Macro and Micro Factors Leading to Credit Crunch

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This paper is about the ongoing economic meltdown caused by the credit crunch in the US and UK economies since the winter of 2007. The paper explains what the credit crunch is all about as well as what caused the credit crunch. It has been said that the post WWII super debt cycle is coming to an end and it has been further pointed out that changes in the macro and micro environment ever since the 1980’s when the Reagan administration in the US and the Thatcher administration in the UK adopted what can be called “supply side” economics, the cornerstone of which was reducing the tax rates for corporates with a view to encouraging them to produce more.

The contention of this author is that the credit crunch of 2008 represents stresses that have been building up ever since the 1980’s and these are the result of the brand of economics and policies followed in the US and UK from that time onwards. As I point out in subsequent sections, the changes in the banking sector because of macro and micro factors led to the financial system being unstable. The fact that there were several crises, notably the Northern Rock, the Savings and Loans scandal along with the periodic instability that led to the Asian financial crisis of 1997 did not make it easy for the regulators as well.

The paper looks at the environmental factors that led to the current crisis as well as the changes in the banking sector regulations that facilitated excessive speculation and risk taking. As the authors of the book that is cited in this paper point out, it was a colossal failure by the “Olympians” and particularly bad considering that the investors and the public had reposed so much faith in them. In the concluding section, I take a look at what can be done to prevent a recurrence of these kinds of crises.

Changes in the Macro Environment

As explained in the introduction, the banking industry went through a period of rapid change ever since the 1980’s with the election of Ronald Reagan in the US and Margaret Thatcher in the UK. These administrations took the first tentative steps towards liberalizing the financial sectors in their respective countries. The accent of both these administrations was providing people access to cheaper credit and a drive towards making credit plenty and bountiful for the investors and the public alike.

Accompanying the credit liberalizing regime was a move to deregulate the banking sector that witnessed sweeping changes in the way in which banks and financial institutions conducted their business. An offshoot of this was the every increasing complexity of the financial instruments that these players started dabbling in. The saying among the commentators is that there are very few people who understand what the exotic instruments are all about whereas the volumes of the financial instruments run into Trillions of dollars.

The financial sector’s malpractice from the mid- 1980s through 2008 was more corrosive than the earlier negligence. This is because in many ways the politics, permissive ideology, and interest-group lobbying during the Multi-bubble years was obliged to be deliberate and uprooting. This involved the capture and disarming of existing agencies existing agencies and boards, as well as the gutting or repeal of existing statutory protections (Philips, 2009).

Hence what we have is a culture of permissiveness that encouraged borrowing and spending and living beyond one’s means. This was further accentuated by the liberal policies followed by the Thatcher government in the UK and the Reagan administration in the US by liberalising access to credit and making credit cheaper for households to borrow and spend. The cultural trends of the era also pointed to an explosion of consumer spending with the corporates recognising the effect of sublime ads targeted at the consumer experience in boosting sales. An ad for a product went beyond that and instead become a vehicle for promoting a way of living and brands became what were called “lifestyle statements”.

One of the factors that led to financial conglomerates and financial hyper-marts was the repeal of the Glass-Steagall act in the late 1990’s that paved the way for investments banks to merge with commercial banks and vice versa. This act that was enacted in the 1930’s in response to the Great Depression essentially divided the functions of investment banking and commercial banking as separate spheres and something that cannot be done together. However, in response to the intense lobbying by Wall Street majors, the Clinton administration repealed the act paving for the mergers between Citigroup- Salmon Smith Barney and other majors.

Changes in the Micro Environment

The banking and financial sector started to experiment with leverage and trading at ratios of 20:1 to the underlying asset. What leveraging means is that for every $1 of “real assets”, the bankers “create” virtual assets in the form of derivates up to twenty times the value of the assets and in the process create a bubble of extraordinary proportions; Once the underlying assets started to depreciate in value, the mountain of securities and derivatives that were built on top of them became “toxic”.

As the book explains, “They have used the US and the UK as laboratories for testing their conviction that economic paradise is attainable if all semblances of regulation are thrown out, all public services (no matter how essential to social well-being) privatised and the markets are left free to work their magic. So lofty are these gods that they are able to look dispassionately on as job security is destroyed, affordable homes disappear and public services wither away (but not the vast army of unproductive bureaucrats needed to run them).

Nor do they seem to care that much of the Anglo-American “real economy” has been destroyed; that the illusion of prosperity has been maintained only by a huge credit bubble that has loaded corporations and homes with unsustainable levels of debt; that the bedrock middle classes in both countries are being milked of tax pounds and dollars” (Elliot and Atkinson, 2008).

The power of the buyers in making large scale investments based on credit was one of the noteworthy features of the banking environment in the 1980’s up to the credit crisis of 2008. Added to this was the proliferation of substitutes in the market that was a long cry from the days of “You can have any colour as long it is black”. Hence, with the ready availability of credit by multiple agencies competing with each other was another feature of the bubble years.

The other noteworthy feature of the credit bubble or the “post WWII super debt cycle” was the willingness of the suppliers to offer credit cheaply and make the government pass policy measures that encouraged their lending practices. Such was the power of this cartel that the governments in UK and US readily acquiesced to their demands to remove restrictions on availability of easy credit.

The point also needs to be made is that the interconnected and interdependent financial system has meant that the toxic assets are spread so far and wide that it is impossible for anyone to know where they are and in what form they are. This makes the issue of locating and fixing the problem that much more difficult and cumbersome. The lenders never really bothered with CSR or Corporate Social Responsibility practices and instead went all out to ignore warnings that the bubble might burst.

The below chart shows Porter’s five models applied to the Banking industry as it pertains to the 80’s and 2008.

Banking Industry

Causes of the Credit Crunch

The credit crunch can be blamed on a combination of factors that include bad regulation, excessive speculation and a tendency towards risk taking that went beyond the acceptable levels. This tendencies were building up throughout the period starting in the 1980’s and reached their apogee in 2007 when the bubble burst with the fall in the housing market and consequent contraction of the economy. What exacerbated the situation was the spike in Oil prices in 2008 which meant that people had lesser money to spare for repaying their mortgages as the oil price increase pinched the wallets of the consumers (Rubin, 2009).

Atkinson and Elliott point out: The modern era has been characterised by slower growth in average real incomes, higher levels of debt to maintain living standards, greater job insecurity and financial crises that have become more frequent and more far reaching. The only class that has benefited unambiguously from this new world order is that of the gods of greed (Elliot and Atkinson, 2008). To explain this point further, what has essentially happened is that there was excessive speculation that came from availability of easy credit and lower interest rates that essentially fuelled the bubble. The policy of maintaining interest rates close to zero made credit and money available in plenty.

By itself, maintaining interest rates at low levels is not necessarily a bad thing as it encourages growth and investment in all sectors of the economy. However, as Kevin Philips puts it in his book Bad Money, “As the contribution of the financial sector to the overall GDP of the US increased and with not much real economic activity, what has essentially happened is that the US economy increasingly was sustained by speculation and over borrowing” (Kevin Philips, 2008)


In the previous sections, we looked at the ways in which the current economic crisis has been caused due to the changing financial environment since the 1980’s. As is apparent from the discussion, the deregulation, and repeal of the Glass Steagall act and the conscious policy of the Federal Reserve in ensuring liquidity have contributed to the current economic meltdown.

As the website for the book puts it, “The Gods that Failed argues that we need a new system: instead of an increasingly risk-prone, privatised, profit-driven economic model overseen by a largely unaccountable and speculation-obsessed elite, we need an economy that is run and regulated in the interests of ordinary people” (Elliot , 2009). Hence, what is needed is more accountability and oversight on the part of the regulators as well as the financial institutions. While this seems to be the ideal course of action that should be taken in order not to have a repeat of the financial crisis again, the current course of action does not indicate that this is happening.

As Arianna Huffington puts it, “The window for reform is closing. If we don’t do it soon, we may not have this opportunity for a long while. And I’m not just talking about health reform. It is just as true of the reforms of the financial system that we were repeatedly promised months ago” (Huffington Post, 2009). Hence, there is an urgent need to reform the financial sector and ensure that the right steps are taken to get the sector contributing in a positive way.

In conclusion, what is needed to be done is to overhaul the financial sector with a view to preventing future crises and ensuring that the “gods” do not fail us again. Relying excessively on the bankers and the financial speculators to give us higher rates of return is not going to work anymore. Unless there is real economic activity and manufacturing competitiveness is restored, the US economy would be prone to the instability that has become the hallmark since the 1980’s and subject to the vagaries of the stock market.

List of References

Elliott, L & Atkinson D 2008. The Gods that failed. Bodley Head: London.

Huffington, Arianna 2009. Remember the whole thing about fixing our financial system. Huffington Post Website.

Philips, Kevin 2008. Bad Money. Simon and Schuster: London.

Philips, Kevin 2009. After the fall: The inexcusable failure of American Finance. Simon and Schuster: London.

Rubin, Jeff 2009. Why your world is about to get smaller. Viking: New York.

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BusinessEssay. "Macro and Micro Factors Leading to Credit Crunch." January 10, 2023.