Thursday, October 25, 2007

Forecasts of More Financial Shocks

The Bank of England yesterday published a report, in which it suggested that there is still a real threat of a future financial crisis. This crisis could be like the recent run on the Northern Rock building society, and potentially even worse.

The Bank of England pointed to several factors that could potentially cause financial volatility in the near future:

  • Financial institutions are already relaxing lending practices, going back to offering risky loans.
  • Confidence has returned too quickly causing over confidence in lending.
  • Potential of house price falls, - which would reduce consumer confidence and make remortgaging more difficult.
  • Potential volatility of commercial property and buy to let sector. A fall in house prices would be magnified in the commercial property sector and amongst buy to let investors. This is because any uncertainty tends to hit these sectors more than others.
  • Weakness of the business model 'originate and redistribute' - This refers to the practise of lending money to consumers and then raising the money by selling the debt onwards (rather than financing the lending through attracting savings) This model is risky because it relies on the well being of companies who are willing to buy debt bundles. - This is what knocked out Northern Rock.
  • Continued weakness in US Sub prime markets. The fall out from the US sub prime mortgage sector is still occurring. More defaults are predicted as interest rate increases continue to bite.
  • Large losses by big financial corporations. Related to the fall out from the sub prime mortgage industry is the fact that many banks will have to write off bad debt. This negatively affects their liquidity and ability to lend.
  • Despite the relatively benign economic conditions (low inflation and stable growth) there are many underlying problems in the economy. This issues have often been neglected as people feel confident in the long period of economic expansion.
  • Threat of recession in America - this would reduce global growth and adversely impact on stock markets around the world.
  • Record debt levels in the UK
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