Sunday, April 13, 2008

The "Credit crunch"

The story of the "credit crunch" continues. Twelve months ago it wasn't even a phrase.

Here is my little diagram of the main players, it looks like the consumers are trapped in some dodgy little pyramid scheme and in some respects we are. In a blamestorm (a blame equivalent of a brainstorm) everyone would be found to be at least partly responsible. The other issue is trust, all of the players are closely connected and any exchange in money is based on trust.

To examine the credit crunch more closely we have to examine the concerns and motivations of each party:

Bank of England:

Main concerns: Inflation is now at 2.5%, over the government target and although the interbank credit markets lack fluidity the bank doesn't want to be seen as bailing out past poor financial decisions.

Options: Interest rates cannot be adjusted sufficiently to boost confidence, the risk of rampant inflation is too high. It is likely the Bank of England will have to offer longer term loans or take risk onto its books to increase confidence.


Main concerns: Avoid going bankrupt and reduce their risk dramatically. Spread the blame and get a bail-out from the government.

Options: Reduce risk, find compromise with Bank of England over longer term loans. Learn from their mistakes, leave risky mortgages to specialist companies.


Main concerns: Win the next election, give the consumer what they want without storing up problems for the next five years.

Options: Reduced since the Bank of England were made independent (A very good thing). Spread the blame to the banks and consumers suggest that their hands are tied while lobbying for other parties to sit round the table.

The government may be able to look at stronger regulation for the financial services or increase funding for home owner schemes to add buoyancy to the housing market.


Main concerns: running out of money fast with inflation, poor pay rises and being heavily extended on credit. If not on the housing ladder now, absolutely no chance. If on housing ladder fears of a market crash and negative equity.

Options: Re-finance debt and lobby for changes to the banking system. If they have over extended themselves learn that the economy can go down as well as up and that no one will come bail you out.


Somehow we need to regain confidence in the banking system I would expect the Bank of England to make more loan money available to lenders over longer terms. Hopefully, all lenders will learn not to take as many risks.

Consumers will loose out, credit that was available will not be extended to the same extent. Everyone now accepts that lenders made some dubious decision and took on too many high risk loans. This is partly the consumers fault for over extending themselves, just because a lender offers you money doesn't mean you should take it.

For the property market using simple demand / supply economics. Demand will fall especially at the lower end of the market as it is the first time buyers that prop up the market. This will then cascade up. However, supply may also fall which may lead to a stabilisation of the property market.

Best guess is the property market will go through a structural re-alignment, we may see a fall before it stabilises at just below or near inflation growth. Falls will be lower at the bottom end of the market, even with credit restrictions I would anticipate that demand for first houses will still outstrip supply.

When it comes down to it I feel blame lies with both the lenders and the consumers. No one thought that the economy would have a hiccup, we built our finances on a house of cards, when one fell so did all the others.

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