The UK has an open economy with 60% of its GDP being generated from imports and exports. It is also the most important global economy after the United States in terms of flows of international direct investment. The era between 2000-2007 was a golden time of increased growth, low unemployment and low inflation. The central banks all over the world did a good job in keeping the inflation under control and at the same time stabilizing the economy. Although, on the outside it all seemed perfect, there were many problems that were being created underneath by the financial sector that eventually led to the recession.The reason behind the housing bubble was the non-regulation of the subprime mortgages. The United States’ mortgage industry’s bad practices of lending loans to subprime buyers had fueled the housing market substantially, reaching up to 25% change in the first quarter of 2004.
Source: Nationwide Building Society
Also, the interest rates had been reduced by governments to stimulate economic growth which made mortgages cheaper. Many countries around the world saw a sharp increase in housing prices, more rapid than wages and inflation. This was caused by growing confidence and bank lending. Banks were making risky loans. Many homeowners obtained loans that they would not be able to pay back due to their limited income and the savings rate falling considerably.
Eventually these loans were bundled, repacked, and sold to banks around the world who bought these mortgage bundles (CDOs) and were also exposed to potential US crisis. When the bubble burst in 2006, the prices of houses began to decline and the number of mortgage defaults increased. By the time banks came to the the re...
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...ailability of loans hurt the housing market, causing prices to drop. Many of the borrowers who had taken large sums of money to speculate in the markets had to repay their loans so they started selling their properties, which caused a further downward slump and the bubble burst. The economy started to shrink due to unavailability of funds, and the newly created money that caused the boom started to disappear from the economy. Many businesses and individuals who were not involved in the creating of the financial crisis suffered as a result.
According to Bank of England.
“Just as taking out a new loan creates money, the repayment of bank loans destroys money… Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy.” (Money Creation in the Modern Economy, Bank of England p3-4)
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