In 2007, the global banking crisis began after incredibly irresponsible loans in the American real estate market. The lending practice was termed “subprime” loans, which means that banks lent to “subprime” borrowers, that is, those who probably did not have the income to pay off their mortgages. This was good for a while, especially for bank executives who received huge bonuses for irresponsible risk.
But once house prices stopped rising, negative capital levels rose sharply, causing a recovery and huge losses for banks. Even banks that were not actively involved in this type of loan felt the effect, as the largest banks in the world were highly dependent on each other for financing.
The crisis quickly spread to the world. While banks have raised billions of pounds in taxpayer money, they remain reluctant to lend to both mortgage seekers and businesses. What for? Because they were more fearful of risk and had to build up their reserves to protect themselves from future liquidity problems.
The government said it would reform the banks and force them to lend again, but three years later, little has been done. By December 2008, house prices fell by a record 16.2% compared to December 2007.
The fall in home prices was not only due to the fact that fewer people were able to obtain the mortgages they need to buy a home, but also because home prices are closely tied to the general economy for several reasons.
Interest rates are an important factor in determining home prices. The Bank of England sets the base rate that banks usually follow when lending to individuals and legal entities. And when the economy crashes, as it did when the banking crisis hit, the Bank of England is likely to lower its base rate to stimulate borrowing (since it’s cheaper) and discourage saving (since the rate of profit is secondary), with the main goal of increasing consumption and the real estate market.
This happened in December 2007, but note the date, as mentioned above, house prices fell sharply from that point. There were two main reasons for the ineffectiveness of the Bank of England shares. Firstly, the Bank of England responded too late, and secondly, as mentioned above, banks are dependent on each other for funds.
They have their own interest rate at which they lend to each other, called LIBOR. Unfortunately, because banks were wary of mutual loans, the LIBOR rate remained high, so any money they borrowed for mortgage loans cost them more in the first place.
Moreover, the relationship between income and Waffle House prices is another factor. House prices have gone very high compared to the average income and are still considered too high. The fewer people can buy real estate, the lower the demand, which means that home prices must be adjusted and fall.