The damaging effects of the recession...

The ‘recession’, the ‘credit crunch’, the ‘economic crisis’ - all of these phrases have been battered around in the media since 2007. It seems everything that’s happening around us in the economy is because of this… so, what is this all about and who is it affecting the most?

A recession refers to ‘a severe shortage of money or credit’ (BBC, 2009) and it is important to address how we ended up in this situation. The UK market was experiencing a sustained period of stability, combined with low rates of inflation, interest rates and steady growth. This all seems great, doesn’t it? However it would seem these factors were all precursors of the crisis which was to follow… Shouldn’t these signs have been picked up on? After all this is not the first financial crisis to face the world, the Asian financial crisis for example. Overconfidence became an issue - this led to a period of irresponsible lending. Debt rose at the same times as huge increases in house prices, leading to house prices increasing higher than income. Subsequently lenders were seen to be offering mortgages in excess of 100% of the value of the property (Mizen, 2008).

A high level of innovation within mortgages appears to be at the root of the current crisis, making it more complex than those in the past. The growth in sub-prime mortgages in the US was a major issue. But why? What are these so called sub-prime products?

These new assets were sold to investors in the form of repackaged debt therefore enabling them to receive a higher credit rating and so being seen as relatively ‘safe’ (Mizen, 2008)! This however was definitely not the case! The value of these products was closely linked to the housing market, which at this period was experiencing great levels of growth. Problems began to come to public attention when these prices fell, sending the financial markets in to a state of panic, with the banking system not being strong enough to cope with the substantial losses which were to come!

However it is believed this current recession stems as far back as 2001, with the September 11 terrorist attacks, which prompted Alan Greenspan to cut short term interest rates in the US, and the burst of the dotcom bubble (Mizen, 2008). If this is the case how come the warning signs were ignored and public knowledge and concerns didn’t arise until late 2007. Again common precursors were seen including high levels of stability across markets, higher levels of net saving and great innovation relating to mortgage backed securities.

Century Financial were amongst the first to file for bankruptcy. Credit ratings on all subprime products were quickly downgraded from their safe AAA rating. This led to reluctance by banks to lend to one another, reducing the liquidity in markets which was so crucial. Severe loss of trust in interbank trading was brought about by fear of the scale of risk they were actually facing (Mizen 2008).

Thinking back to the collapse of Northern Rock in the UK, I remember seeing the queues of people outside on the news and finding it pretty comical – I thought people were overreacting immensely! However after learning more about the situation this week it’s brought to light how severe the situation actually was and indeed is.

Everything seemed to happen so suddenly just one this after another! A catastrophic crash in everything which seemed at the time to be perfectly fine! Now it seems ridiculous than no one picked up on the signs... Why were banks so overconfident! Considering we’ve seen these bubbles burst before…

Even recently the rippling/domino effect of the recession is still affecting the business world. Walking down Northumberland Street a growing number of empty stores can be seen as the consumer recession persists (FT, 2012)… Many companies are still having to scale down operations or completely close in wake of the so called ‘retail recession’, La Senza has become victim to this having to close around half of its stores (BBC, 2012). 

Peacocks was another store to face administration, having been bought out by Edinburgh Woollen Mill some jobs have been saved however significant redundancies have been made (BBC, 2012) with the number of stores being halved (FT,2012) and signs like the one to the right seem to be present on high streets across the country...

Clearly there have been some exceptions with companies including WH Smith, Associated British Foods (ABF) and Dunelm riding high. On the high street Primark is a clear winner, owned by ABF, its share price has increased 18% in the past year.  

It has been claimed innovation in the sector may be the way forward – Richard Hyman, strategic retail advisor to Deloitte expressed that during the noughties the consumer meant retailers “didn’t need to be very good at retailing” to be successful.  He said it was “all about managing the expansion programme and the supply chain, as opposed to anything imaginative and inspirational.”

He stated:

“The middle ground is challenged. Consumers are used to a constant diet of sales and promotions. Many retailers are no longer masters of their destiny, but have to follow what the shop next door does” (FT, 2012).

Sources used:

Mizen, P. (2008) The Credit Crunch of 2007-2008: A Discussion of the Background, Market Reactions, and Policy Responses. Federal Reserve Bank of St. Louis Review. Available at: http://web-docs.stern.nyu.edu/salomon/docs/crisis/FRBStLouisMizen.pdf (Accessed: 13 March 2010)

http://www.ft.com/cms/s/0/3d3c6ef6-5e4e-11e1-85f6-00144feabdc0.html#axzz1pC6pNkdM