanese financial markets are to say the least, precarious and those who predict financial outcomes are torn. Some say that we are on the way out from the credit crunch, others that we are experiencing the quiet before the storm and when that storm comes it's going to be a tornado.
Fear and the Credit Crunch
For any economy to be strong and resilient, there has to be an element of risk. The whole basis of capitalism rests on the premise that you 'got to speculate to accumulate'. Without speculation, there is quite simply no accumulation or profit.
So everyone is fearful of taking risks. Whilst John Doe, who doesn't move house, stops eating out as much and basically reins in his spending isn't going to shape the whole US economy on his own, if millions of people follow his example, then the economy remains dormant.
But, poor old John Doe can't really be blamed for the entirety of the situation. In the financial pecking order, he is pretty low down the chain. Above him are all the financiers and speculators. They are faced with a grim situation. They don't speculate: then they don't accumulate. But if they do speculate, then the risks are enormous. Any project needing capital will incur higher interest rates. These rates will make the project more risky and so more likely to fail so it isn't the best time to be embarking on new projects. But without new projects, the economy can't recover and so it goes on.
Fear and the fear of risk is now a major obstacle to the global markets recovering sufficiently to be able to put a stop to the credit crunch.
But is this fear misplaced? Have we weathered the storm and calm seas are now ahead?
In the US and parts of Europe, central bankers have responded to the credit crunch by flooding markets with money to create short term liquidity, they have also made it easier for banks to borrow. Making it easier for banks to borrow money means that they can pass on loans to consumers and then in theory, everything starts to pick up again.
In the United Kingdom in 2008, a Building Society ended up being propped up by the government, to stop it from collapsing. This too was a direct consequence of the credit crunch and sent shockwaves through the world. Were we returning to the bad old days of the depression, where banks collapsed and people faced financial ruin, virtually overnight?
How does the future look?
Currently there are two main schools of thought. One is that globally we will actually be able to come through this crisis and that it will soon be over. Some experts think that by the end of 2008 and into 2009, everything will be much calmer.
Others assert that this is only the beginning and life is going to get a lot worse.
Everyone is agreed on one thing and that is that there will be casualties on the way. Some people will suffer as a result of the credit crunch and whilst many, many people have already suffered, millions more will feel its negative effects before we come out the other side. This is a given, there has to be some collateral damage.
Wall Street and American financiers are not making any wild predictions that the credit crunch will soon come to an end.
Globally the price of food is set to escalate. Throughout 2007, food prices went up and the United Nations estimates that in 2008, the price of food (on a global level) will rise by 40%. Add in to this mixture the fact that the price of oil is now something that is squeezing almost everyone and the result is: globally people are now faced with increased living costs associated with food and getting around.
Businesses are also hit by the price of oil being so high, because they then have to pay more to transport their goods to the point of sales. Even airlines are hit, as flying becomes more expensive.
All these issues are not just affecting one country: they are affecting everyone on the planet, to a greater or lesser extent.
So, external factors are also contributing to the economies of the world being slow to recover from the crunch. Since everyone has less money to spend, because they are spending more on food and gas or heating, they have less money to pump into the economy and therefore less money to be able to fuel the global economy that is so desperately needed.
This means that recovery will not be without considerable pain to a great many people.
What can we hope for?
If the price of oil can stabilise, as well as the price of rice and wheat, then we can hope that the economies of the world will be able to settle down and recover fairly quickly, although housing will continue to experience some stagnation and this is likely to continue for some time.
OPEC the national body of oil producers (Organization of Petroleum Exporting Countries) announced in May 2008 that 4 of its members, namely the United Arab Emirates, Qatar, Saudi Arabia and Kuwait are pledging that they will try to stabilize the price of oil, thereby making economies throughout the world hopeful that there will be at least some light at the end of the tunnel.
Oil prices may stabilise in the immediate future, if the pledge made by the 4 OPEC countries is maintained. This would substantially help markets to make accurate financial predictions and thereby result in economies stabilizing.
How effective this policy of stabilization is, will to some extent depend on how other oil producing countries react to it and how rigorously it is applied. If it breaks down, oil prices will not stabilize. If it is successful, then we will see increased stability.
But the price of food is an increasing concern and should be regarded as potentially being almost more of a threat to stability than the price of oil. If staples of food such as wheat and rice do rise by up to 40%, then many countries where currencies are weak, may simply not survive. Argentine's currency has been kept deliberately weak for some time and this policy is set to continue for some time. It last saw food riots happen in 2000. But the situation is already very strained. A 40% rise in the price of food may result in these being repeated.
Given that the credit crunch is no longer the only factor that economies have to deal with and they are now struggling with the impact of high food and oil prices, it is unlikely that things will dramatically improve over the next few years. There are other uncertainties that have come into play and these do have an effect.
Many of the predictions made about how recovery from the credit crunch was imminent were made prior to the 2008 oil price increases or the price of food starting to escalate. Indeed, if the credit crunch were the only financial issue, then recovery may indeed have started to take place and could have been underway. But unfortunately, this was not the case.
Instead, the credit crunch will be around for some time, with economies struggling to keep afloat. Potentially, times could get very tough, particularly for smaller economies that are reliant on importing food. If they go under then the more developed countries such as the US and Europe are unable to recoup debts. Thus the credit crunch is effectively sent into a spiral of decline once again.
We can only hope that oil prices will remain stable and that somehow the global price of food can also be stabilized. Until these two factors are effectively 'dealt with' we will find that there is little hope of even beginning to deal with the credit crunch.
So in effect there is a glimmer of hope that things will get better, but this is only a glimmer, it is not a strong ray of sunlight, but rather, it is more like a little chink of light and we should probably fasten our safety belts and wear our hard hats: it's going to be a bumpy ride for everyone!