A new report points to a likely cause of the 2008 to 2009 crisis and that is the excessive lending of banks. According to the report, excessive lending opened the doors for increased risks of defaults. The failure of banks to collect on loans has then resulted to banks refusing to grant new loans. Hence, the overall flow of the economy got seriously affected.
But why did banks exceed in the approval of lending applications? Were there just too many borrowers and did that happen only in the pre-recession times? Apparently not. Economists believe that the widespread inequality of income has killed the capitalist systems.
The Lending Cycle
When the economy started failing in 2008 to 2009, the Federal Reserve lowered its interest rates in order to allow banks to lend more money. Depositors also participated, with or without them knowing it, because it is their money in the banks that were used to keep the cycle going. The problem is, the Central Bank’s act of flushing money to a lot of banks all over the US has led to irresponsible lending.
Irresponsible lending is when banks advance credit even on investments that do not sound right or have no chances of succeeding. This means that the appraisers are no longer doing their jobs as meticulously as before. With the amount of money the banks have plus the number of applicants received, lending frenzy evolves to a phenomenon that was uncontrollable.
When the Federal Reserve decided to stop the lending frenzy by increasing their interest rates, banks began to feel the effects of their irresponsible ways. House prices crumbled, banks got into trouble as their assets are not left in the trail of liabilities and hence, the borrowers were pressured even more to pay up.
Re-Starting Bank Lending Becomes a Problem
After the fall of the lending frenzy, banks had to impose stricter guidelines when it comes to lending. These pushed consumers to look for other means of borrowing cash and thus came the bad credit loans from online alternatives. The banks now have stiff competition online and with the way the economy is going, it looks like the online options are winning.
So to fight back, the government has been bailing banks out. Bail outs come in the form of the central bank printing money and then putting them into the banking system. However, banks are still not getting enough loan applications and they are only collecting so much. Apparently, banks still need collateral and that worked when the housing market was still booming.
The Role of Income Inequality
But there is one other thing that’s been keeping banks from getting the successful loan transactions that they need. Studies show that the primary borrowers are those coming from middle class to average families. These are families that may be working but are not getting enough income to support their needs plus have enough still for emergency funds. The problem is, their credit scores may not be good and they may not have collateral to show as proof. Hence, they go to nontraditional lenders for bad credit loans.
Analysts believe that to truly resolve the issue on debt and not fall back to recession, the Federal Reserve or the Central Bank should not be the only institutions working. There must be considerable efforts coming from the policymakers too in amending the basic rights of employees particularly in the area of wages.