Further thoughts on the credit crunch

History books are likely to remember the financial crisis of 2007/2008 as the ‘sub-prime’ crisis, referring to the turn of events in the U.S Mortgage market that precipitated the credit squeeze, which in turn ripped through the western world. Easy money conditions made funds available to finance millions of U.S. sub-prime borrowers, in essence less well-off people who in earlier times would not have been seen as credit worthy borrowers.{{more}} Today, financial institutions worldwide are experiencing a lack of available money across their markets. As money becomes tighter, banks are no longer able to lend or borrow from one another, and as the credit crunch effect worsens, financial institutions compensate for this shortfall through their customers; they increase fees and rates on their mortgages, loans and credit cards.

The beginnings of the credit crunch can be traced back a year ago in the United States of America, when people with a poor credit history were allowed to take out mortgages called subprime mortgages which they were later unable to repay. With falling house prices and rising interest rates, these missed repayments led to a vast increase in repossession levels. Given that we are now living in a globalized environment, a process by which people of the world are unified in a single society and function together, it seems certain that those of us who reside in St.Vincent and the Grenadines and the Caribbean generally will be subject to some effects of this worldwide crisis at some time.

Owing to the fact that subprime mortgages have been sold by the originating institution and resold many times, banks simply do not know how much bad mortgage business they have bought, let alone what the impact has been on other banks. As a result, banks don’t want to lend money to each other anymore, and the continuous movement of money, referred to a liquidity, has dried up, creating what is now known as the credit crunch. Because banks are not lending to each other anymore, the global economy has started to freeze up and stock markets across the world have become unstable. Our daily, weekly or monthly earnings are feeling the impact of the crunch, too, as prices for food items; gas and electricity continue to rise. We would be obliged to take defensive measures in response to the crisis; at the supermarket we must be transformed into buying what we really need rather than attempt to satisfy our more extravagant wants. Credit card financing is one of the most expensive forms of credit you get from your bank. You may consider transferring that balance to a less costly means of financing. Eating at restaurants is convenient, but costly. You may want to take a packed lunch to work instead. These are but a few of the cost-cutting measures that are within our grasp; you will be able to think of others.

It is still too early to say what the events of the past weeks and months will mean for the long term. What seems sure, however, is that there will be a major impact on economic thinking going forward. The decision of some governments to take stakes in banks is one of the most significant economic developments for decades. De-regulation of financial markets seems clearly to have played a role in the current crisis, but let us not oversell the idea of the ability of regulators to spot problems that directors of companies they regulate cannot.

The former Chairman of the U.S. Federal Reserve Allen Greenspan admitted being partially wrong in thinking that relying on banks to use their self interest would be enough to protect shareholders and their equity. Greenspan had earlier argued that government regulators are no better than markets at imposing discipline. The implications of these recent developments will not necessarily be a significant shift back towards major state intervention in the economy. Perhaps there will be renewed interest in a state role in certain sectors but the main impact will be a more positive view of the role of the state in resolving economic problems rather than being an owner itself.