The Impact of Credit Crisis on Mortgage Credit Conditions in the UK - Literature review Example

Critically evaluate the impact of credit crisis on mortgage credit conditions in the UK Introduction The credit crisis just as any other economic crisis affected the growth and expansion of various sectors in global economies. Caused by myriad economic factors, the crisis led to the stalling of various industries, which further perpetuated the crisis thereby gravitating the financial situation in most countries globally. In the united kingdom just was the case in other developed economies, the situation affected the growth of the real estate’s industry following the successive stringent policies that the government implemented in order to safeguard the economy from such unprecedented financial crises. Prior to the 2007 – 2009 financial crisis, the government of the united kingdom had provided various incentives to the housing sector thereby making it one of the most lucrative industries to invest in throughout the country. The industry therefore appeared lucrative as financial institutions relaxed their terms and conditions enabling more people to access funding for the development of their houses (Wallace & Henry, 1922). However, would change following the determination of the role the industry played in perpetuating the credit crisis (Campbell, Lo & MacKinlay, 1997). The housing sector was a major contributor to the spread of the credit crisis and the global financial crisis a feature that resulted in various stringent policies to the industry after the country survives from the crisis. Among the factors from the housing sector that caused the crisis included the housing bubble. The housing bubble resulted from the illusionary belief that the house prices never decline despite the prevailing market factors (Bogomolova, 2011). The belief intensified competition for the market thereby attracting more investors most of whom included the financial institutions that had sustained the economy over the years. Just as with any product or service in the market, the increase in supply while the demand remained constant led to a great decline in houses thereby reducing the value for the investments. Such was a major lesson that the players and the government learnt thereby resulting in the radicalization of the industry and the revision of mortgage policies in order to cushion the market from similar crises in the future. Among such resultant policies with the distinction of the roles between investment and commercial banks both of which had invested extensively in the housing sector. The provision of mortgage facilities requires the effective consideration of various factors that affect both the market and the earnings of every applicant. Prior to the credit crisis in 2007, the government had provided incentives to both the investors and the market in order to enable most people in the country to afford descent housing thereby improving the living standards of the people in the country (Kotler, 2010). The provision of incentives made the industry more precarious. Investors saw such as an opportunity to expand the market thereby increasing the demand for housing units, more investors thus took the risk. The clients on the other hand also took the risk of applying for mortgages from the various financial institutions that were willing to offer the much-needed financial services. In search of market, the financial institutions relaxed the policies previously regulating the acquisition of mortgages. By relaxing the policies, the financial institutions increased the risks in the sector since they provided mortgages even to a section of the population that could not qualify for such services in normal circumstances. This heightened the risks later compounding the losses the financial institutions incurred in the resulting crisis (Walter, 1995). The financial institutions learnt various important lessons from the crisis that later governed their operations and provision of mortgage facilities. Currently, financial institutions such as banks require more securities before the provision of mortgages or similar services. Just as loans, banks seek to profit from the interests that the mortgages attract. To secure the interests, the financial institutions currently demand more elements from the applicants. Such include a security that they claim once the applicant defaults and proves inability to service the mortgage. The security currently includes worthy assets such as cars and plots among many others. With the securities, the financial institutions safeguard their interests by ensuring that they never incur losses. In case of the inability by an individual applicant to service the loans, the financial institutions simply claim the security and sell it thereby reclaiming their investment. In addition to the securities explained above, the financial institutions consider various other factors that prove the ability of the applicant. Key among such is the receipt of a steady income either monthly or annually. The steady income proves to the financial institution that one would readily service the loan without defaulting. Currently, banks among other financial institutions that offer mortgages consider the earnings of an applicant before the issuance of the mortgages. This is unlike the years preceding the credit crisis in which the government offered financial incentives to both civil servants and those employed in the private sector thus increasing the rush for houses in the country. The perceived incentives led to the financial institutions offering mortgages to people who could not qualify for mortgages under normal circumstances. This thus made the industry more precarious as people later lost their jobs and could not service their mortgages following the economic uncertainty that ensued thereafter (Nanto & Library of Congress, 2009). Another radical security measure that financial institutions currently undertake in before the provision of the mortgage facilities is the involvement of other financial institutions on the country. In case an applicant defaults a loan given by any bank or similar financial institution in the country, the institutions record such information on a designated logbook, which they all share among themselves. The communication and incorporation of other financial facilities was missing prior to the crisis. The intense competition led banks and other financial institutions to operate in secrecy with the view of maximizing profitability. The crisis however was a revelation that resulted in greater correlation among the financial institutions in the country. With the logbook, the financial institutions share information about the market and keep track of applicants’ financial history. This makes the market safer since they carry out extensive background searches on the applicant before qualifying them for the loans. This has made the industry safer since the financial institutions prefer clients without prior negative financial histories. Coupled with the security they demand from the applicant and the steady income, the financial institutions have succeeded in safeguarding their financial interests in the market. Among the major causes of the financial crisis in the years stated above was the growth of the real estate’s industry that enticed financial institutions to relax their financial terms and securities. While the industry promised more returns and value for investment, it requires more capital. Investment in such an industry would therefore deny the financial institution the much-desired liquidity in order to sustain their daily financial operations. With such understanding, the government had dedicated specific types of bank to participate in such risky investments while others provided the security for the economy. While commercial banks invested heavily in different types of economic opportunities including the housing sector, investment banks avoided such investments as a policy matter in order to cushion the economy from such unprecedented economic crises. The government would later relax the policies in desire for rapid economic expansion. This permitted both the commercial and investment banks to compete in the market and scramble for profitability in the market. This would later prove to be a fatal mistake as the economy latter plummeted. The investment rush by both the commercial and investment banks for the market they both perceived large and lucrative exposed the economy to various negative economic factors and features of the housing industry. The economy of the United Kingdom among other major economies whose housing sectors were expanding thus began experiencing diminishing liquidity levels. The market that appeared lucrative thus threatened to perpetuate and worsen a global financial crisis (Lane, 2005). After a sustained investment in the housing sector for more than three years prior to the crisis, the market began decreasing as the competition heightened. The incentive provided by the government to the civil servants in order to enable them access mortgage facilities from financial institutions had only succeeded in attracting more investors but not the would be home owners. This proved the housing sector to be one of the most precarious markets in any economy. The financial institutions that had invested in the sector with the hopes of gaining the largest market share began incurring losses, as they would later realize that the economy could not rely entirely on one sector (Cavanagh, 2002). The housing sector is precarious and investment in such a market requires the consideration of various factors. The previous policy barring investment banks from taking such investments purposed to avert such crises. The economy is a self-sustaining cycle that relies on the growth and activities in the numerous sectors. Liquidity and economic growth in any economy relies on the financial policies in the country and the activities in the various markets. By investing entirely in the housing sector, the various investors denied the economy a chance to expand their activities and sustain the uniform economic growth. The resulting imbalance thus drained the economy of credit facilities that would have sustained the growth of other sectors in the economy thus cushioning the economy from plummeting into the financial crisis in 2007. The stock market was yet another great contributor to the spread of the financial crisis. Following the promise of incentive by the government, the industry appeared lucrative enough to back the stock markets (Thomas & Michael, 2001). The stock market therefore relied on the housing sector as most investors showed preference to properties. The subsequent decline of the prices of houses in the market would therefore escalate loses to investors in the stock market. Globalization of the stock market thus spread the effects thus making the crises a global one. Globalization has influenced the change in economic policies currently evident in developing economies. It is evident that there has been a lot of cross border cash flows from the developed economies to the developing world. The increase in cash flow arises from numerous pull and push factors arising from both the local and international markets. The pull factors originate from the beneficiary countries often the developing countries (Walter, 1995). Such countries have changed their economic policies to permit cross border trading and investment in their countries thus expanding the financial markets in order to accommodate the increasing demand for such products (Fournier, 1998). While globalization presents several positive effects to both the developed and developing world, it also presents several severe negative effects that may stall the growth of either specific companies or even the entire national economy, as was the case with Greece early 2013. Among the key negative effects of globalization in the financial markets is the rapid spread of financial crises. The 2008-2008 financial crisis currently considered the worst financial crisis after the great depression was an avid manifestation of the negative effects of economic globalization. The crisis that began in the United States as a dollar crisis resulted in dollar shortage globally and resulted in the near collapse of several multinational corporations, which invoked government bailouts in the strong economies in a bid to prevent total economic collapse of the countries (Alexander, 2010). The rapid spread of the crisis from the United States to Europe and the rest of the world was a self-portrayal of the negative effects of globalization on financial institutions. Financial institution in the United States such as the Wells Fargo and the Bank of America were among the first to register shocks because of the financial crisis. Since they operate in financial markets in other countries especially in the Europe, traders in such banks began speculating on the future of the institution thus initiating an unprecedented fall in their share prices among their other products. Besides the collapse in the share prices, the banks just as many other multinational corporations at the time began incurring loses which they further spread to their shareholders in the form of dividends. Shareholders share often share only the profits of a company however, they indirectly share the losses as well. When the share prices fall, they incur losses since they rush to sell their shares thus creating a virtual increase in the products with minimal demand. Most likely, they therefore sell their shares at lower prices thus incurring losses on their investments (Chatterjee & Hevner, 2010). Another great negative effect of globalization on financial markets arises from the increased operations in the markets. Among the probable causes of the 2008, financial crisis was complex financial products, high risk and undisclosed conflicts of interests. Globalization increased activities in the financial markets in the leading economies. The markets became precarious as investors and companies alike could not formulate new profitable venture. In despair, some of the leading companies opted for high-risk investments. With globalization, the risk is compound and affects various investors in different countries. At the time, AON had thousands shareholders in London and had invested millions of dollars marketing in the country even supporting a local football club. The loss the company incurred in the United States affected its stability in London and instigated a similar financial crisis in the insurance industry in London as speculation began in the London stock market (Iacobucci, 2012). Shareholders rushed to sell their shares causing an increase in supply and decline in demand of the shares; this resulted in massive financial losses for both the companies and the shareholders alike possibly causing the financial crisis. The economy is a web of interconnected financial activities and stakeholders, a negative activity in a sector in the economy instigates several negative ripple effects that explain the nature of the financial crisis (Tabbush, 2011). The loss incurred by AON in the United States instigated the speculation in the New York financial market resulting in the supply of the shares and decline in their demands. While the traders incurred massive financial losses since they had to sell their shares at lower prices, the company also suffered from reduced capital forcing it to cut down on its operations. The bank began by forceful retrenchment of employees thereby declining the purchasing power of the American population a trend that affected other sectors of the economy. Such ripple effects spread to other countries such as Britain where shareholders incurred similar losses. This explains the AON situation yet economists contend that numerous multinational corporations incurred massive losses similar to the AON case. Such explains the network and flow of financial activities facilitated by the economic globalization specifically by the financial markets that instigated the global economic crisis. Another evident manifestation of the negative effects of globalization on financial markets was the Enron cries in 20001. The steady growth of Enron for ten years to about eighty billion dollars was a marketing enough to attract millions of investors from all over the world. The company appeared lucrative as its share prices kept rising despite the prevailing market factors. The mangers portrayed creativity and charisma that marketed the company too both the American and overseas investors. However, the company’s twenty-four day collapse portrayed great fraud that resulted in an international financial shock as investors globally felt the effects of the collapse of the third largest corporation in the United States. Investigation into the fraud revealed clearly planned and institutionalized accounting swindle. The mangers would devise imaginary financial products and sell in the financial market. The managers capitalized on the fact that the company had earned the trust of the market as the strongest product in the market, every of the products the company would therefore introduce to the market would result in the strengthening of the company’s share value thus attracting more investors. Financial markets do not sell any tangible product to the market; it is therefore a high-risk operation capable of bankrupting an investor in hours. Globalization compounds such high risks thus exposing any potential investor to possible bankruptcy, as was the case with those who invested on Enron, American leading energy distributor. In retrospect, the credit crisis in 2007 to 2009 was a great revelation, which resulted in the radicalization of various sectors of the economy including the precarious housing sector and the stock markets, which was an equally great contributor to the spread, and sustenance of the crisis. Currently, the housing sector has myriad competitors most of who rely on the mortgage services to enable their target market to afford the products. The financial institutions who provide mortgagee service on the other hand have to date implemented very stringent policies in order to safeguard their interests and make the market safer. 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