Credit Crunch
By Angelo Mastrogiovanni (BA Hons)
In recent weeks, the specialists have talked long about the credit crunch and its consequences. At its centre has been the Northern Rock crash and ensuing instability in the financial markets.
What has so far been missed is that the US’ mortgages crash and knock on effect in the UK has been incidental to bringing forward the onset of recession, but that the UK has for long been simmering in its own credit crunch.
In the last 10 years or so, there has been a dramatic increase of easy credit card borrowing. This is an old trick; you borrow but by the time it has to be repaid the economy will have expanded, thus making the debt comparatively smaller than it originally was and the repayments cheap.
But in this case this was not just a financial instrument, this was a combined credit card borrowing by the general public with risky mortgage lending to rising house prices. The other side of the coin is that successive budgets trimmed income tax, but then expenditure had to be reduced somewhere else to make ends meet. This includes axing grants to local authorities that resulted in large council tax increases, increasing top up fees for students and changing eligibility rules for job seekers allowances that resulted in “historic low unemployment”, (since they count claimants, not how many new jobs are created). The public has thus been induced to rely more on credit to make up for the shortfalls.
Expenditure on credit card is paid upfront by banks, but there is a limit on how much a bank can or is prepared to afford until the bank wants its money back. While the retail sector enjoyed years of growth and expansion, and while the multiplier extended the benefits of this expenditure beyond the retail sector, it must be said that it was on credit money being financed by credit cards and banks. This is an artificial bubble, not real money paid on sustainable debt.
This is only the onset, and you can expect some form of recession to hit in a period of 2 to 4 years. The lesson here is that this is not about financial regulation, but about common sense. The economists were and are obviously aware that credit cannot last for ever but were prepared to try, counting on the financial naivety of the average citizen who gets now caught out in debt.
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Copyright © FABCP 24 December 2007