The idea of a “crunch” sounds reassuringly swift. One short, sharp bite and
it's done. Yet the global credit crunch is not at all like that. It is
proving far from the short-lived shock that some had hoped for - and it is
still far from being done.
Almost exactly a year since the crunch took hold with a vengeance last August
9, no let-up is truly in sight. The vice-like squeeze on Western economies'
lifeblood of lending to households and businesses grows tighter still.
There are plenty of observers who understandably will argue that irresponsible
borrowers and “credit drunks” among both individuals and companies, who have
binged for years on lax lending, were overdue for a painful spell of cold
turkey.
Yet the impact of the credit crunch is more akin to the lending equivalent of
American Prohibition in the 1920s than of merely forcing a reckless few
intoxicated by debt on to the wagon of prudence. Now, whole economies have
got a bad case of the shakes as a result.
Recent developments have made it painfully clear that the flow of readily
available finance will be severely curtailed for many more months, if not
years.
The critical reasons why the credit drought is set to grind on are outlined
compellingly in a recent report by David Miles and colleagues from Morgan
Stanley.
Ominously, Professor Miles and his team also highlight how Britain is
peculiarly vulnerable to the protracted financial squeeze from the credit
crunch. In turn, the UK's high exposure to the resulting upheavals will have
vital implications for what happens to interest rates.
More on that later, but let's begin with why the crunch is proving so
prolonged. Several of the key factors were also starkly set out by the
International Monetary Fund (IMF) last week in an interim update on its
twice-yearly Global Financial Stability Report.
First, and crucially, the IMF underlined the real prospect of a further wave
of serious losses for banks on lending in the United States as the American
housing slump continues to deepen.
The IMF's analysis points to the danger of a vicious downward spiral taking
hold in the US, where new losses for banks lead to still tighter lending
conditions, further sapping economic growth, plunging more companies and
households into financial distress, leading to more defaults on loans, still
deeper bank losses and further legs downward.
Secondly, as Morgan Stanley emphasises, huge uncertainties over the scale of
the eventual losses facing banks in the US and elsewhere is inducing an
ultra-cautious approach, leading them to pull down the shutters on would-be
borrowers and insulate themselves against exposure to the toll on rival
institutions.
A third issue is that, after banks on both sides of the Atlantic overstretched
themselves by lending too much against too small a foundation of capital,
they are continuing to struggle to raise the extra capital they need to
rebuild their financial strength.
As the IMF and Professor Miles note, the fresh capital raised by banks remains
lower than the huge $400 billion-plus (£200 billion) losses they have
sustained.
Yet with investors fearful over new losses, the banks' falling share prices
make infusions of new equity finance both elusive and expensive. With still
more turbulence ahead, institutions are left with little option but to rein
in lending to safeguard their existing capital.
Nor has debt finance from the lending market between institutions become any
more readily available, or any cheaper. Interbank loan rates remain elevated
and markets in asset-backed securities are still effectively shut down.
Why, then, is Britain finding itself on the frontline of the continuing credit
crunch?
There are several key issues: the relatively large scale of the financial hit
still being shouldered by UK banks and the increased funding costs they
face; the banks' greatly increased reliance since 2000 on now scarce finance
raised in wholesale markets to back mortgage lending; and the greater
reliance on bank finance by a heavily indebted British corporate sector.
The financial strains on Britain's banks are apparent from an estimated gap of
$11.8 billion between the $43.3 billion that they have written off since
last autumn and the $31.5 billion they have raised since in new equity
finance.
The scale of the wholesale funding problems in the mortgage market was
underlined last week by Sir James Crosby's report on causes of the home
loans drought.
It found that some £40 billion of mortgage-backed securities that have
financed existing lending will mature and need to be refinanced each year
over the next three years simply for banks to maintain existing mortgage
lending levels.
This vast £40 billion sum is the equivalent of more than a third of last
year's total net mortgage lending in Britain, yet these funds are simply no
longer available.
The repercussions are clear from the drastic slump of more than two thirds in
the numbers of new home loans now being agreed each month.
At the same time, the credit crunch also appears to be inflicting an
increasingly brutal squeeze on businesses. Bank of England figures
highlighted by Capital Economics show that the amount of ready cash held by
UK companies is now plummeting at a record pace even faster than that seen
in the last recession - a red alert over growing financial strains.
The causes can be traced back, at least in part, to a diminished availability
of bank funding. Citigroup points to data showing that the level of
available borrowing facilities yet to be used by businesses fell in June at
a rate not seen since 1992.
All of this argues persuasively that the credit crunch in Britain remains
intense, is aggravating an already acute danger of recession and that the
Bank of England must reject any case for a rise in interest rates that would
amount to overkill in its fight to quell inflation.
The ferocity of the credit crunch must surely mean that the present 5 per cent
level of interest rates, which might once have been regarded as relatively
low, is now underpinning excessively tight financial conditions that are
acting to choke off economic activity.
As Professor Miles argues, the harsh scale of the squeeze on lending
conditions almost certainly means that the so-called neutral level of
interest rates, where the Bank is neither applying the brakes to the economy
nor putting its foot on the economic gas, has fallen markedly - perhaps some
way below 5 per cent.
The Bank is already squeezing Britain's brakes hard enough. Hitting them still
harder would risk turning a sharp slowdown into a crash.
Why do people think lowering rates is about prolonging the bubble? the bubble has ALREADY popped and can't be re-inflated. The big issue now is staving off a severe recession, if people loose their jobs good savings rates won't mean a thing. Think about the big picture. To much negative thinking.
kevin, sleaford,
In a free society the banks can do as they wish. However the Gov can make rules, lend as much as you want but above 3.5 times salary the bank carries half of any loss on the loan. They would very quickly behave responsibly and a stable house price relative to incomes would result.
lee maughan, Ely, Cambridgeshire
it makes me laugh how all the people with savings want rates up just as those who want to buy property love talking the Market down.here's the way to shut them up .don't sell any of your property til the situation changes.make it a stalemate.if you don't sell then property prices can't fall.tough it
Kevin, London, England
rates must go up, end of. Inflation must be reduced and increasing interest rates will start to do that . High energy and food prices are not caused by greed oil and food companies but by our central bankers that are creating money.
Steve, Edgware, UK
If UK housing prices follow their US counterparts then we can look forward to more banking problems since no doubt these loans were re-packaged as well ..
Olivier, London, UK
Where on earth did you get your information from: the "credit crunch" was to be short lived? people saw this coming 2 years ago, the "Austrian Economists" 5 years ago. This was long in the making (Dot Com bubble and then 9/11 Bush relaxations). The world is never going to be the same again!
Andrew Graham, London, UK
The Bank of England has left interest rates at 5% because of inflation in oil and commodity prices. There has been a sharp fall in these recent weeks, which is likely to continue.
Falling commodity prices will rapidly curb inflation allowing the Bank of England to significantly lower interest
John Collins, Bromley, Kent
Reducing the interest rate will not ease the situation. The banks will not suddenly start lending to each other. But the Pound WILL fall, inflation will head upwards, savers and pensioners will loose out. Interest rates must go up to put the lid on inflation, which even Major said is at around 10%
Bob Travels, Stevenage,
Why should Briton suffer because of US who wants to keep US$ weak,which in turn has impacted the oil prices.First they blamed China for Yuan being too cheap. If the Old Lady leaves the Interest rates unchanged now,making up later may be too late. Lets not forget the lessons aftermath of N Lawson.
E Asad, croydon, surrey
When bank workers are rewarded based on the amount of money loaned out before it is repaid is asking for trouble. The obligation is then passed onwards in the form of other financial instruments and the picture becomes increasingly clouded. Disaster must follow
David, London, UK
It is tiresome to hear turkeys continuosly asking for Christmas to be cancelled. Rates too low for too long were the problem. Now you propose lower rates as the solution?
Debt is the problem, repayment is the solution.
Cut public spend, encourage living within means, work hard.
Michael, Bay of Plenty, NZ
Long term average house prices are about 3 times average eranings, so that would mean about £90k. Current average house prices = £170k. What exactly do regulators do?
An easy way to help the economy is reduce hidden taxes, e.g. regulations.
The UK could switch from the EU to EFTA. Google: efta
Hugo van Randwyck, London, UK
Well actually Newton's third law is "For every action, there is an equal and opposite reaction" & the last free lunch was the big bang. To balance an economy is no easy task I know I do not possess the skills but its easy to jump up & down & blame others. We ALL made this mess lots of blame to share
Jason Pearson, Toronto, Canada
Regulators must force the banks to declare their full losses & recapitalise urgently. This is an accounting standards problem.
US has changed accounting standards, but delayed introduction for 1 year, probably because most of the banks would fail capital ratio rules! UK must do the same now!
Alistair Nicholls, Manchester, UK
Friedman argued that inflation was related to money supply TIMES VELOCITY, the speed cash circulates. This latter was much reduced by the credit crunch, even as Downing Street ramped up the former. Hence when credit relaxes inflation will take off.
We're in an unholy mess, with no easy way out.
Noel Falconer MEcon, COUIZA, France
The problem has been caused by deregulation in the financial sector and, on a deeper level, by the fractional reserve banking system itself. Monetary reform is the only solution - we cannot have banks able to create money out of nothing. Only governments can repair this, not banks or markets.
Philip Robinson, London, UK
King has blown every major decision he faced,from M4 growth pre-2007 ,to the liquidity crisis, via northern rock collapse.With interbank rates almost 1% above the base rate,the real economy is already squeezed by high rates.Commodity prices are dropping,sales slowing ,so King will.....raise rates!
C.Elder, Bristol, England
All the central banks and most other private banks use a criminal gimmick called "fractional reserve" lending. They NEVER have, nor will they ever have, sufficient funds to back their loans. See FAQ, "How does the Fed “create” money out of nothing?"
http://www.themoneymasters.com/faqs.htm
victor compton, Cherbourg, France
When are you going to stop calling it a 'crunch?' What a comfortable emotive sound that word has like a sort of choc. bar or biscuit. It is a world international financial disaster going to the very roots of capitalism as we know it. Interest rates must rise for the sake of the pound and savers.
Victor M., Cricklewood, London,
This article misses the point that central banks have lost control of interest rates. Money market rates are what count and they are heading up regardless. As a saver I expect a return more than inflation, and don't see why I should subsidise profligate borrowers. BoE puts rates up or savers exit £.
Pete, London, UK
Get the house price crash over and done with and lending will return to normal, ie pre-boom, levels.
Paul, Coventry,
Just like Global warming and oil prices, this is a problem talked into exsistance by vested interest groups for their own finacial gain, only in this case it has back fired and now the bank refuse to lend to anybody out of fear and nothing else.
They were called spivs, now there called investors!
I Johnson, Ramsgate, UK
Good article, but the writer failed to use the dreaded ‘S’ word – Stagflation. Britain is caught in a bout of stagflation the likes of which it has never experienced before, created for us by Mr. Brown. If BoE raises/lowers/maintains Interest Rates, the economy will collapse. No way out. Cheers
William Kent, Brandon, Canada
Good article, but also increasing unemployment and recessionary forces will additionally add to banks' corporate Non Performing Loans, default of personal debt and recessionary induced (rather than credit crunch) property price falls. Lowering interest rates will make Sterling fall - more inflation
Ron, Oxon,
Too few savers in the UK and too many borrowers!
Until we make saving worthwhile we will be forever scrabbling around with other nations who want a lifestyle they can’t afford for a finite pool of capital from the world’s creditor nations-& lowering rates won't really make us the most attractive.
rick, sydney,
If you reduce intrest rates now the cost of energy will go through the roof as the £ will slide against the dollar and oil is traded in dollars.
the problem we are in now was caused by low rates and it wont work as a cure, in the US they have practiucally run out of room on rates - has it worked?
Peter, Aldershot, UK
Frank, It is called, Newton's Third Law of Motion in mechanics and not in thermodynamics.
John, Atlanta, GA
Many aspects of the UK economy reflect the recent availability of cheap credit. Even if its cost returns to its pre-2000 level and doesn't overshoot, many businesses will need to go under. Interest rates can start falling, but inflation must be contained by a sharp increase in unemployment.
tom legassick, dunedin,
Interesting article
Roger Barley, Wellington, New Zealand
Obviously, you ask a Drunk for the cure to Alcoholism..
It's far easier than understanding the problem.
Neale Coules-Miller, Northwood,
The central bank's remit is protect the value of the currency, not to sustain a property maket bubble. It is payback time for the excesses of the fools' paradise economy. Newton's third law of thermodynamics: for every action there is a reaction (of equal magnitude). No free lunches I am afraid.
Frank, London, UK