Thursday, September 11, 2008

Credit Crunch in No Rush

BBC News, “Credit Crunch to Last Into 2010"
Financial Times, “Recession to Hit Germany, UK, and Spain”
BBC News, “UK Recession This Year, OECD Says”

While the news of the nationalization of Fannie Mae and Freddie Mac, America’s giant mortgage underwriters, rippled throughout the world economy this week, other global players were taking stock of their economies’ health. The head of Halifax Bank of Scotland (HBOS), the largest mortgage provider in the United Kingdom, predicted that the fallout from the global credit crisis will most likely affect the UK economy until at least 2010 – until housing prices in the US start to rise again.

UK banks get about two-thirds of their wholesale funding from US banks, and US money-market investors will not have the credit to loan to UK mortgage-lending banks until US housing prices start to climb from their current trough. Hornby estimated that US housing prices will start to climb in about eighteen months, the time it will take for banks to regain the confidence to start lending again.

The effect of US housing prices on UK markets highlights the interdependence of major world markets, as US money market lenders’ drying funds is causing housing price deflation in the UK similar to that of the early 1990s. However, economists note that the unemployment rate now is nowhere near where it was during that time period, which means that people’s abilities to pay their mortgage bills will not be affected the way it was then.

Also this week, the Organization for Economic Cooperation and Development (OECD) forecasted that the UK economy is likely to shrink by 0.3%-0.4% this year, causing it to fall into a recession. Chancellor Alistair Darling said the UK is experiencing the worst economic conditions in 60 years. Though Chancellor Darling suggested that the right policies can pull the UK out of a recession, Hornby noted that there is little that the UK government can do to alleviate the pressure of the credit crunch because it was a reduction in the availability of credit that spurred the economic slowdown.

Economists blame the fact that UK mortgage lenders are too dependent on selling mortgage-backed securities to foreign (most notably American) investors. A lack of credit in the US means a lack of credit in US banks, and a lack of credit in US banks means a lack of credit to buy British mortgage-backed securities to fund the British housing market.

Questions for discussion:

1) Can the UK government do anything to alleviate the pressures of the credit crunch? What can it do? Will it be effective in the long term?

2) What does a recession in major European markets mean for developing countries?

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