Contemporary Business Issues in the UK - Essay Example

Contemporary Business Issue- Sub-Prime Lending, It's Adverse Effects on UK And Methods to Rectify and Protect Consumers: Contemporary Business Issue- Sub-Prime Lending, It's Adverse Effects on UK And Methods to Rectify and Protect Consumers: Introduction The purpose of this study is to bring to light, the effects of sub prime lending on the UK economy. The study also tries to find out the steps that can be taken to revive the economic slowdown and a slowdown in the housing market. The primary reason behind chosing this topic is the fact that the world financial markets have been impacted by the recent sub prime mortgage crisis marking it to be a significant event of this decade. Fed of the US has been cutting rates to revive the housing market and the economic slowdown, which has made things better for the short term. Literature Review One of the most important responsibilities for the Fed is that of ensuring monetary stability in the economy, which can be achieved through a combination of stable prices of goods and services across the economy coupled with a low inflation level and level of confidence of the investors in the currency of the country. The Fed comes out with the monetary policy in order to ensure a certain key objectives like, delivering price stability with a low inflation level coupled with an objective to support the Government's economic objectives of growth and employment. To have a look on how the Fed monitors the price related regulations to keep a check on inflation, we can consider a small example of the regulation on house and property prices. To take any decisions related to interest rates keeping in mind the ongoing inflation rate, the Fed must be thorough with the booming property prices and must take steps to ensure that the prices are not artificial. Government intervenes through its central bank to regulate the prices of many commodities, similarly it also regulates the prices of houses like any other important commodity. Fed has the responsibility to keep a check on asset prices including the prices of houses. There can be a number of reasons why the prices of houses may shoot up, like the simple rule of demand and supply has a definite impact. (Demand and Supply for Housing). Other reasons behind a change in property prices can be Mortgages. A mortgage is the money borrowed to buy a house, as for most people buying a house is not easy. Over the years mortgage market has picked up greatly and the current scenario is totally different from the one that existed in the beginning. (The UK Housing Market - Factors Influencing the Housing Market: Mortgages) The central bank of any country has a monetary policy and it uses the same to regulate mechanism of the economy and deal with such erratic swings in the prices of property. Like when it decides to change the interest rate, the government is trying to check the overall expenditure of the economy. A change in interest rates is mostly used to contain inflation, which is the result of lavish expenditure by the country. The Bank sets a fixed interest rate at which it lends money to financial institutions and depending on this interest rate, individual banks and other financial institutions set up their own interest rates, which apply to the whole economy. This interest rate also regulated the savings in an economy, which eventually results in capital formation and reinvestment. It is notable that when interest rates are high, people prefer to invest money in government deposits that are less risky in nature than the stock markets and similarly high interest rates boost up the savings. Lower interest rates make asset and real estate prices go up, as people start ignoring conventional saving instruments and make use of the high growth ventures like shares and houses, which pushes up their prices and this is where the problem of easy availability of finance crops up. The sub prime crisis started with the sub prime lenders lending at higher rates than usual to the borrowers with bad economic history and lesser ability to pay back. The sub prime lending functions on the principle of no collateral and higher interests. There debt instruments are then traded and are passed on to other banks or institutions which are ready to take them for the higher interest they get out of them. Effects on the UK Market Due to the passing on of the debt instruments some prominent hedge funds have failed to declare their current asset values. The problem has led to a total crunch of liquidity in the US. The markets witnessed BNP Paribas announce that it had frozen 3 of its hedge funds due to evaporation of liquidity, totaling around 1.6 billion pounds. The reason was that, it was not possible for the bank to value units of the funds due to the affect of the US sub prime market on them. The funds contained the bundles of sub prime loans, the demand for which have fallen drastically over the last few months. Banks around Europe feared a total liquidity crunch as they feared that they might run out of cash to sustain day to day lending. ECB went to the extent of injecting 155 billion pounds to ease the system of. Investors around the world started backing off from the markets fearing the ill effects of over exposure to the mortgage markets. (How the US Subprime Mortgage Crisis Affect Irish Markets) The high liquidity crunch faced by the US has made the Fed cut key interest rates several times over the last one year. The problems of the US sub prime have made their way to the UK economy also. A number of sub-prime lenders have now announced that they are taking their mortgage ranges off the market, in some cases for just a short space of time but on a longer term basis for most others. New mortgage products that were due for launch have been delayed, and a number of other lenders have hiked up interest rates on bad credit mortgages still further. One of the brokers in the UK spoke about the announcements that have been made by a number of bad credit sub-prime lenders with regards to withdrawing sub-prime mortgages or hiking up rates on these mortgages further, stating that it would be customers with bad credit that would most likely be affected by the changes. (US credit crunch starts to take effect on UK sub-prime market) The liquidity crunch that the US has witnessed had also done bad to the commodity prices and the willingness of the banks and financial institutions to lend each other or even to the consumers. The Bank of England has kept rates steady at 5 percent in its latest monetary policy, though it would have very much liked to cut rates, but that would not have been possible in the wake of inflation touching its 16 year high in the United Kingdom. This would also result in the housing prices falling in the UK as the buyers will not be able to raise mortgage finance and sellers will be forced to cut down their asking prices. The collapse of Bear Sterns has affected their London operations with over 2,000 jobs in London. (Q&A: How will the financial crisis hit us) Condition in the US and Fed's Rescue operation Fed has come to the rescue of the economy by cutting rates to make it easy for the markets as well as to give confidence to the sub prime borrowers by cutting rates, and making it easy for them to pay back. Sub prime borrowers have been defaulting on their payments due to the high interest rates and falling property prices. A decision in this regard will also boost up housing sector as explained earlier, and with lesser interest rates coupled with a pick up in housing sector, sub prime problems of the US economy will definitely ease out with time. Measures to Solve the Problem Going forward the Bank of England has to keep a balance between interest rates and inflation. Price stability is taken care of, by the Government's usual inflation target of 2%. There is a need to contemplate the crucial and critical role played by price stability in achieving the aforesaid economic stability, and in providing just the right conditions for a sustainable and longer living growth in output and employment. Chancellor of the Exchequer announces the Government's inflation target every year in the annual Budget statement. (How Monetary Policy Works) If the discount rate is left unchanged and the inflation keeps scaling up higher than the money market and fixed income securities will suffer a set back and the people on the street will run towards more risky investments that could fetch them higher returns, as a result there will be a sharp upsurge in the prices of riskier assets like the real estate and shares. Also, in this way people will be able to raise money at lower rates and invest the same money elsewhere, but all these are the factors which might require some thinking in the long run as for the short term, housing prices are witnessing a stiff pressure and the commodity prices are scaling up higher and the Bank of England is looking to cut rates, but the rising inflation is not letting it do so. Works cited "Demand and Supply for Housing" tutor2u. 8 Aug. 2008. tutor2u. http://www.tutor2u.net/economics/content/topics/housing/housing_demand_supply.htm "How the US Subprime Mortgage Crisis Affect Irish Markets". 8 Aug. 2008. Irish Mortgage Brokers http://mortgagebrokers.ie/index.phpa=mortgage_article_view&article_id=21 "How Monetary Policy Works" bankofengland. 8 Aug .2008. Bank of England. http://www.bankofengland.co.uk/monetarypolicy/how.htm "The UK Housing Market - Factors Influencing the Housing Market: Mortgages" 8 Aug .2008. bized. biz/ed. < http://www.bized.ac.uk/current/research/2004_05/090505e.htm> Read More