1. Banks created too much money…
Every time a bank makes a loan, new money is created. In the run up to the financial crisis, banks created huge sums of new money by making loans. In just 7 years, they doubled the amount of money and debt in the economy.
2. …and used this money to push up house prices and speculate on financial markets
Very little of the trillion pounds that banks created between 2000-2007 went to businesses outside of the financial sector:
- Around 31% went to residential property, which pushed up house prices faster than wages.
- A further 20% went into commercial real estate (office buildings and other business property)
- Around 32% went to the financial sector, and the same financial markets that eventually imploded during the financial crisis.
- But just 8% of all the money that banks created in this time went to businesses outside the financial sector.
- A further 8% went into credit cards and personal loans.
3. Eventually the debts became unpayable
Lending large sums of money into the property market pushes up the price of houses along with the level of personal debt. Interest has to be paid on all the loans that banks make, and with the debt rising quicker than incomes, eventually some people become unable to keep up with repayments. At this point, they stop repaying their loans, and banks find themselves in danger of going bankrupt.
4. This caused a financial crisis
As the former chairman of the UK’s Financial Services Authority, Lord (Adair) Turner stated in February 2013:
financial system’s creation of private credit and money.”