It’s crunch time

As the global economy goes into downturn, James Maxwell and Callum McCormick investigate the credit crunch and what it means for students

Over recent months, ‘the Credit Crunch’ has become a near-ubiquitous phrase, used in reference to the continuing contraction of the global credit markets. However, it fails to convey the depth and scale of the unfolding financial catastrophe. It suggests that the escalating economic crisis is a short-term nuisance that can only be successfully addressed by more regulations and more responsible banking.

In fact, the credit emergency raises fundamental questions about the sustainability of prevailing market orthodoxy and its effects on working people and students. For nearly thirty years, successive governments in London and Washington have refused to compromise their cast-iron belief in the free-market. The turbulence of the last twelve months has forced them to reconsider.

The crisis has its immediate origins in the dramatic collapse of the ‘sub-prime’ mortgage business in the United States. Sub-prime was the euphemism applied to mortgages that were seen as risky or potentially risky – that is, mortgages that were knowingly sold to customers who were unable to repay them.

Traditionally, banks and mortgage companies have refused to lend large sums of money to people who might have difficulty paying them back. However, the relative strength of the world economy and lack of proper regulation meant that even ‘high-risk’ credit applications were being accepted. These loans were then parcelled together and sold on to third-party financial institutions, mainly in the United States. This combination of staggering dishonesty and remarkable incompetence was rewarded with temporary success: massive profits for banks and financial institutions.

Inevitably, though, the ‘sub-prime’ mortgages defaulted: people were simply unable to repay the huge loans they had taken out to buy homes, properties, cars. Repossession rates soared. House prices tumbled. The “re-selling” of the bad loans meant that the sub-prime market had infected all quarters of the financial and money markets. The United States effectively started down the path to recession and took the rest of the world with it.

The failures of under-regulated financial markets have forced a partial reassessment of the doctrine of non-intervention (the idea that the state should have no part in directing the flow of the market). Devout free-marketers (such as President Bush) have turned to “big government”, previously anathema, to rescue the system – culminating in the re-nationalization of the American mortgage giants, Fanny Mae and Freddy Mac.

The U.S. government is currently negotiating with the Senate and the Congress in an attempt to agree to inject a massive $700 billion into the system, in the hope that it will promote liquidity in the credit system and salvage auspicious financial institutions teetering on the brink of collapse. Whether this bailout will succeed is an open question.

What is becoming increasingly clear is that it will be taxpayers who foot the bill for these rescue attempts. Barack Obama and John McCain have begun to express concern that middle- and working-class Americans- already cash-strapped and debt-ridden- will suffer for the ruthlessness of Wall Street. Critics of the moves made by governments on both sides of the Atlantic have called it “socialism for the rich” and warned against rescuing institutions that have only themselves to blame for their problems.

Supporters have argued that if the financial markets are not stabilized, the effects on ordinary people will be even greater.

The consequences of the implosion of the American mortgage industry are massive. World economic growth has slumped and continues to fall. Banks across the globe are expected to announce a total collective loss of $1 trillion. Uncertainty over the extent of “sub-prime” liabilities has ensured that financial lending services have become far less willing to authorise loan applications or extend credit.

In consequence, there has been a sudden decrease in the availability of credit for both ordinary consumers and major money lenders. Hopes that the crisis would be restricted to the financial world and not impact upon the “real economy” have been dashed.

In Britain, the severity of the credit emergency was confirmed by the collapse of mortgage lender Northern Rock, and compounded a year later by the rushed take-over of Halifax Bank of Scotland: the single largest lender in the country. The take-over has left thousands of shareholders feeling cheated. Lloyds TSB bought the company at what amounts to a bargain-basement price.

Scotland’s biggest and oldest bank is now owned and run by the same City of London operatives whose recklessness and greed contributed heavily to the current disorder of the financial markets. As a desperate response to narrowing profit margins, HBOS executives will probably slash the number of people they employ north of the border and relocate central offices to the southern England.

None of this bodes well for student life in Scotland or across the world. Almost all student incomes are dependent on or supplemented by credit. In the coming months, students are going to find it increasingly difficult to extend an overdraft or take out a loan because banks will be ever more reluctant to lend to customers.

This will have particularly severe consequences for areas with high student populations, like Glasgow’s West End. Students will find themselves with less and less disposable income and, in turn, begin to focus their purchasing power on essential goods. ‘Frivolous’ or leisure spending will decrease and the local economy will suffer.

Small businesses will be forced to make cuts and workers in temporary or part-time employment will be the first to be jettisoned. Needless to say, these workers tend to be students. Those students who are already struggling with rising food and fuel prices and stratospheric debts could soon be faced with added the disadvantage of joblessness.

What is particularly shameful and frustrating about this situation is that those who are responsible for the financial meltdown- bankers, mortgage company CEO’s, financiers- have been lavishly rewarded for their arrogance and criminal stupidity. For example, Adam Applegarth, formerly a senior member of the board at Northern Rock, received a £760,000 severance package and a £346,000 pension agreement when he was relieved of his job by the state last August.

In contrast, students, low-paid workers and the poor have been told that they must deal with the credit emergency on their own terms. During times of economic slowdown or recession, state spending will be kept at a minimum. That means a decrease in the funds available for welfare programmes, bursaries and grants.

The extent of the crisis is illustrated by the increasingly polarised debates concerning the nature and general direction of capitalism in the recent decades and at the start of the 21st Century. Most observers have noted that the roots of the problem lie not only in “bad practice” but in an economic and political ideology that valorises free-markets and endless de-regulation at the expense of a more practical and honest approach to wealth creation.

Whilst these criticisms are valid, they miss one crucial factor: financial institutions endorsed and encouraged reckless behaviour because it was highly profitable. As noted above, some executives at banks that are now struggling (or have already failed) have grown exorbitantly rich in the preceding years. And the purpose of capitalism is, in a phrase, the pursuit and accumulation of greater and greater profits.

Therefore, any criticisms of the practice of financial institutions must first accept that their behaviour had a rational basis if viewed from the perspective of a financier, speculator, or corporate executive. This is quite possibly the most sinister aspect of the present economic crisis.


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