This report will examine the affects of the global financial crisis, which was a result of the collapse of the sub-prime mortgage market in the United States, on the UK economy. First of all, it will look at the background of the global financial crisis. Secondly, this paper will analyses why the UK economy has been influenced by the global financial crisis, what effects of the financial crisis on the United Kingdom have been, especially labour market. Lastly, brief conclusions will be drawn and a number of recommendations will be made.
Financial crisis is a sharp deterioration of a group of financial indicators, such as business and financial institutions bankruptcy rates, short-term interest rates and asset prices. There is no precise definition of financial crisis. Jickling (2008) gave a common view that ‘disruptions in financial markets rise to the level of a crisis when the flow of credit to households and businesses is constrained and the real economy of goods and services is adversely affected.’
When it comes to the global financial crisis of 2007-2008, it is well known that the main cause of the credit crunch of 2007, the whole global financial structure crashing down in 2008 and the recession of 2009 was the US sub-prime mortgage crisis. Sub-prime loans involved making high-risk loans to applicants with poor or non-existent credit histories. Sub-prime loans’ origin was the Community Reinvestment Act (CRA), which President Jimmy Carter signed on 13 October 1977 (Booth, 2009, p. 53). It imposed an obligation on banks to provide mortgages to everyone and listed a number of criteria and a number of compliance measures, so that low-income families would not be simply refused by banks (Gamble, 2009, p. 21). It was seen as a way of promotion of home ownership for minorities. In 1992 the Federal Reserve Bank of Boston advised lenders that a mortgage applicant’s lack of credit history should not be seen as a negative factor in assessing them for a loan (Booth, 2009, p. 53). These policies led banks to making loans to people who could not afford them. Therefore, when interest rates rose sharply after 2004, borrowers defaulted, especially homeowners with sub-prime loans, and banks discovered that prices of housing they had bought were less than before. More and more banks faced bankruptcy and the whole global financial structure crashed down.
The United Kingdom, as well as many advanced economies, is experiencing a severe economic downturn because of the global financial crisis of 2007-2008. The main reason is that the bursting of the housing bubble. Similarly, the UK economy has been suffering from the sub-prime mortgage crisis. First of all, compared to traditional banks, most of banks take a very aggressive strategy and run a different business model. For example, three-quarters of Northern Rock’s funding comes from the wholesale inter-bank markets and it was lending it out in the form of mortgages (Brummer, 2008, p.13). It is obvious that Northern Rock relied heavily on the liquidity of the wholesale markets. On the contrary, Lloyds TSB is a symbol of conventional banks. 75 per cent of Lloyds TSB’s funding comes from retail and business customer deposit and it only borrows 25 per cent of its money from the wholesale markets (Brummer, 2008, p.13). That is why some banks were in deep trouble when the source of funding was disrupted. Secondly, in order to pursue profits, many banks lend a large amount of money to people who are less likely to afford the loan, especially when interest rates go up. Customers, especially young people, could apply for a mortgage loan easily before the global financial crisis of 2007-2008. They could borrow 125 per cent of the value of the property and mortgages loans were worked out on the basis of five times income or more than became commonplace in 2006 (Brummer, 2008). It is no doubt that it...