With the credit crunch wreaking havoc on the global economy certain governments throughout the world have stepped in with bail out plans involving the injection of money into their individual banking systems. The reason behind this is to stave off the bad or `toxic? debt which they see as crippling to their countries' economies due to unstable institutions and negligible public borrowing.
The burning question now is whether or not this cash injection will have the desired effect so that we are able to borrow money confidently again. At present I am only able to comment on the effect these changes will have on the general public in the United Kingdom, as I am unaware of how other global markets work within their countries, and therefore am unqualified to comment. There may be similarities in how the markets work, but it is best to take my comments here as a rough guide only if outside the UK.
The general public is under the impression that the credit crunch is due to the banks not having enough money to lend. Logic would then dictate that by giving the banks more money the problem is resolved. Unfortunately this is rather far from the truth. The lack of money to lend is only the tip of the iceberg. Banks have been burned by the bad debt accrued over the last few years and are therefore now much more cautious about lending again. Their careless actions in the past will prove much more difficult to rectify in times to come.
House prices are the most important element of the current financial situation, and the prices are dropping fast and are showing no sign of stopping any time soon. Because of this drop in value, lenders are having to be extra vigilant when it comes to lending money from now on. This is particularly relevant when it comes to loan to value (LTV), which is the amount lent in relation to the value of the property. For example, in 2007, lenders were giving 95%, 100% and even 125% of the value of properties.
While the market is buoyant most annalists will agree this type of lending is OK. Think about it if you lend on a 100,000 house 125% which results in a loan of 125,000 and the house price rises over the next three years at a rate of 10% per annum, which was not unheard of. Then your LTV in three years time would only be 93% this is alright from a lending point of view and what would be considered an acceptable risk.
The problem now is that rather than rising by 10% per annum the housing prices are in fact dropping by that much, and they are set to drop even more. If you consider that drop, if a lender was to give 85,000 on a 100,000 property which continued to drop in value, in 3 years the LTV could rise to 118%, which in these turbulent times is simply not acceptable. This is why lenders are now slow to lend out quantities much over 85%.
So what does this mean to the bailout and the future of the market? Well in my opinion, and I may be right or wrong only time will tell, I think that the bailout will have little effect. Yes the lenders are under a commitment to lend at the levels of 2007 during 2009, but if you understand what has been said in my previous paragraphs they cant lend at the high loan to values. Most of the urgent cases for lending are the people coming out of rates that have been arrange in the last five years, these people are going to be pushing the LTVs due to the current house price falls.
In addition you will also have to factor in the situation that a lot of people over the last five years have obtained self certification mortgages. Most of these mortgages are now not available due to the fact that they represent too much of a risk for the lenders, and if they are available they will be at much reduced LTVs, so what are these people going to do?
Don't get me wrong, I am all for the government trying to give the economy a much needed boost, but I just think that the institutions will be unwilling to take the risk on loans at the 2007 and before levels. They will most probably stockpile for the future. This will mean that house prices will continue to spiral downwards due to the LTV not being at a suitable level and the banks will be even more cautious about the type of loans on offer and also the vetting process. It really is a difficult situation and I think that the only way around it if for one of the institutions to bite the bullet and take a calculated risk with regards to their lending.