Friday, December 19, 2008
The credit crunch part 1 - what caused it?
Welcome to my advertised series on the economy! Hopefully I'll cover a few things like what caused it, is the UK in a strong position, the effect on house prices and how it's all going to end up. Maybe I'll get bored and not finish the series though, you never know...
So first up - we have the question of what caused this mess? People have come up with all sorts of explanations, but the crux of it is not so difficult.
The crux of the matter - Greed. This has been around since the dawn of time - it happens all the time in the Bible. People want things that other people have, so they kill or steal or manipulate in order to get it. In our "civilized" society, these methods aren't so open so that leads us onto...
Borrowing too much. This is the worldly explanation and is entirely correct. This has been going on since 2000, and has been frankly obvious to anyone who cared to look at the housing market from a neutral point of view. The government and the 70% of the country that are homeowners are not neutral points of view, so there was never anything done to address this. By 2004, there was clear evidence that the situation had got out of hand. Banks were lending to anyone and everyone - regardless of the likelihood of that money being repaid. Mortgage brokers and estate agents were advising first time buyers to lie about their income so as to obtain a bigger mortgage - not talking about adding 10% onto your income here, but people putting down £50k - £55k as their income instead of £25k. Why did people go along with this - well, see point 1. Put number on bit of paper, get what you want (the house) - who cares about consequences of the actions?
If you want some firm numbers, then how about this. In 2000, the UK banks were lending equivalent to their deposits. In 2007, the UK banks were lending more than they had in deposits - to the staggering sum of £666 billion. This is all owed to overseas investors - and they want the money back.
So, how come the over-borrowing continued for so long? Well, there's two reasons as far as I can see it.
Banks disguising the quality of debt - a lot of this is far too technical for my knowledge, but basically, the banks packaged up a lot of bad debt (debt owed by people unlikely to be able to repay it) and disguised it as good debt, and sold it on. Due to the continued increase in house prices, and the myth that this would continue forever, this became somewhat of a free money merry-go-round on the international market place. Think about it - if you knew the value of something would go up indefinitely, wouldn't you want a bit of it? The big banks took leave of their senses in this regard, and just chased the profits. But there was another reason too...
Insufficient regulation/government intervention
The government's primary interest, unfortunately, is not run the country well, it is to get re-elected. Furthermore, people have a tendency not to look beyond their own vested interests. This is why, despite the fact that it was obvious that there was too much borrowing and that house prices were too high and it all had to come crashing down, nothing was done. I mean, if you wanted to get re-elected, would you tell everyone that their houses were worth too much and that they had borrowed too much?
Furthermore, the financial authorities were not keeping too close an eye on things, indeed the Labour government relaxed the rules of regulation in the late 90's. Bah.
Welcome to my advertised series on the economy! Hopefully I'll cover a few things like what caused it, is the UK in a strong position, the effect on house prices and how it's all going to end up. Maybe I'll get bored and not finish the series though, you never know...
So first up - we have the question of what caused this mess? People have come up with all sorts of explanations, but the crux of it is not so difficult.
The crux of the matter - Greed. This has been around since the dawn of time - it happens all the time in the Bible. People want things that other people have, so they kill or steal or manipulate in order to get it. In our "civilized" society, these methods aren't so open so that leads us onto...
Borrowing too much. This is the worldly explanation and is entirely correct. This has been going on since 2000, and has been frankly obvious to anyone who cared to look at the housing market from a neutral point of view. The government and the 70% of the country that are homeowners are not neutral points of view, so there was never anything done to address this. By 2004, there was clear evidence that the situation had got out of hand. Banks were lending to anyone and everyone - regardless of the likelihood of that money being repaid. Mortgage brokers and estate agents were advising first time buyers to lie about their income so as to obtain a bigger mortgage - not talking about adding 10% onto your income here, but people putting down £50k - £55k as their income instead of £25k. Why did people go along with this - well, see point 1. Put number on bit of paper, get what you want (the house) - who cares about consequences of the actions?
If you want some firm numbers, then how about this. In 2000, the UK banks were lending equivalent to their deposits. In 2007, the UK banks were lending more than they had in deposits - to the staggering sum of £666 billion. This is all owed to overseas investors - and they want the money back.
So, how come the over-borrowing continued for so long? Well, there's two reasons as far as I can see it.
Banks disguising the quality of debt - a lot of this is far too technical for my knowledge, but basically, the banks packaged up a lot of bad debt (debt owed by people unlikely to be able to repay it) and disguised it as good debt, and sold it on. Due to the continued increase in house prices, and the myth that this would continue forever, this became somewhat of a free money merry-go-round on the international market place. Think about it - if you knew the value of something would go up indefinitely, wouldn't you want a bit of it? The big banks took leave of their senses in this regard, and just chased the profits. But there was another reason too...
Insufficient regulation/government intervention
The government's primary interest, unfortunately, is not run the country well, it is to get re-elected. Furthermore, people have a tendency not to look beyond their own vested interests. This is why, despite the fact that it was obvious that there was too much borrowing and that house prices were too high and it all had to come crashing down, nothing was done. I mean, if you wanted to get re-elected, would you tell everyone that their houses were worth too much and that they had borrowed too much?
Furthermore, the financial authorities were not keeping too close an eye on things, indeed the Labour government relaxed the rules of regulation in the late 90's. Bah.
Labels: Credit crunch, house prices
1 Comments:
Wow.. that explains a lot..
*waves*
By 
, at
21 December 2008 00:54