Effect of Credit Crunch on Consumers - Essay Example

(approx. Word count – 727 words) Credit Crunch (Impact on Consumers) 14 February Introduction The term creditcrunch was once an obscure phrase used only by economists. But this term has gained a more widespread currency lately due to the implosion of the housing market in the United States of America which in turn triggered a global financial crisis which affected not only big businesses but even entire countries (like Ireland, Greece, Spain, Portugal, etc.). A credit crunch is also known as a credit squeeze or a credit crisis; the public is now aware of what it means that the venerable English Oxford Dictionary included it in its latest edition (Budworth, 2010:1); the objective of this research paper is to educate consumers on the effect of a credit crunch on them and also make them financially literate. A credit crunch usually happens during a recession (as what we are in right now) that results in greater difficulty in getting or securing borrowed money from banks and lenders. A crunch occurs because the usual lenders are nervous about lending out their monies due to the reduced prospects of repayment, such as during a recession when the economy is not doing so well and impacts negatively on people’s ability to repay a loan. This brief paper aims to look and discuss how the current credit crunch is affecting all consumers. Most academic research and newspaper reports only talked about a credit crunch and its impact on big corporations but neglected its effect on individuals. It is the objective of this paper to correct this oversight and enlighten people on how the credit crunch affects them individually on a personal level. The rationale for choosing this topic is that a credit crunch has a negative effect on everybody from availability of jobs to the ease of getting a loan and to the interest charged on credit cards and home mortgages; its impact is very wide ranging. Discussion Consumer spending accounts for roughly 70% of the United States economy. GDP is the measure of all the goods and services produced by labour and property within the country (Young, 2011:1). The United States economy has a big impact on the world economy because of its sheer size. However, there are also some constraints to consumer spending, primarily a depressed economy that contributed to a high 9.8% unemployment rate. Even here at United Kingdom, the economy is also largely dependent on consumer spending. Figures produced from the statistics office showed that household final consumption expenditure (HHFCE) had grown by 1% only in the third quarter of last year (at current prices) compared to1.9% growth in the second quarter of 2010 (Clancy, 2011:7). The practical implications of a credit crunch are more expensive credit cards, higher rates for housing mortgages, decreased savings or pension funds reduced in value and perhaps even much worse, personal bankruptcies and repossessions. A cause of the credit crunch that is experienced today can be traced to the “housing bubble” in the US where house prices kept increasing due to low interest rates. An asset price bubble (residential properties) came about when house prices went up without any corresponding change in the fundamental demand. It simply means house prices increased due to speculation (Kroszner, 2005:3). Because of this sudden drop in housing prices, the wealth of most home owners had been wiped out. Structure of this paper follows the trail of effects of a credit crunch on people. It begins with different channels of credit, then how it affects jobs and employment, then on to interest rates and then followed by the implosion in savings and pensions. The last part of this portion talks on the pain of home foreclosures. The next parts of the paper discuss how an asset price bubble will start to form because once a bubble bursts, it results into a recession and a credit crunch. The last part discusses how the central bank deals with it and how people can cope with it. Because of the credit crunch, it is now harder for ordinary people to obtain a mortgage (Elliott, Teather & Treanor, 2010:1). Although interest rates are still relatively nominally low, the real cost affects prospective first-time home buyers who are charged a higher premium for housing rates due to their lack of large deposits for mortgages (Collinson, 2010:1). Conclusion The credit crunch today showed those who already owned their homes had houses being foreclosed or repossessed since the beginning of the credit crunch (House of Commons, 2009: 32). Moreover, banks had stopped providing 100% financing for mortgages across all types of home ownership such as shared ownership, shared equity and rent-to-buy schemes. A credit crunch is a vicious cycle; it leads to reduced consumer spending that causes businesses to reduce investments and in turn contributes to high unemployment because they do not hire back many people laid off earlier, causing a jobless recovery (Elsby, Jobijn & Sahin, 2010:2). Progress and Plans (Expected Table of Contents) A. Different ways of how a credit crunch impacts on individual consumers- (1st week) A.1. Jobs and Employment- (1st week) A.2. Higher interest rates for credit cards and mortgages- (1st week) A.3. Reduced savings or pensions (wiped out by the bursting of the bubble)-(2nd week) A. 4. Increasing number of home foreclosures since the credit crisis- (2nd week). B. Brief Overview of the Asset Price Bubble Phenomenon- (2nd week) C. Failure of the Free Market to Correct Asset Price Distortions- (2nd week) C. 1. Sudden Price Increases in Asset Prices due to a bubble- (3rd week) C. 2. Bursting of an Asset Price Bubble- (3rd week) C. 3. Central Bank Approaches to Mitigate its Bad Effects- (3rd week) D. How to Prepare for a Credit Crunch- (4th week) D. 1. Having enough savings to ride out a crunch- (4th week) D. 2. Become multi-skilled and prepare for a second job or career- (4th week) D. 3. Do not follow the crowd (herd mentality) when it comes to investments- (4th wk). I will try to integrate graphs and tables to show some financial or economic data in my next report. However, I expect to encounter some difficulty because it has to very selective in some ways; only relevant data sets will have to be included that shows how the credit crunch has affected people these days. I also plan to look for other material sources to be cited within the next report that are authoritative and reliable also. I believe that graphs and tables are able to convey critical financial information in a much more direct, succinct and accurate way. References Budworth, D. (2010) The Credit Crunch Explained. [on-line]. The Sunday Times, 4 Jan. Available at: http://www.timesonline.co.uk/tol/money/reader_guides/article4530072.ece [Accessed 10 Feb. 2011]. Clancy, G. (2011). Consumer Trends: Quarter 3 2010. Office for National Statistics (ONS). [on-line]. Available at: http://www.statistics.gov.uk/STATBASE/Product.asp?vlnk=242 [Accessed 10 Feb. 2011]. Collinson, P. (2010) High cost of borrowing may be the legacy of the credit crunch. The Observer, 9 Aug. Available at: http://www.guardian.co.uk/money/2010/aug/09/high-cost-borrowing-legacy-credit-crunch?intcmp=239 [Accessed 10 Feb. 2011]. Elliott, L., Teather, D. and Treanor, J. (2010) Credit Crunch Consequences: Three years after the crisis, what’s changed? The Observer, 8 Aug. Available at: http://www.guardian.co.uk/business/2010/aug/08/credit-crunch-analysis [Accessed 11 Feb. 2011]. Elsby, M. W., Hobijn, B. and Sahin, A. The Labour Market in the Great Recession. The Brookings Papers on Economic Activity, (Spring 2010), pp. 1-48. House of Commons (2009) Communities and Local Government Committee: Housing and the Credit Crunch (Third Report of Session 2008-09). London, UK: The Stationary Office. Kroszner, R. S. (2005) “Asset Price Bubbles, Information and Public Policy.” In W. C. Hunter, ed. Asset Price Bubbles: The Implications for Monetary, Regulatory and International Policies. Cambridge, MA, USA: MIT Press, pp. 3-22. Young, L. (2011) Consumer spending, real gross domestic product rise in last quarter of 2010. All Headline News, 28 Jan. Available at: http://www.allheadlinenews.com/briefs/articles/90032532?Consumer%20spending%2C%20real%20gross%20domestic%20product%20rise%20in%20last%20quarter%20of%202010 [Accessed 11 Feb. 2011]. Read More