Marketing and the Credit Crunch

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The Credit Crunch what is it?

When banks and building societies and other lenders decided to tighten their lending criteria for loans and mortgages, this became known as the Credit Crunch, as many people and small businesses could no longer obtain credit

Why did lending suddenly reduce/stop?

Banks and building societies lend money with the aim of making profit from the interest charged to the applicants taking out the loan. In theory a large number of loans should result in a large profit i.e. more loans equal more interest back from customers. However during the latter part of 2007 it started to become apparent that many individuals could not afford to pay back their mortgages. Investigations revealed that financial institutions had engaged in “risky” lending through

• Increasing lending multiples so that individuals were lent five to ten times their annual income

• Lending to individuals with poor credit history including missed loan repayments, defaults and county court judgments

• Lending to individuals on very low or no income other than state benefits

• Not verifying the information provided by the loan applicant e.g. checking income through wage slips and or P60

• Providing individuals with mortgages which were greater than the value of their property or the borrower didn’t need to contribute towards the purchase price i.e. the mortgage covered the full value or purchase price of the property

A lot of high street lenders were borrowing money from other financial institutions via the money markets and then lending (the money that they had borrowed) to individuals and businesses. These lenders made a profit by lending money at a high interest rate than the one they had paid to borrow the money.

After the news regarding risky lending practices broke, financial institutions became apprehensive about lending to each other. This apprehension reduced the amount of money available to high street lenders and it led to an increase in the interest rates that high street lenders had to pay for borrowing money. The lack of credit available to high street lenders reduced the number of mortgages and loans offered by high street lenders to individuals and businesses. High street lenders also tightened their lending criteria through:

• Reducing lending multiples
• Only accepting individuals with excellent credit records
• Limiting lending to individuals with proven employment/self employment income
• Requesting the loan applicant to provide documentation proving the information provided on their application
• Only granting mortgages to applicants able to fund at least 10% of the purchase price themselves.
• Increasing the interest rate charged for mortgages above 90% of the purchase price.

Recession- What is it?

The credit crunch has contributed towards economies around the world falling into recession as businesses have found it difficult to secure short term lending for every day operations.

Recession is where manufacturing output falls in two consecutive quarters; a decrease in demand within the economy is the cause behind this fall. Businesses and customers are not buying because of either a shortage of credit (as discussed above) or an increase in costs or both.

In order to continue trading and to deal with sudden drops in demand, businesses have reduced the number of people they employ and/or reduced working hours. Some businesses such as the car manufacturer Honda have suspended car production. On the 30th of January 2009 Honda suspended production of cars from its car plant in Swindon for 16 weeks. Honda employees at the Swindon plant were told to stay away from work during the 16 weeks. The workers were on full pay for the first two weeks and around 60% for the remaining 14 weeks. Honda said that they will resume a reduced level of car production on the 1st of June 2009.

Repossessions, toxic debt, inflation and deflation

Reduced income has left some individuals and businesses unable to pay back their mortgages and loans. The inability to meet loan repayments has been exacerbated by an increase in other costs such as utility and food bills. These rising prices are known as inflation.

2008 was dominated by news headlines reporting a large increase in the number of properties repossessed due to house owners and creditors not being able to make repayments on their loans. Financial institutions have also written off loans that they feel will never be repaid by the individuals and organisations that borrowed it. This is known as toxic debt and includes loans that were made decades ago.

We have briefly discussed inflation above however recession can also lead to the reverse of this deflation. Deflation is where prices drop as opposed remaining constant or increasing. Deflation can also adversely affect businesses and the economy as it can lead to reduced demand because buyers are expecting future price decreases. It can also lead to reduced profits because businesses are charging less for their goods or services.

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