Why did the banking sector become so greedy prior to the credit crunch?

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If there is one element which stands out by a mile with regard to the recent credit crunch it is the greed of the banking sector worldwide and the ever increasing risks which they were willing to take in the mortgage and personal finance markets. While “over exuberance” was a quote once used by a famous US economist this was something of an understatement in relation to the recent problems in the worldwide financial markets.

So where did it all go wrong?

As the last recession in countries such as the UK started to diminish in the late 1990s there was a renewed vigour as a new Labour Party came to power with new thoughts, ideas and a seemingly midas touch. At that time Tony Blair put the economy in the hands of Gordon Brown and while there was friction between the two, in the good times the UK moved onwards and upwards. This situation was being repeated in many areas of the world as the worldwide economic boom hit new levels in 2007.

However, as business continued to boom we saw more and more entrants to the mortgage and financial markets and competition began to increase. While interest rates at the time were fairly low, this fed increasing competition and cut margins to the bone ensuring that home buyers around the world were never without attractive short and medium-term mortgage offers. So the double whammy of increased competition and low interest rates seemed to feed an ever growing property boom.

Even though margins were under pressure, the fact that the property market around the world was flying high meant that more risks could be taken as any mortgages agreed would be backed by “solid assets”.

Over extension of the financial markets

As profit margins in the general mortgage market continued to decrease we saw the emergence of what for many years had been a sector cast into the shadows and relatively untouched by the majors, i.e. the sub-prime mortgage market. This is a sector which involves high risks but in many cases exceptionally high returns. As mortgage companies looked for ways to increase their overall profitability and margins, many decided to try their hand at the sub prime mortgage market.

The US in particular saw a massive increase in sub-prime mortgage agreements with many people taking on homes which they had little chance of ever repaying back in full. However as the property market continued to rise this would give a number of options to those who may struggle in the longer term, including taking profits were possible and moving on to the next property.

The property market

Like so many corrections, nobody seemed to see (or nobody wanted to see!) the end of the worldwide property market boom. The signs in the US had been there for some time, with personal debt higher than it had ever been, savings lower than at any time in recent history and property prices increasing at an alarming rate. However, while those in the mortgage market were making good money and investors were able to follow the upward trend in the property market, everybody seemed to be happy.

Unfortunately underneath the surface everything was not rosy as the economy started to slow and the seemingly rock solid confidence in the future started to show cracks.

The economy

As we all know, the credit crunch started in the US which is for all intents and purposes the engine room of the worldwide economy. Despite a number of senior economists expressing their concern at the onwards and upwards rise in the US stock market and property market these were dismissed on more than one occasion by the US government and investors seemed happy to take his advice at face value. However, there were definite signs of an economic slowdown in the US around about 12 months prior to the credit crunch but many of the population refused to believe that the dream was dying.

Even when the first sub-prime mortgage lender went under this was dismissed by many as a one-off and it was very much business as usual for the mortgage industry and the property sector. When the second sub-prime mortgage lender failed, a number of investors sat up and began to wonder whether the dream was in fact coming to an end. Slowly but surely we saw a softening of prices in the property market and signs that the economy was slowing its rate of growth.

Slowly but surely more and more sub-prime mortgage lenders hit the buffers and the massive mortgages, which had been offered to customers who had little chance of ever paying them back, started to come to the fore. As homes began to be repossessed and families made destitute the sub-prime mortgage market suddenly collapsed. From a seemingly situation of strength we saw the market literally collapse overnight which had a massive knock-on effect to money markets and financial markets all around the world.

Is the US to blame?

While countries around the world have blamed the US for the current difficult economic situation many are very short sighted in the fact that the US was the country which led the worldwide economy higher, with each and every country around the world benefiting. The fact that many overseas banks have heavy exposure to the US is also another weakness to the argument that the US government and US population are wholly to blame.

There has been a suggestion that the US government was too slow to react to the sub-prime property market collapse and the knock-on effect this had on the money markets. However in hindsight this was very difficult to forecast as nobody had seen anything like it for about 80 years.

The worldwide economy is now in recession (or as good as) because mortgage lenders and financial companies around the world continued to chase every last percentage point of profitability even when markets were reaching dizzy heights. The US has become an easy target for blame but the fact remains that mortgage debt around the world has increased dramatically over the last 10 years, fuelled by cheaper and cheaper mortgage deals which helped to feed the worldwide property market boom prior to the crash.

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