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Contribution of the Credit Crunch Towards a Downturn in UK House Prices Essay

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Updated: Oct 27th, 2021

Introduction

Credit crisis is also referred to as liquidity crisis and it means a situation where credit is generally squeezed to an extent where the banks are not in a capacity to lend more money to the investors in a given state. When a state’s economy is in such as state, investors become unable to buy debts because they cannot borrow capital that can sustain their investments. On the other hand, both consumers and large scale businesses end up spending very little and definitely the situations impact negatively on the country’s economy especially regarding the issue of housing. Research has shown that, credit crunch has to a great extent contributed in the downturn of prices in the UK houses. Today, much effort is being made to improve the economy in UK which has been to a great extent experiencing much impact from the challenges of western countries’ crisis in economy. The credit crunch has also resulted from sharp rise in the price of commodities such as oil and gas which are supplied from the east. Generally, even the decline in the food reserves in the world has made the prices of staple foodstuff to increase by more than 50% for the first time in a period of thirty years. Therefore, from the studies it would be right to make a quick conclusion that, the UK decline in economic growth has been much to do with external influence rather than the states’ economic policies (Brenner, 2006).

Causes for the credit crunch

The hard economic time being experienced in UK is as a result of economic pressures experienced in the United States, the economic progress being made in china as well as India. This is consequently rising up the prices of most goods such as oil and coal not just in the UK but also at global level. However, the current credit crunch is a sign of the more significant challenges going on in the UK’s economy similar to what is being witnessed in the western countries. Such challenges may not be addressed through the current priorities in the government of the United Kingdom that include expansion of programs in training and better financial systems and services as well as efficient control of the spending in the public sector. As a result, there is a great impact on the UK economy from the financial crisis in the rest parts of the world affecting to a great extent the house prices. The London city is among others, going to experience much of the impact in the downturn regarding the economic fortunes in the UK sectors (Richard, 2008).

Research has shown that, credit crunch is a usual occurrence especially when both the government of UK and US has wanted to expand credit facilities. For example, in 1970s, most of the western economies influenced the trend in recession as a result of the weak performance by most of the sectors that dealt with production. These efforts finally resulted to inflation in debts and most of the governments had to intervene and address the problem in 1980s through control of spending in the public sectors as well as making the credit controls tighter. Research has made a reflection on this and found that, a similar intervention requires to be made in order to obtain a solution to the current crisis by the UK government. The only challenge is that, the credit crunch in UK has its source in US as a result of the crisis in the housing markets. Instead of the banks gathering enough information about their customers, they gave a lot of credit to majority of investors who lacked credit histories that could be made as a reference before dispatching the credit to them. These investors were put under the category of sub-prime rather than the banks dealing with prime markets. When the economy was exposed to the risky market, some financial institutions were hit negatively. The situation became worse in Sumer period of the year 2007 when the housing market in US dipped and begun indirectly influencing the subprime borrowers not to honor their loans. The situation became even worse when the effects of the subprime crisis became felt in most of the financial institutions globally. This was because the institutions that were responsible in selling subprime mortgages decided to repackage those debts and in turn selling them to other financial institutions in the housing sector. This was being done in good faith but unfortunately spread the risk even more especially to the banks. This method of securitization had originally been designed as a way of spreading the risks encountered by the banks to other investors through the banks giving part of their loans as assets. The original proceeds gotten from the transaction between the banks and their customers is resold as bonds and securities in a process referred by the term derivatives. These securities that were asset-backed were further invested by other institutions most of which were privately owned and which were dealing with complex portfolios targeting high returns. Most of the returns were meant for individuals and other key companies that dealt with investment such as pension funds as well as insurance companies (Jonas, 2008).

The above merry-go-round involving investment of loans severally in the UK resulted into negative consequences because banks as well as other key financial institutions could not estimate how exposed they were to the crisis involving credit which started being felt in US housing market. As this went on, the financial institutions were characterized by a rapid spread of the crisis and within a very short time, uncertainty increased so much. Key banks and other similar financial institutions were not willing to lend among themselves and lending actually stopped. The money market in the UK that initially used to operate in large scale was forced to close down. When the government considered the issue, a quick solution was found to work only if the bank of England intervened to supply more liquidity into the UK money market. Northern rock had to be rescued by the bank of England and through quick government policies. Other key institutions in UK had to consider write-down in most of their values with as much as more than $200 billion dollars. Such a huge amount of write-down undoubtedly had to significantly reduce credit normally extended by UK government through its financial institutions by as much as $910 billion in one year’s time. (Black, 2007).

Consequences of credit crunch

Research has shown that, such an impact by the credit crunch in UK is still to be felt more especially in the sector of housing as a result of both the failures by the banks in following strict professional policies as well as the problems being encountered through fundamental issues in western economies. The impact caused by the credit crunch is clearly evident through the analysis of the properly market especially housing. Studies have shown that, the prices of houses has gown down and this has been accompanied by a drastic downward trend in the levels of transaction witnessed in offices and residential as well as retail markets. It is therefore not surprising to find that, property market has been majorly impacted by the credit crunch. Rents as well as capital values are therefore being expected to reduce by a big margin especially if the UK economy undergoes a stable slowdown. Lending by most of the banks has now been tightened through use of strict criterion and this has resulted to a reduction in demand. Consequently, this has affected the housing market especially the residential, as the credit crunch continues being witnessed. Research has shown that, the demand for the housing in UK compared with its supply is therefore not balancing and economist are projecting this trend to continue for some time before it stabilizes and from the past trend , this is a historical issue in UK. This has been a key feature for more than 20 years where the imbalance has caused the rise in the prices of houses. In the past, more than 150, 000 houses in the UK have been getting completed at the end of every year but research has shown that, this number is no longer matching the need of the current growth in population. On the other hand, the contribution that used to be given by the local authority towards housing has declined significantly from 40% to almost zero for the last less than 50 years (Yuan, 2004).

The current credit crunch has limited many people from accessing mortgage facilities reserved for customers and this is preparing the prices of most houses to go down following a continuous trend. However, this may not be uniform and in London, disparities are therefore expected to be witnessed in spite of the fact that, the need for more houses is still rising. Studies have shown that, when banks become more rigid in lending loans, the facility meant for mortgage finance to the customers reduces and this consequently results to a significant decline in finances accessible to investors in housing development. The impact on new development as well as regeneration is therefore expected by most economists to be severe. There was a cut of 50% in speculative development between the end of 2007 and the first quarter of the following year. There was also a significant decline in prime rent witnessed in London within the same period. Most of the central locations in London have also been receiving expansion of the spaces reserved for offices (Vlamis, 2008).

Housing market in the central region of London has now received almost full consequences of the credit crunch. However, the economic observers are expressing their suggestion that, consequences of the credit crunch on the issues of housing may not take a long time before it is over. Much of the contribution of the credit crunch is expected to be witnessed in those areas that were on more speculation for the development to incur high cost. Most of such sites include Eastern London as well as Thames Gateway which if developed, it will be under pressure while others might be delayed for a significant duration or even get scrapped from the plan. The Government of UK, from a broader perspective had an initial plan to bring up 3million new houses by the 2020. The analysts say this figure exceeds construction rates that were recorded before the problem of credit crunch was witnessed by more than 30, 000 units where all these figures were rated per annum. The study shows this to be a too ambitious plan by the government and chances of achieving the targets are minimal amid the downturn of the UK economy. This is because house developers may be redundant to take more burden through the agreement in section 106 as well as housing provisions at affordable rates likely to be introduced at a time of upward trend in building cost, reduced profit margins. Most of the financial institutions are also currently not willing to extend more funds on speculative development. Generally, the total number of affordable houses built is likely to go down significantly in spite of the fact that, there may be a rise in a few developments that have not yet taken place and which are likely to raise the proportion of this particular kind of housing in comparison to private houses. This is because; there might be a fall on the demand for housing in the private sector as UK economy continues to experience unavailable access to the mortgage facilities. Studies have shown that, the general need for the housing in UK may however not fall but rather having more of it remaining unmet (Yago, 1991).

Conclusion

In a general way, the current situation of the credit crunch will contribute to the trend in the housing development in various ways. Housing development projects linked to regenerating areas in the outskirts of central London will drastically be delayed and they also stand a chance to be re-scaled as well as not taking place at all. Another great impact will be on the pace of construction whereby, there will be a general slowdown in constructing housing units that are affordable to majority. There will also be general construction in the volume of offices being developed. This will equally affect retail as well as commercial markets whereby, all construction in these areas will generally be delayed. The areas that might receive full housing development and have their value remaining constant are likely to be the ones that are near efficient transport means as well as those that will be facing the busy schedule of 2012 Olympics in London. It can confidently be concluded that, the target by the UK government to construct new homes as guided by its policies has been crippled by the current credit crunch. This downturn being experienced in UK caused by the credit crunch will consequently influence the contribution regarding public spending in the general economy towards declining for a period that may not be less than 2 years. The price of the houses may also continue falling even when the values have remained stable in the market and this will hinder a quick recovery. This is because of the fact that, it is very difficult to measure the prices of houses especially in a turning point such as the one being experienced now.

References

  1. Brenner R. (2006): The Economics of Global Turbulence: London: Verso pp. 45-53
  2. Richard C. (2008): Credit crunch and the property market: London: GLA. Pp. 23-27
  3. Jonas D. (2008): Crane Survey, Central London: Blackwell synergy pp. 36-39
  4. Black F. (2007): The Pricing of Options and Corporate Liabilities: university of Chicago Press pp. 27-32
  5. Vlamis P. (2008): Default Risk of the UK Real Estate Companies: Blackwell synergy pp. 19-23
  6. Hubert R. (2007): The credit crunch crisis Property: Elsevier pp. 46-49
  7. Yago G. (1991):the credit crunch: a regulatory squeeze on growth capital: Blackwell Synergy pp. 37-43
  8. Yuan M. (2004): Credit crunch in a model of financial intermediation and occupational choice: Elsevier pp. 89-95
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