Credit card limits have begun to decrease by 10 percent and according to the Bank of England, average interest rates have increased by nearly one percent to 17.67.
So, what’s driving this sudden change? Is it the fear that the United Kingdom will feel the heat of the eminent recession in the United States?
As the heart of the financial world, England seems to be leading the globe in trends and ideas, so when they begin making massive changes, everyone will pay attention. But according to major English financial institutions, like HSBC®, Halifax®, and Co-Op®, this trend is nothing to be alarmed about because it happens all the time. There’s only been extensive press on the issue because of the troubles with inflation, unemployment, foreclosures in the housing market and other indications of trouble with the American financial industry.
The bottom line is that it’s a matter of simple economics: supply and demand. Credit cards in the past were used only in case of an emergency, and were considered a privilege to have. Because the demand at the time was so small, the general consensus among credit card companies was to persuade people to apply for credit cards using low to zero interest rates. Today, the demand has increased significantly, and financial institutions can afford to be more prudent about those they choose to extend credit to. With 3.2 million people in the UK owning at least five credit cards and 1.8 million having five or more, demand is very high for credit despite issues in the United States.
Americans are feeling in a credit crunch. Having been lured in by low interest rates and incentives, despite an 11 percent rise in the cost of energy resources in 2007, consumers are now facing interest rates over 20 percent. Although credit cards in the US are cancelled everyday, most companies will simply raise rates to try and recuperate as much money as they can before a potential default. The US recession has made people realize that they need to get a hold on their financing and that overextending credit in a volatile economy can turn to disaster when things start going a little sour. The UK movement has shown that financial institutions recognize that they've been a bit careless with their lending. With unemployment in the US increasing at an alarming rate and an eminent recession, tightening of the credit lending standards and a revaluating the risk ratio are both necessary.
However, despite all of the signs that emphasize caution with regards to credit lending, consumer spending is vital to economic stability in the US—which will reasonably affect the world’s economy. Many economies have thrived on spending in the US through the outsourcing of numerous production lines. This means that the fates of nations around the world are intertwined with the fate of the US. On an international scale, the slowed economy has already created a global impact. The Canadian government has spent $1 billion Canadian dollars to support small industrial towns that had previously received income from US trade.
Government intervention is the answer for most consumers at this point. ARM mortgages that have reached the end of their 5 or 7 year fixed rate have skyrocketed more than consumers’ yearly salary increase, leading to a record number of foreclosures. Rather than allowing the market to collapse and companies going bankrupt with massive inventories of foreclosed homes with very few buyers in the market, the Federal Reserve Bank (the Fed) has decided to cut their lending rates to financial institutions to allow them to extend better rates to consumers. With many homes continuing to be foreclosed, or put on the market in anticipation of being foreclosed, and the national unemployment rate, presently at 5.1 percent, continuing to raise, the Fed will have to continue to cut rates to keep the market from sinking further.
The Bush administration is attempting to curb this dip in the market with a $3.1 trillion spending that included tax cuts to middleclass Americans and increased spending to the Federal Housing Administration (FHA). This is only a temporary solution to a very long problem. Named the Economic Stimulus package, this small bump in income is designed to increase consumer spending, but is a financial burden to the government at this time because of the war occurring abroad—which has devastated the federal savings account. Not to mention, bankruptcy rates and “bad” debt continue to increase, resulting in financial institutions reporting losses all over the world. Some have reported such low earnings that they have turned to the government for help.
Bear Stearns® recently made news with the government loan that cost taxpayers $30 billion. Instead of taking this opportunity to allow a meager buyout from JP Morgan® —that would have a negative monetary impact on the shareholders—they have asked for a share price increase from $2 per share to $10. If things continue at this pace, Americans will undoubtedly be holding the bag. The US government simply can not continue to extend itself financially. Once they stop doling out assistance, financial institutions will have no choice but to raise interest rates to keep their books out of the red. This means that the worse of the credit crunch is yet to come.
The answer is not simple, especially given that this recession is unprecedented, so there’s no previously established way to deal with this situation. Would increasing rates and closing accounts negatively impact future customers when the market turns around, or will banks have to change the way that they determine risk to all future customers and give their current accounts a reprieve? Gone are the days of 100 percent mortgages; companies will not be able to offer lower interest rates in the long term. Expert economists predict that the recession will be shallow, but long, so adjustments need to be made by everyone and expectations of credit lending will need to be revised on all levels from financial institutions to the end consumer.
