The credit crunch – one year on.jpg

The credit crunch – one year on


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Bill Blevins is Managing Director of Blevins Franks. He has specialised in expatriate investment and tax planning for over 35 years. He has written books and gives lectures on this subject in Southern Europe and the UK.

IT IS difficult to know exactly when the credit crunch started… or when it will end. Its roots go back probably a decade when banks began to alter the way they handled their loans by cutting and packing them up into securities that were sold to investors around the world.

Banks became more confident in passing on their debts and felt that any risk would be fairly easily absorbed across millions of investors globally rather than putting the burden on just a few banks.

The US credit agencies helped matters along by overrating the securities packages and encouraged more “slicing and dicing” of debt to continue.

In 2004, US interest rates fell to one per cent and mortgage providers supplied loans to people with no or poor credit histories. The lending banks figured that if borrowers could not make the mortgage payments, properties could be repossessed and the banks would get their money back.

Then the Federal Reserve Bank (Fed) began to raise the interest rate, increasing it 17 times over two years until June 2006 when the interest rate topped at 5.25 per cent. Over that time, people started to default on their mortgages and the housing market began to fall. Banks found it hard to sell repossessed properties and were lumbered with billions of dollars of bad debt. This debt was packaged as “collaterised mortgage obligations” and sold on until it was buried in the global financial network. Banks grew wary of lending to each other. Inter-bank rates went up. The credit crunch was under way.

In Europe, the first warning bells rang on August 9 2007 when the European Central Bank (ECB) injected 95 billion euros (75 billion pounds sterling) into the Eurozone banking system to prevent borrowing costs from spiralling upwards. Not since September 11, 2001, had such a move been made. The ECB called it “fine tuning” and the injection had an immediate effect, forcing overnight lending rates back down… but that wasn’t the end of the story, just the start.

The Federal Reserve then injected 24 billion euros into the money markets and the Bank of England (BoE) followed on with firstly 4.4 billion pounds sterling and then 10 billion pounds sterling to try and ease the climbing inter-bank interest rates.

In the UK, Northern Rock hit the headlines with the memorable queues of customers withdrawing their savings, marking the first run on a UK bank in 140 years. The BoE provided emergency funding for Northern Rock to try and stem the crisis and the UK Government guaranteed savers’ deposits in the bank. After a period of failed bids to buy the bank, it was taken into public ownership.

In the US, Bear Stearns got into trouble over the collapse of two hedge funds in its control and its exposure to the housing market. The Fed gave the bank emergency funding and it was sold to JPMorgan Chase in March. Other banks including Citigroup, UBS and Merrill Lynch suffered with billions of dollars of asset write-downs.

The past year has taken its toll on several of the largest banks in the UK. Bradford & Bingley, HBOS, Royal Bank of Scotland and Barclays have been forced to raise billions in extra cash. Alliance & Leicester agreed to a takeover bid by Spain’s Santander bank.

When the sub-prime crisis first came to light, the US government estimated that losses would be 50-100 billion US dollars. The Institute of International Finance calculated that in the year to June, banks made 476 billion US dollars in credit write-downs. There is likely to be more writedowns to come; the question is how much and what effect this will have on the banking industry.

On August 19, Kenneth Rogoff, an influential economist who was chief economist to the International Monetary Fund between 2001 and 2004, warned that the financial sector was probably only halfway through the crisis and that there was worse to come. Speaking about the US he said: “We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one, one of the big investment banks or big banks.”

Housing market

Housing sectors in the US and Europe have slumped dramatically. In the UK, the average price of a house has fallen by just over eight per cent over the year, according to Nationwide.  Since January the level of mortgages defaults has risen around 50 per cent and is particularly prevalent with “buy to let” mortgages. In Spain, house price sales dropped 34 per cent in the year to May.

According to the Ministry of Justice, the number of home owners in England and Wales facing repossession in the second quarter rose by 24 per cent compared with the same period in 2007.

Data provided by Moneyfacts shows that last summer there were 15,599 mortgage products on the market. A year later, this had dropped to 3,500. The BoE’s figures reveal that 9.9 billion pounds sterling was borrowed in mortgages in June 2007. In June 2008 it had plunged to 3.1 billion pounds sterling.

Property website, Rightmove, said: “The lack of mortgage finance is central to the problem, and perhaps that is where policymakers’ attention should be focused, as the banks can’t or won’t sort out the mess they were instrumental in creating.”

A survey by Reuters news agency reveals that the majority of economists polled felt that the credit crunch would last well into 2009 and possibly 2010. There isn’t an instant remedy for the credit crunch and recovery is still some way ahead.

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