Mind Map: Credit Crunch

Our A2 macro group mind-mapped the Credit Crunch in a lesson on Friday, a text summary appears below and the original map is also available as a pdf file.

Credit_Crunch.pdf

Meaning of the credit crunch
Unwillingness to lend
Fall in inter-bank lending (wholesale money markets)
Fall in supply of credit causing a rise in inter-bank interest rates
Rise in wholesale rates feeds through to retail credit rates - making borrowing more expensive
A collapse of liquidity

Key words
Risk
Debt
Asset price inflation / deflation
Irrational behaviour
Confidence
Trust
Contagion
Sub-prime
See document: 7073131.stm

Macroeconomic Consequences

US Housing Market
Fall out from sub-prime
Collapse of mortgage lending
Bad debts causing write offs and big losses
Risk of mortgage lender collapse / business failures
Bail outs e.g. Bear Stearns
Fall in housing demand
Sharp decline in construction output and jobs
Fall in prices - negative wealth effect for US economy

Financial markets
Equities
Boost for commodity-related equities e.g. mining companies
Downside for banking stocks / Internet stocks and other financial businesses
Increasing role for sovereign wealth funds - providing source of fresh finance / capital to distressed lenders
Insurance - worsening of credit ratings for insurance companies linked to the sub-prime

Household sector
Harder to get loans
Increased mortgage interest rates
Increased incentive to save (e.g. for a deposit)
Negative wealth effect from falling property prices
Rise in inflation due to commodity prices
Distressed selling of property
Worries over stability of banks / savings

Other parts of the real economy
Fall in employment in construction and related industries
Auto industry
Rise in defaults on car loans
Demand falling - over-capacity / scale downsizing
Fall in business confidence and investment

Commodity markets
Gold prices - seen as a safe haven investment - gold price > $1000 in Mar 2008
Most commodities priced in dollars thus demand rises as dollar weakens
E.g. $110 oil prices, rising wheat prices

Currency markets
Depreciation in the value of the US dollar
Falling Fed interest rates
Loss of reserve currency status
Decline in FDI into the USA
Probably good news for the US trade deficit – may cause some expenditure switching
Euro rising strongly against the dollar
Threatens a recession in the Euro Zone
ECB may start to intervene in the currency markets to stop the euro appreciating

Policy responses

Monetary Policy
Sharp cut in US official rates - now 3%
Massive injection of liquidity into the system $230bn
Fed is allowing the dollar to fall to stimulate the export sector of the US
Federal Reserve is moving real interest rates into negative territory

Fiscal Policy
Bush’s tax rebates $1500 - will they be spent or saved?

Tougher regulation on mortgage lenders and hedge funds etc

Benefits of the Credit Crunch

Need to burst financial bubbles
More sober assessment of risk
More accurate credit ratings
Falling dollar will help to reduce the US trade deficit
Falling property prices will improve affordability
Encourage more savings
High oil prices might constrain demand
Encourage substitution away from petroleum
Low price elasticity of demand for gasoline

Impact on the UK economy

Economic links with the USA - 15% of trade is with the USA
UK mortgage lenders are exposed
Stronger £ hits out export sector
Fall in FDI from the USA in 2008
Weaker dollar helps to cut commodity prices for UK
Northern Crock and the subsequent nationalisation
Loss of credibility for the BoE
Increase in the size of government debt
Other mortgage lenders have tightened up loan criteria
Now harder to get a mortgage
Housing market effects - might tip our property market into a recession?

Good Background Articles
Tutor2u Macro Blog:
BBC Special Report
The Guardian Special Report: