Tuesday 10 February 2009

Is it all due to the Credit Crunch?

Understanding the current economic and financial crisis is quite a challenge. The original emphasis on the sub-prime mortgage market in the USA and latterly the emphasis on the Credit Crunch seem to me to confuse the issue rather than offer any enlightenment. Why would a collapse in the sub-prime part of the US mortgage market lead to the near collapse of the global financial sector? And is there really a credit crunch?

To help me begin to get some kind of hold on the issues I first turned to Wikipedia for their take on the Credit Crunch. There I found the following: “credit crunch (also known as a credit squeeze or credit crisis) is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks. The crunch is generally caused by a reduction in the market prices of previously "overinflated" assets and refers to the financial crisis that results from the price collapse.” So it seems the credit crunch is a result of the reduction in prices of overinflated assets. And how did assets get overinflated in the first place? Easy credit anyone?

According to economist Nouriel Roubini, one of the few economists to predict the current mess, the world has been awash with easy credit for decades. As he wrote in January 2009 for Foreign Policy magazine: "This crisis is not merely the result of the U.S. housing bubble’s bursting or the collapse of the United States’ subprime mortgage sector. The credit excesses that created this disaster were global. There were many bubbles, and they extended beyond housing in many countries to commercial real estate mortgages and loans, to credit cards, auto loans, and student loans. There were bubbles for the securitized products that converted these loans and mortgages into complex, toxic, and destructive financial instruments. And there were still more bubbles for local government borrowing, leveraged buyouts, hedge funds, commercial and industrial loans, corporate bonds, commodities, and credit-default swaps—a dangerous unregulated market wherein up to $60 trillion of nominal protection was sold against an outstanding stock of corporate bonds of just $6 trillion."

Wow, let's just read that again - $60 trillion of nominal protection was sold against an outstanding stock of corporate bonds of just $6 trillion! In terms of the likes of you and I what did all this mean? The Economist in a November 20th 2008 article suitably titled The end of the affair, informed us that: “USA household debt as a percentage of annual disposable personal income was 127% at the end of 2007, versus 77% in 1990.” And according to Robert Peston in an online BBC presentation the ratio of personal, corporate and public sector debt to GDP is 300%. This means that 20% of our total economic output goes on simply paying the interest on what we collectively owe. In addition we still have to repay the original loans. Don't panic, don't panic.

The result of all this easy credit is that globally we suffer from overproduction. As that grand old man John Kenneth Galbraith informed us many decades ago, the capitalist system tends to overproduce anything and everything. Cars, trucks, I pods, computers, you name it and we can and usually do overproduce it. And the only way that can go on is by ever more credit. Which of course is unsustainable in the long run. Or, like just now.

Which brings us back to the credit crunch. Or does it? The banks continue to claim that they are in fact lending. Seems to me it is less of a credit crunch than a solvency crunch. With so many people in debt, consumption just has to be cut back. Which in turn leads to cuts in production – car makers lay off workers, high street stores close. And banks don't want to lend to bankrupt consumers and businesses any longer. And why should they? If it was unsustainable lending that got us into this mess why would anyone think that even more lending will get us out of it?

Collectively we need to consume and spend less on products. Of course, some of us never spent that much in the first place, so we are not best pleased about calls to tighten the belt and other suchlike calls. If there has to be an adjustment in the UK, and there has to be, then let those who benefitted most from the rising inequalities in income and wealth over the Thatcher and New Labour decades be the first to make the adjustments. As a little suggestion, a fairer tax system would enable all those losing their current jobs to be retrained and re-employed in the public service sector providing not just employment but a real improvement in the quality of those things that most people value, either for themselves or their families – better schools and colleges, better health care, better care for the elderly and so on. The wealth is there, but is the political will?

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