Recession and Credit Crunch

IMPORTANT FACTS- How the credit crunch happened

VIDEO: The Credit Crunch Explained

For a slightly more detailed written version of the above see here.

VIDEO: Another explanation of Credit Crunch and Recession from a campaign group called Positive Money.

Credit Crunch - whose fault was it?

Various people have been blamed - these include:

• Bankers - for coming up with "mortgage backed securities" and other instruments that they didn't understand, and for being greedy
• Regulators like the FSA - for failing to keep up with what the bankers were up to
• Estate agents - for persuading people to purchase homes they couldn't afford
• Individuals - for taking on debt they couldn't afford to pay back

See here for more details.

Bank Bailout

This is usually used to refer to the package of financial support governments provided to banks to keep the financial system running. This includes:

• Buying shares in Lloyd's Bank and Royal Bank of Scotland
• Providing cash to the Bank of England to then provide to banks to keep them liquid (i.e. ensure they have enough cash to keep running)
• Guaranteeing loans from banks
• Setting up the Financial Services Compensation Scheme

IMPORTANT FACTS - Recession

The Credit Crunch led to the value of the stock market falling, house prices falling and credit being a lot more difficult to get hold of.

All of these factors meant that the world economy went into recession. A recession is usually defined as two quarters where GDP falls. See here for information about the recession in Europe.

During recessions tax revenue falls; this is because company revenues fall, leading to less corporation tax, while increased unemployment means the population is earning less and spending less, and therefore pays less income tax and VAT. Government expenditure also increases as people claim more benefits.

Government Deficit

Deficit is the difference between government income (i.e. taxes) and expenditure (on schools, hospitals, benefits, etc.)

As you can see from the graph below, during the recession the income dropped (quite a lot) and expenditure increased (a little).

(Source)

• The difference is known as the deficit. In order to finance this deficit the government must borrow money (by issuing gilts - see here for more detail).
• The more they borrow, the more interest they have to pay, which further increases the deficit.
• However, as recessions are usually cyclical (i.e. things recover after a while) some people do not worry about this type of deficit as much.
• But from the graph you can also see that the government had been spending more than its income for a number of years.
• This is known as a structural deficit. See here for more information about this.
• In order to reduce this deficit the UK Government introduced a number of spending cuts.

What happens if a country doesn't pay back its debt?

Countries can, and have, gone bankrupt. See here for a list of 10 countries have gone bankrupt including Argentina, Iceland and Zimbabwe.

REAL LIFE EXAMPLE: Greece

Greece's deficit has been growing in recent years. In May 2010 it had to be bailed out as it had become too expensive for it to borrow money on the bond market. The European Union and the IMF lent Greece money. The idea was that Greece would be able to sort its economy out and then go back to be able to borrow money on the commercial markets. This didn't happen - in fact ratings agencies downgraded its credit worthiness further. Greece had to take more money from the IMF and EU and there have been ongoing protests in the country about the cuts the government is trying to make in order to address the deficit. See here for more details.

REAL LIFE EXAMPLE: USA

In America the government has a debt ceiling - effectively a credit limit to what the government can borrow. In order to increase this it has to be agreed by Congress. If they are unable to agree then the government will run out of money and the government won't be able to pay for things like teachers or social security payments.

You can find the video explaining what is a debt ceiling here.

Boom & Bust Economics

Keynes v Hayek economic theories, in rap.

Trivia: Some economists believe that the credit crunch and associated recession was caused by an unpredictable 18-year property boom. The theory is that economic depressions can be predicted when there is an unsustainable rise in land prices, leading to a peak in property prices which then crashes. Economists support this theory with historical evidence of peaks in land sales in the US from 1818-1944 that have all been followed by depressions.