Economics Weekly By Lloyds TSB

One week after the US congress passed the Troubled Assets Recovery Programme (TARP) that was supposed to be the solution to the credit crisis and just 1 day after the UK agreed to spend upwards of $500bn (SARP – Stability and Restructuring Plan) to protect its financial system and after a global coordinated cut of ½ a percentage point in official interest rates, financial markets saw the worst turmoil in decades. What is going on and why did the plans not work? The truth is no one really knows when or how this crisis is going to end, though end it will.

End of an era as credit bubble bursts

 

Too much debt led to bubbles…

One week after the US congress passed the Troubled Assets Recovery Programme (TARP) that was supposed to be the solution to the credit crisis and just 1 day after the UK agreed to spend upwards of $500bn (SARP – Stability and Restructuring Plan) to protect its financial system and after a global coordinated cut of ½ a percentage point in official interest rates, financial markets saw the worst turmoil in decades. What is going on and why did the plans not work? The truth is no one really knows when or how this crisis is going to end, though end it will. However, this is the
latest of many bubbles to have plagued the world economy in the last 10-15 years, did not just develop overnight and will therefore take time to resolve. Hence, one year since the start of the realisation that asset markets – more especially housing and
credit markets – were grossly overvalued and so was the value of the securities written on them (on which so many financial firms borrowed heavily), the crisis is intensifying rather than abating, see chart a. And this is despite the measures that have been announced to tackle it. We look at some of the main issues in this briefing.

 

…as fast global growth was accompanied by low inflation and hence low interest rates…

At the root of the current financial market problems is the huge amount of liquidity that was generated in the period of fast global economic growth from the second half of the 1990s to 2007, and the destructive effect that this had on financial markets.
Effectively, it led financial institutions in developed economies (because this was where the liquidity ended up) to take excessive risk with their balance sheets and to adopt business models that were not sustainable once this liquidity stopped expanding or asset prices fell. But in the background also lies the fact that the world economy was becoming increasingly unbalanced over this period. In crude terms, emerging markets in Asia save and the developed economies, especially in North America and the UK, consume, this is illustrated in charts b, c and d.

 

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