Will throwing money at the Banks really solve the problem?
With the credit crunch wreaking havoc on the global economy certain governments throughout the world have stepped in with bail out plans involving the injection of money into their individual banking systems. The reason behind this is to stave off the bad or `toxic? debt which they see as crippling to their countries' economies due to unstable institutions and negligible public borrowing.
But the big question on everyone's lips is, will this have the effect of kick starting the institutions lending again, and if it does, what how will it affect the individual and the public in general. The analysis off this problem will be based on the UK as that is where my financial experience stems. The situation within the UK may bare similarities with that of other countries but I am not in the position to comment on whether the outcomes would be similar or not because I would not be as au fait as to how their markets tend to function.
To most people the credit crunch is all about banks not having the money to lend. So it is fair to assume that if you give the banks the money that will solve the problem. Sorry this is not the case in fact this is actually far from the case. Banks not having the money to lend is only one aspect of the problem. Most banks are "once bitten twice shy" to coin a phrase. They have lent badly and are now paying the price, it is this issue that will be with us way beyond any bailout plan has been agreed and distributed.
The main result and contributory factor to the current financial predicament is that of house prices, and house prices are not only falling but are set to continue to fall for the foreseeable future. Consequently lenders are finding that they have to tighten all their criteria not least in the area of loan to value LTV, that is the amount of money that is lent based on the value of the property. Most lenders during 2007 lent up to 95% LTV some lent 100% LTV and in some cases they went as high as 125%LTV.
Most experts will agree that as long as the market is buoyant, this lending is alright. If you take into account that the market was rising at a rate of 10%, lending 125% on a property of 100,000 means you are lending 125,000, but with that 10% rate of increase in value over just 3 years your LTV has already dropped to around 93%. In a buoyant market, this sort of lending would be considered a calculated profitable risk and was therefore given the o.k..
But the problem that we face is that house prices are going in the opposite direction. The decline is at least 10% and analysts figure that it could get worse. So, if 100,000 was lent on an 85,000 property then in the same three year time span the loan could have actually increased to 118% LTV. Now I am sure you would agree that in this present climate that this sort of loaning is both irresponsible and detrimental to all involved.
So what does the future hold for the market and will the bailout be the solution to the problem. Well I can only give my own personal professional opinion and nothing is set in stone but realistically I would perceive the bailout as having very little effect. They simply cannot lend at the high loan to values even though they have been committed in 2009 to lend at the levels reached in 2007. You see the majority of loans being agreed at present are dealing with people coming out of rates that had been pre-arranged over the last 5 years. Due to the downward spiral of house prices these people are going to be pushing the LTV up.
In addition you will also have to factor in the situation that a lot of people over the last five years have obtained self certification mortgages. Most of these mortgages are now not available due to the fact that they represent too much of a risk for the lenders, and if they are available they will be at much reduced LTVs, so what are these people going to do?
Don?t get me wrong, I am all for the government trying to give the economy a much needed boost, but I just think that the institutions will be unwilling to take the risk on loans at the 2007 and before levels. They will most probably stockpile for the future. This will mean that house prices will continue to spiral downwards due to the LTV not being at a suitable level and the banks will be even more cautious about the type of loans on offer and also the vetting process. It really is a difficult situation and I think that the only way around it if for one of the institutions to bite the bullet and take a calculated risk with regards to their lending.
But the big question on everyone's lips is, will this have the effect of kick starting the institutions lending again, and if it does, what how will it affect the individual and the public in general. The analysis off this problem will be based on the UK as that is where my financial experience stems. The situation within the UK may bare similarities with that of other countries but I am not in the position to comment on whether the outcomes would be similar or not because I would not be as au fait as to how their markets tend to function.
To most people the credit crunch is all about banks not having the money to lend. So it is fair to assume that if you give the banks the money that will solve the problem. Sorry this is not the case in fact this is actually far from the case. Banks not having the money to lend is only one aspect of the problem. Most banks are "once bitten twice shy" to coin a phrase. They have lent badly and are now paying the price, it is this issue that will be with us way beyond any bailout plan has been agreed and distributed.
The main result and contributory factor to the current financial predicament is that of house prices, and house prices are not only falling but are set to continue to fall for the foreseeable future. Consequently lenders are finding that they have to tighten all their criteria not least in the area of loan to value LTV, that is the amount of money that is lent based on the value of the property. Most lenders during 2007 lent up to 95% LTV some lent 100% LTV and in some cases they went as high as 125%LTV.
Most experts will agree that as long as the market is buoyant, this lending is alright. If you take into account that the market was rising at a rate of 10%, lending 125% on a property of 100,000 means you are lending 125,000, but with that 10% rate of increase in value over just 3 years your LTV has already dropped to around 93%. In a buoyant market, this sort of lending would be considered a calculated profitable risk and was therefore given the o.k..
But the problem that we face is that house prices are going in the opposite direction. The decline is at least 10% and analysts figure that it could get worse. So, if 100,000 was lent on an 85,000 property then in the same three year time span the loan could have actually increased to 118% LTV. Now I am sure you would agree that in this present climate that this sort of loaning is both irresponsible and detrimental to all involved.
So what does the future hold for the market and will the bailout be the solution to the problem. Well I can only give my own personal professional opinion and nothing is set in stone but realistically I would perceive the bailout as having very little effect. They simply cannot lend at the high loan to values even though they have been committed in 2009 to lend at the levels reached in 2007. You see the majority of loans being agreed at present are dealing with people coming out of rates that had been pre-arranged over the last 5 years. Due to the downward spiral of house prices these people are going to be pushing the LTV up.
In addition you will also have to factor in the situation that a lot of people over the last five years have obtained self certification mortgages. Most of these mortgages are now not available due to the fact that they represent too much of a risk for the lenders, and if they are available they will be at much reduced LTVs, so what are these people going to do?
Don?t get me wrong, I am all for the government trying to give the economy a much needed boost, but I just think that the institutions will be unwilling to take the risk on loans at the 2007 and before levels. They will most probably stockpile for the future. This will mean that house prices will continue to spiral downwards due to the LTV not being at a suitable level and the banks will be even more cautious about the type of loans on offer and also the vetting process. It really is a difficult situation and I think that the only way around it if for one of the institutions to bite the bullet and take a calculated risk with regards to their lending.
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